UK economy forecast.

Barrell, Ray ; Kirby, Simon ; Riley, Rebecca 等

The production of this forecast is supported by the Institute's Corporate Members: Abbey plc, Bank of England, Barclays Bank plc, Ernst and Young LLP, Marks and Spencer plc, The National Grid Company plc, Nomura Research Institute Europe Ltd, Rio Tinto plc, Unilever plc and Watson Wyatt LLP.

Introduction

Following a period of weakness, economic growth has been sustained for three quarters only a little below trend and appears to be gaining momentum (figure 1). We expect to see a further acceleration in growth, resulting in growth per annum of 2 1/2 per cent this year and 2 3/4 per cent per annum in 2007 and 2008. Robust growth ahead is supported by the strength of external demand and small improvements in UK competitiveness. Demand is also supported by sharp rises in equity prices over the recent past. On the supply side, strong labour force growth is central to the near-term outlook.

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The public sector continues to contribute to the short-term strength of the economy and public sector borrowing continues to hover around 3 per cent of GDP. This prop to the economy must eventually fall away if the Government's fiscal rules are to be met. In our forecast we assume, much as in the Budget, that the size of government spending is reduced in the period covered by the next Spending Review. If this does not happen, the additional spending will have to be paid for via an increase in the tax burden.

We expect the fiscal imbalances to be resolved in the medium term. We also anticipate a gradual improvement in the trade balance and current account and a rise in the household sector saving ratio. Thus, over the medium term our forecast implies that a number of imbalances in the economy are gradually redressed. As discussed in Hall and Henry on pages 120-7 of this Review, it is quite possible that these imbalances share the common cause of a relatively loose (structural) budget position.

Inflationary pressure appears a little stronger than at the time of our last forecast. With interest rates set in line with current market expectations our forecast shows inflation rising a little above the central target of 2 per cent this year and next before returning back to target in 2008 (figure 3). It is still the case that the effect of sharp rises in oil and gas prices last year does not appear to have fed through very strongly to domestic consumer prices in the UK economy, and we have noted in the past the role of expectations and the credibility of the inflation target in helping to achieve this. In the past three months we have seen a notable upward shift in inflation expectations, raising the possibility of stronger feed-through of these factors to the target measure of inflation. Inflation further ahead is supported by accelerating growth, which closes the output gap by the second half of next year.

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The profile for inflation is also affected by the depreciation in sterling observed over the past year. Since the second quarter of 2005 the sterling effective rate of exchange has fallen by 4 per cent. This is likely to reflect narrowing interest rate differentials between the UK and elsewhere, as monetary policy has been tightened abroad. In the past year the difference between UK and OECD 3-month interbank rates narrowed by 1 percentage point.

A separate concern affecting the outlook for sterling is whether or not the current account position is sustainable. This depends very much on market perceptions. Since 1997 the trade balance has deteriorated from a position of balance to a deficit of almost 4 per cent of GDP at the end of last year (figure 4). The current account has deteriorated by less as income flows from assets held abroad by UK residents have generally been rising faster than income flows generated by foreign owned assets in the UK, although this has not been the case in the past half year. From an economic point of view there is nothing inherently wrong with a current account deficit of 2 1/2 per cent of GDP or even the 3 1/2 per cent we observed at the end of 2005. It simply implies that we accumulate external debt. With nominal GDP growth at approximately 5 per cent per annum, a 3 per cent current account deficit should imply that net external assets stabilise at -60 per cent of GDP. Indeed, the net asset position of the UK has been on a downward trend since the mid-1980s (figure 5), and the current account has generally been in deficit over that period. The net asset position has fallen quite sharply since 2003. If the trade balance and current account continue to trend downwards over time it must eventually become clear that the economy is on an unsustainable path. We expect the exchange rate to remain stable for the rest of this year and then to move in line with interest differentials derived from yield curves.

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Were the market to perceive that the current account was unsustainable, leading to a depreciation of sterling, this would have a profoundly different effect on inflation from a similar depreciation that resulted from rising interest rates elsewhere. We discuss this in Box A. In our forecast the current account position stabilises at around 3 per cent of GDP over the next few years, as the trade balance improves. We note the potential for a further fall in the exchange rate, as a consequence of a further worsening of the current account position, as an upside risk to the inflation forecast.

Box A. The impacts of an exchange rate decline on the UK economy

Between our January and April forecasts the UK exchange rate weakened.
At the same time the external balances have deteriorated to a position
not seen since 1990. However, these factors are not necessarily
linked, as there are many reasons why the exchange rate may fall.
Long-term interest rates have risen since our last forecast,
especially in the US (by 0.5 percentage point) and the Euro Area (by
0.4 percentage point), and this can be taken as an indication of an
anticipated or actual monetary tightening.

If the exchange rate falls because others adopt a righter monetary
stance, then the impacts on the UK economy are different from those
that follow from either a monetary loosening in the UK or a rise in
the risk premium on UK assets. A monetary tightening elsewhere changes
nothing real in the long run, and hence the UK real exchange rate must
end up at the same place as it would have done. As inflation will fall
elsewhere, this can be achieved either by a lower UK nominal exchange
rate or by lower inflation in the UK. If markets believe that the UK
will continue to target inflation successfully the exchange rate will
fall, much as it has, with little consequence for the UK economy.

We have undertaken two simulations on our model of the UK to
illustrate the differences. In both we assume that the exchange rate
is determined by expectations of future interest rates, adjusted for
relative risk premia. In the first simulation, we tighten monetary
policy in the US and the Euro Area by enough to raise long rates
relative to the UK by around the amounts we have seen in the past 3
months. This tightening induces a 2.4 per cent fall in the UK
effective exchange rate. As illustrated in figure A1, the fall in the
exchange rate (of 2.4 per cent) causes inflation to rise in the first
year by almost 0.2 percentage points, and output increases marginally
as the real exchange rate has declined. However, as inflation falls
elsewhere the real exchange rate returns to base. The effects of the
decline in the exchange rate quickly pass away, with output and
inflation returning to baseline within four years. The monetary policy
feedback in our model induces a rise in the interest rate which is
about 25 per cent bigger than the increase in inflation, and hence
interest rates return quickly to baseline.

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We compare this scenario to a rise in the risk premium on UK assets of
a size sufficient to induce the same fall in the exchange rate. A rise
in the risk premium on UK assets induced by a worsening current
account raises the required real rate of return on UK assets
permanently, lowering equilibrium output in the long run. However, in
the short term the effects are much closer to those of a traditional
'devaluation' as the exchange rate fall is not offset by a fall in
inflation outside the UK. Output increases for three years as the real
exchange rate falls, but then slowly falls back to its new
equilibrium. Inflation is notably higher for several years, with the
largest impact coming in the first year. The monetary feedback rule we
use has interest rates rising by about 0.3 percentage points for the
four-year period, and inflation slowly subsides. A larger rise would
of course reduce the inflationary impact of the shock.

In the first year after any exchange rate fall we might expect to see
output growth strengthen in the UK, and inflation to rise. However,
what happens after the first year depends upon the reason for the fall
in the exchange rate, as does the appropriate response by the Bank. A
rise in the risk premium would require much more response than a
monetary tightening elsewhere. We assume in our forecast that the
recent change in the exchange rate reflects a strengthening of other
currencies because of a change in their perceived monetary stance.
Hence we expect the recent fall in sterling to have little impact on
UK inflation and to require little response by the Bank.

There are other risks to the outlook. At the time of writing oil prices are temporarily higher than the average level we assume for the second quarter, inflated by increased geopolitical uncertainty. If oil prices remain at recent levels of over $70 a barrel, we would expect to see some inflationary consequence and some depressing effect on GDP growth. As discussed in our October Review, our model simulations suggest that a permanent $10 rise in the price of oil could add up to 1/2 percentage point to inflation and depress GDP growth by up to 0.2 percentage point for several years.

Based on past forecast errors, the probability that inflation rises above the 3 per cent upper band of the target range in the next two years is less than one in five. The chance that GDP growth next year is at least as strong as the Chancellor expects is approximately two in five.

Interest rates, exchange rates and prices

The time since our last forecast has been characterised by an upward shift in expectations of future interest rates in the UK and elsewhere. In the UK, the shift in the yield curve implies that by the start of next year interest rates are now expected to be approximately 1/3 percentage point higher than was expected in January, although the shift in yields on commercial bank liabilities is a little less than the shift in yields on government liabilities illustrated in figure 6. Yields on 10-year government bonds have also risen since our last forecast, from 4.1 per cent in January to 4.4 per cent in April. As we have noted since the autumn of last year, there appeared to be little room for the interest rate cuts that markets were expecting and long-term interest rates seemed inexplicably low. We are more comfortable with the present path for interest rates implied by the yield curve.

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The change in interest rate expectations reflects to some extent an increase in expectations of future inflation. Differences in changes in bond yields and index linked bond yields indicate that inflation expectations have risen by 0.2 percentage points a year over the next three years in the indexed bond market. In the same market there has also been an increase in expectations of real interest rates of around 0.2 percentage point by the end of 2008. This should have a small dampening effect on inflation and output.

The stronger increase in short-term inflation expectations implied by the findings of the Bank of England's survey of public attitudes to inflation is of more concern to the immediate forecast than are changes in the indexed market. The survey shows an increase in median inflation expectations for the coming year of 0.4 percentage point in the three months to February. So far these do not appear to have fed through to wage demands, although the evidence is mixed. Data on pay settlements to March suggest wage pressure is currently weak, but average earnings including bonuses have risen sharply in the latest data. As we discuss below these may be affected by short-term factors. Pay settlements data for the next few months may be more telling. One of the factors helping to contain wage pressure is the strong increase in labour supply observed in the past couple of years, partly in consequence of strong migration into the UK. This should have a dampening effect on wage and price inflation and should raise unemployment in the near term, as we currently observe. The potential magnitudes of these effects are discussed in Kirby and Riley (2006).

Separate from changes in inflation expectations, there is also some sign that sharp rises in unit costs last year and further increases in input prices in the first quarter of this year are feeding through to output prices. Inflation in manufacturing output prices excluding food, beverages, tobacco and petroleum had been declining throughout most of last year. In November that trend was reversed.

The recent fall in the exchange rate and sharp increases in gas prices also add upward pressure to inflation this year and next. Our forecast shows strong inflation in import and export prices this year. Import prices rose sharply in 2005 because of large increases in the price of oil. These are also partly responsible for strong import price inflation this year. The weakening of the exchange rate also contributes to this picture. In 2007 and 2008 we expect a softening in import price inflation, as the effects of oil price rises and the depreciation of sterling dissipate. Export price inflation is artificially weak in 2005, and artificially inflated this year by the treatment in the National Accounts of estimated insurance payouts by Lloyd's of London for the damage caused by Hurricane Katrina. These are deducted from the value of UK exports through the export deflator. In consequence, we see a small improvement in the terms of trade and a worsening in export competitiveness this year, despite the depreciation of sterling.

Equity prices have been rising sharply since the beginning of 2003. At the turn of the year equity price inflation was particularly strong. Measured on average over the quarter, we expect the FT All-share index to exceed its peak of the third quarter of 2000 in the second half of this year. This is sooner than we expected at the time of our last forecast. Our forecast has equity prices growing at the same rate as nominal GDP in the G7 economies, adjusted for exchange rate movements. Due to strong growth at the start of this year the annual average level of the FT All-share index is almost 20 per cent higher in 2006 than in 2005. Equity price movements of this magnitude have an effect on GDP. In the model that underlies the forecast this occurs via their effects on wealth and hence consumer spending. Based on model simulations (see Al-Eyd et al., 2006), it appears that a 20 per cent rise in UK equity prices maintained for two years has a relatively small effect on GDP. But, if the rise in equity prices is global, as has been the case, the effects on GDP are significantly stronger due to trade spillovers. A 20 per cent rise in equity prices worldwide maintained for two years raises UK GDP growth by on average 0.1 percentage point for three years.

Demand

The forecast shows some pick-up in domestic demand growth this year following the sharp deceleration to 1.9 per cent per annum in 2005 from 3.8 per cent in 2004. Weak demand growth last year was led by a slowdown in consumer spending and gross fixed capital formation. Our forecast shows some improvement to growth in these components of demand this year. The pick-up in growth in consumer spending is partly a result of robust spending growth at the end of last year and strong gains in the value of equities. The forecast for household expenditure and investment is discussed in more detail in subsequent sections.

In terms of contributions to GDP growth the slowdown in gross fixed capital formation in 2005 was as much a result of weakness in inventory accumulation as of a deceleration in investment growth. Stockbuilding is very erratic, but it can also be a reasonable indicator of the cyclical position. Figure 7 shows the share of stockbuilding in GDP alongside growth per annum in GDP (less the stockbuilding component). The simple correlation coefficient between the two over the period shown is 0.86. With a correlation coefficient of 0.60 the share of stockbuilding in GDP is a less satisfactory indicator of GDP growth for the following year.

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Our forecast of general government consumption expenditure is based on the projections as set out in table B10 of Budget 2006. From an accounting perspective these imply a contribution to overall GDP growth for the next three years of 1/2 percentage point, similar to 2004 and 2005. We note the large revisions to the data for government expenditure volumes last year between consecutive National Accounts releases. Since December nominal spending volumes were revised down for the first three quarters of the year, and real spending volumes were revised up. The result is that where previously we expected to see growth in government spending volumes of 1 per cent adding 0.2 percentage points to GDP last year, the current vintage of data suggest an increase of 3 per cent in government spending volumes adding 0.6 percentage points to GDP. Since the outturn for GDP growth last year was much as we expected in January, the corollary is that demand outside the public sector was correspondingly weaker.

Net trade improved markedly last year and we expect to see further improvements in 2007 and 2008, with net trade making a positive contribution to GDP growth for the first time since 1995. This represents a departure from the experience of earlier years of this decade. Exports were depressed by weak world trade growth over the period 2001-3, but have also been depressed by losses in competitiveness. As illustrated in figure 8, the rate of decline in world trade share gathered pace following the secular loss in competitiveness since 1997. In 2004 this was particularly noticeable, when world trade growth (from a UK perspective) accelerated to 9.4 per cent per annum, but UK exports rose by only 4.6 per cent held back by a marked deterioration in competitiveness. Export growth strengthened in 2005 and this can be attributed to gains in competitiveness and the continued strength of demand in the UK's main export markets. Our forecast shows robust export growth this year and to 2008. This is based on the expectation that growth in world trade remains relatively strong, and that with competitiveness at around current levels, we should see only a marginal loss of trade share. Exports of goods expanded more rapidly than exports of services in 2005 for the first time since 2000, and may reflect the strength of demand for investment goods outside the UK.

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The deterioration in the trade balance in recent years is in part a consequence of strong demand for imports. Import demand is determined amongst other factors by total final expenditure demand, which has been growing strongly, especially in 2004. Nevertheless, import growth has been stronger than we would expect on the basis of its determinants, which include the ratio of import prices to domestic prices and the level of import duties (the equation is described in full in Barrell et al., 2006). It is possible that factors such as the removal of quotas that have followed from the Agreement on Textiles and Clothing, formerly the Multi-Fibre Agreement, which are not captured in the equation, have contributed to strong growth in import demand. We note that the share of clothing and footwear in imports of non-oil goods has risen from 4 1/2 per cent in 1996 to 5 1/2 per cent in 2005. In constructing the forecast we have assumed that the recent rise in imports, over and above that which can be explained by our model, is partly maintained, but not of the magnitude observed recently. In combination with a moderation to growth in total final expenditure volumes and an increase in import prices relative to domestic prices this leads to more subdued growth in the demand for imports in 2007 and 2008.

These developments result in a forecast of an improvement in the trade balance measured as a share of GDP. The trade balance has deteriorated quite significantly since 1997, when sterling appreciated sharply. Although the trade deficit is exacerbated in the third quarter of last year by one-off factors such as the estimated payment of insurance claims by Lloyd's of London, the trade deficit and the current account deficit do not look significantly better at the end of last year. In the forecast the current balance stabilises at around current levels.

Income and saving

The recent data for average earnings including bonuses point to a pick-up in wage inflation. Growth in the headline rate in the three months to February increased to 4.2 per cent, from 3.6 per cent in the three months to December and January. But it is possible that this is explained by shifts in the timing of bonus payments into February from surrounding months, rather than a sign of increased pay pressures. The majority of large annual bonuses are paid between December and April. Within this period companies may vary the month when bonuses are paid. This can have a significant effect on the headline rate of average earnings growth (see Freeman, 2005). Indeed, the headline rate of average earnings growth excluding bonuses is relatively stable ranging from 3.8 to 4 per cent since May 2005.

Our measure of average earnings is derived from the National Accounts and is defined as compensation per employee. This includes employers' social contributions, as well as wages and salaries. Much of the 4.5 per cent growth for 2005 was due to the increase in employers' social contributions. Examining the growth of wages and salaries per employee, we see a pattern of annualised growth throughout 2005 broadly consistent with the headline rate of average earnings growth. Data for the fourth quarter of 2005 show some weakening in quarterly growth. At the same time data on pay settlements from the IRS pay databank show a fall in the mean rate of increase in the first quarter of 2006. Part of the reason behind the moderation in average earnings growth may have been the deceleration in inflation, as measured by the Retail Prices Index, throughout 2005. The recent easing of the labour market will also have helped to contain pay pressures. Our forecast is for growth in our definition of average earnings of a little under 4 1/2 per cent per annum this year and next.

In constructing our forecast of average earnings growth we have not taken into account the recent rise in household inflation expectations. If these expectations feed through to pay rises, we might expect to see stronger average earnings growth than we have currently forecast.

As inflation returns to target we expect to see stronger growth in gross disposable income to lead to rising real disposable income growth. This does not translate into an acceleration of household consumption expenditure growth. Rather, we expect households to increase the proportion of income saved.

In the past four years the household savings ratio has remained broadly stable. This is very much due to changes in the adjustment for the change in net equity of households in pension funds. This adjustment adds contributions to less receipts from private pension funds to the income of households when calculating the savings ratio. Excluding this adjustment the savings ratio in 2005 is half that of 1998 (figure 9). It is possible that this increase in the adjustment for net equity of households held in pension funds reflects increasing contributions in light of pension funds' future liabilities. Alternatively this may reflect strong equity price inflation. Our forecasts for household incomes and consumption expenditure imply an increase in the household savings rate to around 6 1/4 per cent on average in 2008, from 5 per cent in 2005.

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Table 7 shows the balance between saving and investment in the economy as a whole. These figures for saving and investment are gross of depreciation. An excess of investment over saving is financed by means of a financial deficit, and an excess of investment over saving for the nation as a whole is represented by the current account deficit of the balance of payments. The ratio of household savings to GDP is lower than the ratio of household savings to disposable income because nominal GDP is larger than household disposable income. The savings rate for the economy as a whole declined from 14.8 per cent in 2004 to 14.2 per cent in 2005 due to a fall in the savings rate of the corporate sector. Except for 2005, the savings rate of the economy has been between 14 3/4 and 15 1/4 per cent since 1999. We expect the savings rate to rise back to around 15 per cent in 2008. The company sector is expected to retain its position as net lender to the rest of the economy, a position it has held since 2002, although, net lending by the company sector is expected to moderate somewhat, as saving as a proportion of GDP remains flat, while investment rises by around 1/4 percentage points of GDP between 2005 and 2007. The rise in national saving forecast for 2008 comes from increases in household and government savings rates. We are also forecasting an increase in gross investment as a percentage of GDP. This is from both the company sector and the general government sector, as the Government moves towards reaching its investment target. Consequently, we expect the UK to require finance from abroad of between 2 3/4 and 3 per cent in each of the next three years.

Supply conditions

Annual business investment growth in the past few years has been notably weaker than in the latter half of the 1990s. Whether the past few years constitute a period of exceptional weakness is discussed on pages 60-2 of this Review. The conclusion reached there is that, from an aggregate perspective, there is no firm evidence that growth in business investment has been particularly weak in recent years. We expect business investment growth to strengthen in 2007 and 2008, to around 3 per cent per annum from the 2 per cent seen in 2005, as capacity utilisation becomes more constrained. A small rise in the user cost of capital, due to increasing real long-term interest rates, has a dampening effect on investment. We have assumed that weak productivity growth last year proves an additional stimulus to investment in 2006, helping to increase the capital stock and the rate of productivity growth.

Since 2001 general government investment has reported annual double-digit growth, outstripping the growth in investment of the other sectors of the economy. We have based our forecast on projections set out in table B6 of Budget 2006, although our forecast is for general government investment as a whole, rather than general government non-residential investment as forecast by the Treasury. As in the case of the Treasury we expect the growth rate of investment to moderate as they near their investment target of 2.3 per cent of GDP.

The annual growth rate of investment in housing declined from 6.2 per cent in 2004 to 1.5 per cent in 2005, coinciding with the slowdown in the housing market. The growth rate for 2005 belies the fact that in each quarter of 2005 growth in dwellings investment declined. National Accounts data on housing investment include transactions costs associated with house purchases, and the recorded positive contribution to growth in housing investment in 2005 came entirely from these transfer costs associated with non-produced assets. As the housing market stabilises and economic growth rises above trend we expect to see an improvement in investment in dwellings.

Growth in manufacturing output volumes was disappointing last year. Following the recession in manufacturing that accompanied the collapse in world trade growth at the start of the decade, growth in manufacturing output recovered in 2004 to 1.7 per cent. In 2005 the manufacturing sector was once again in recession, with output in the sector declining by 1.1 per cent. Contrasting the performance of the manufacturing sector last year with that of exports, the decline in manufacturing output is all the more disappointing. Figure 10 shows annual growth in goods exports alongside annual growth in manufacturing output volumes. Historically these have moved together. Last year growth in the volume of goods exports accelerated sharply to 7.9 per cent, in stark contrast to developments in manufacturing output. The discrepancy is not explained by changes in the composition of goods exports away from manufacturing goods. Our forecast shows continued strength in export demand and correspondingly a recovery to growth in manufacturing output volumes this year and next.

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Whole economy output per hour grew by only 0.6 per cent in 2005, down from 2.4 per cent in 2004. However, there are now signs that productivity growth may be picking up. GDP growth returned to around its trend rate at the end of last year. Our estimates suggest that the economy is expanding at its trend rate in the first half of this year as well. Although employment growth in the fourth quarter was relatively robust, total hours worked in the economy declined. Consequently, in the fourth quarter of 2005 growth in output per hour worked was 0.9 per cent. We expect to see modest growth in employment this year. Trend GDP growth is achieved through improvements in productivity rather than through strong gains in employment. As productivity growth recovers we expect to see robust GDP growth translate into stronger increases in labour demand.

The labour force expanded by 0.8 per cent in 2005, putting upward pressure on unemployment. This growth was largely driven by an unanticipated increase in migration on the accession of the Central European EU New Member States. The scale of migration to the UK was larger than expected because most EU members decided at a rather late date to maintain barriers to mobility whilst the UK did not. (1) Such large-scale unanticipated migration is likely to be a factor behind slow productivity growth until the capital stock can catch up. We expect labour force growth to moderate, but to remain relatively robust, supported by inward migration flows. With relatively modest growth in employment this year, unemployment rises a bit further from current levels. Also contributing to the current picture of rising unemployment and weak productivity growth is the rise in oil prices observed in the past few years. We expect the International Labour Office measure to rise to 5.2 per cent, from an annual average of 4.8 per cent in 2005. The unemployment rate stabilises at around 5 1/2 per cent over the medium term.

Public finances

Revisions to data suggest the deficit on the current budget in 2004-5 was less than previously thought. However, with three-quarters of data for the fiscal year, we expect the deficit on the current budget in 2005-6 to be a little larger than projected in the January Review. We now expect a deficit on the current budget of 14.7bn [pounds sterling], an increase in the deficit of 1.2bn [pounds sterling], or 0.1 per cent of GDP. Further ahead, we have increased our estimate of the deficit for fiscal year 2006-7 from 9bn [pounds sterling] to 12.2bn [pounds sterling].

Downward revisions to the current budget balance are not a result of policy measures announced in Budget 2006. Policies here were estimated to reduce the yield to the Exchequer by less than 1/2bn [pounds sterling]. Much of the increase in the deficit is attributable to the increase in spending on goods and services that the Treasury now projects. The Treasury have also revisited their estimate of the yield from the increase in supplementary charge and first year allowance elections for North Sea oil corporations announced in the Pre-Budget Report 2005. They have reduced the estimated yield for 2006-7 by 1.1bn [pounds sterling], due in part to receipts being received in the first quarter of 2006, instead of in fiscal year 2006-7.

The Treasury expects the policies announced in Budget 2006 to have a relatively small impact in 2007-8 and 2008-9, compared to policies announced in recent Budget and Pre-Budget Reports. The yield to the Exchequer of these policies is expected to be 0.4bn [pounds sterling] and 0.7bn [pounds sterling] respectively. We expect the current budget to move from a deficit to a surplus in 2009-10. Crucially this depends on a reduction in the size of government spending relative to the economy as a whole. The medium-term public finances are also supported by strong net migration, which simulations suggest will improve the budgetary position by 0.2 percentage point (Kirby and Riley, 2006).

Our forecast of tax receipts depends on the growth of money GDP, the composition of this growth and our assumptions about the effective tax rates in the economy. We have taken into account policies and revisions to policies announced in Budget 2006 and previous fiscal statements. Our revenue projections also allow for increases in income taxes as a result of fiscal drag, i.e. the automatic increase in taxation that results from indexing income tax brackets to prices when incomes rise faster than prices. In line with the Treasury assumptions, in each year we assume fiscal drag adds 0.1 percentage points to the ratio of income tax to money GDP.

Our forecast for spending on goods and services over the period covered by the current Spending Review is based on the assumption that government spending is as set out in Budget 2006. The difference between our projections and those of the Treasury is due to the reclassification of the BBC and Channel 4 Wales (S4C) from public sector corporations to central government, which has not yet been implemented in the National Accounts consistent data used in our projections. The effect of these reclassifications on the public finances is discussed in Box B. After accounting for the discrepancy between the data series, spending on goods and services is projected to be approximately 3bn [pounds sterling] higher than in the Pre-Budget Report 2005, in 2006-7 and 2007-8. We have then assumed the growth rate of spending on goods and services moderates from an average of 6 per cent to around 4 1/2 per cent per fiscal year in the medium term and this allows the share of government current expenditure to fall by 0.6 per cent of GDP over the period 2007-8 to 2010-11, as projected in Budget 2006. On a comparable basis this leaves current expenditure in 2010-11 4bn [pounds sterling] lower than forecast in Budget 2006. All else being equal, without this assumption our forecast would not show the current budget moving into surplus without further tax rises.

The other components of current expenditure are endogenously determined within our model and depend on unemployment, prices, GDP growth and interest rates. The recent rise in interest rates has reduced the chances of the Golden Rule being met by increasing debt interest payments on new debt issues. Simulations using NiGEM (2) suggest that a rise in short-term interest rates, similar to that which we have recently seen, sustained for two years will increase the budget deficit by around 0.1 percentage points of GDP for the first three years. This reflects the impacts of higher long-term interest rates on the interest payments associated with newly issued debt, which comes both from the overall government deficit, after allowing for increases in non-interest bearing money, and from issues made to finance retiring debt.

We have assumed that the Government meets its target of net investment as a per cent of GDP during the course of our forecast period. However, we assume that the meeting of this target occurs with a slight lag. In the past, government investment targets as set out in Budget and Pre-Budget Reports have been missed, and we expect this to continue. We expect net investment as a per cent of GDP to increase from 1.8 per cent in 2005-6 to 2.2 per cent in 2008-9 and 2.3 per cent in 2010-11.

Table 12 shows our estimate of the cumulated surplus on the current budget since the fiscal year 1997-8, the Treasury's dating of the beginning of the current economic cycle. As explained in the notes to table 12, these are based around data and our forecast of the public finances reported in table 11, but involve simple adjustments to account for the difference between National Accounts consistent data that underlie our forecast and the public sector finance data used to evaluate the fiscal rules. As noted in Box B, the current budget data is unaffected by the reclassification of the BBC and $4C, and the deficit is only marginally greater due to the reclassification of London and Continental Railways (LCR). We also show projections for the cumulated surplus on the current budget based on the data available at the time of constructing the forecast and the latest Treasury projections. We report two estimates of the cumulated current budget surplus since the beginning of the cycle. The first is simply the sum of the surpluses measured in billion [pounds sterling]. The second is the average annual surplus on the current budget measured as a share of money GDP. If the latter is positive or zero, then according to the Treasury the Government's Golden Rule is met. This method of assessing the Golden Rule tends to inflate surpluses accrued early in the cycle if, as is normally the case, nominal GDP rises over the cycle. As we have noted in the past, the logic behind this method of adding up surpluses is not entirely clear.

Box B. Public finance statistic revisions

The Office for National Statistics (ONS) has recently introduced a
number of reclassifications into the public finance statistics. The
BBC and S4C have both been reclassified as central government bodies,
whereas they were previously classified as public sector non-financial
corporations (see Kellaway and Shanks, 2006). For the BBC this is
because the TV licence is now defined as a direct tax on income,
whereas before it was classified as a service charge. The
reclassification of the BBC from one section of the public sector to
another increases both general government receipts and general
government current expenditures. Public corporations income is
recorded as gross operating surplus in the public finance statistics.
The general government sector is a consumer of goods and services.
Consequently, in reclassifying the BBC as central government, its
expenditure is now recorded separately from its receipts in the public
sector accounts, and both taxes and expenditure as a proportion of GDP
have been shifted upwards. There is no effect on the current budget.
This reclassification has yet to be included in the National Accounts
and as such we are forecasting receipts and expenditure lower than the
Treasury. In Budget 2006 it is assumed that this reclassification has
added approximately 2 1/2bn [pounds sterling] to both expenditure and
receipts. As table B shows, if we apply this assumption to our
forecast, our projections for total current receipts and total current
expenditure would be revised up by between 0.1 per cent and 0.3 per
cent of money GDP. By 2010-11 this reclassification accounts for a
fifth of the difference between our forecast and the Treasury's
forecast of current receipts and half the difference between the
forecasts for current expenditure.

London and Continental Railways (LCR) have been reclassified as
a public non-financial corporation since 1999. Before this LCR
remains classified as a private sector non-financial corporation.
The primary effect of this has been to increase the net debt figure.
Indeed the ONS estimate that public sector net debt will have
been revised up by 0.4 percentage point as a consequence of this
reclassification (see Shanks and Kellaway, 2006). Unlike the rest
of the public sector balance sheet variables we forecast, the
public sector net debt is consistent with the figure used by the
Treasury.

Table B The effect of reclassifications
on current receipts and spending

 Total current Total current
 receipts expenditure
 (% of GDP) (% of GDP)

 Without With Without With
 adjustment adjustment adjustment adjustment

2004-5 38.1 38.3 38.4 38.7
2005-6 39.0 39.3 39.0 39.2
2006-7 39.5 39.7 39.2 39.3
2007-8 39.9 40.1 39.1 39.3
2008-9 40.0 40.2 38.8 39.0
2009-10 40.0 40.1 38.5 38.7
2010-11 40.0 40.2 38.5 38.6

REFERENCES

Kellaway, M. and Shanks, H. (2006), 'National Accounts classifications
of public sector broadcasting', 20 January, http://www.statistics.gov.
uk/articles/nojournal/PSB_article_190106.pdf.

Shanks, H. and Kellaway, M. (2006), 'National Accounts classifications
of London and Continental Railways Ltd', 20 February, http://www.
statistics.gov.uk/articles/nojournal/LCR_class_article.pdf

The sum of the surpluses for both our forecast and the Treasury's Budget 2006 forecast suggest that the current balance would be in deficit over the economic cycle as defined by the Treasury. This compares with the forecast from the Pre-Budget Report 2005, where the forecast showed a small surplus by the end of the economic cycle in 2008-9. Consistent with previous projections, the Treasury expects the current budget to be in surplus on their measure. By 2008-9 our forecast suggests that the Golden Rule would be broken, as our central projection is for an average deficit of 0.1 per cent of GDP. However, it should be noted that the difference between our forecast and the Treasury's forecast of the current budget is less than the average absolute error of the Treasury net borrowing forecast reported in table 2.2 of the End of Year Fiscal Report published in December 2005. Indeed the inherent uncertainty surrounding these forecasts is highlighted in figure 11. It is clear there is no statistically significant difference between NIESR and the Treasury's projections for the current budget balance one and two years out.

[FIGURE 11 OMITTED]

It would be rather unusual for an economic cycle to last for as long as a decade, as the Treasury suggests, and our estimates of the output gap suggest that cycles have been rather shorter over the past few years. Our estimate is that the last economic cycle covered the period 1999-2000 to 2003-4, and over this period both methods of calculating the Golden Rule suggest that it was met. However, on our estimates a new cycle then began, and over the current economic cycle the Golden Rule is clearly likely to be broken. If the rule were to be taken as anything other than a broad guideline there would be a clear case for raising taxes in the short term, and we do not expect this to happen. Whatever the public comment, we believe that the Treasury sees the rule as no more than such a guideline, and as such we regard it as a success, even if it does not bear the weight of the firm commitment the Chancellor appeared to be making in 1998. Public borrowing has, after all, been significantly lower than in the decade up until 1997, and the debt stock has been kept within reasonable bounds.

Our projection of public sector net debt is consistent with that forecast by the Treasury. It includes the effects of the recent revision to LCR. By the end of 2008-9 we expect public sector net debt to have increased to around 39 1/2 per cent of GDP. This is very close to the ceiling of 40 per cent imposed by the Chancellor's second fiscal rule, the sustainable investment rule. Our simulations suggest that the recent rise in interest rates should increase the public sector debt stock by around 1/3 per cent of GDP by 2008-9. Our debt forecast is 1.1 percentage points above that of the Treasury for the same fiscal year. Hurst and Riley (2006) show this difference is less than one root mean square error from past Treasury projections of public sector net debt, or those implied by stochastic simulations, and hence the difference is not significant. However, it may be important, as it may mean the debt rule will be breached, and this may well require a rise in taxes to ensure that the credibility of policy is maintained.

Accumulation

The housing market showed signs of a pick-up in activity at the turn of the year. Our preferred measure of house prices is a seasonally adjusted version of the Office of the Deputy Prime Minister mix-adjusted index. This index reported an increase in the quarterly rate of house price inflation in the second half of last year, consistent with accelerating house price inflation as measured by the Halifax and Nationwide. Evidence on whether this acceleration continued into the first quarter of this year is mixed. The Nationwide report that quarterly house price inflation increased from 1.4 per cent in the fourth quarter of 2005 to 2.3 per cent in the first quarter of this year. However, the Halifax house price index would suggest that house price inflation has moderated somewhat, as does the latest survey from the Royal Institute of Chartered Surveyors (RICS), although the RICS survey does note that sales activity has continued to rise in the first quarter of this year. Data on lending also suggest that the housing market remains relatively robust. Data from the Bank of England suggest that the number of approvals for mortgage lending increased into the fourth quarter of 2005. This level has been maintained in the first quarter of this year.

In constructing our forecast we have not assumed that house price growth continues to accelerate. A number of studies suggest that the current level of house prices is higher than can be explained by its long-run determinants. Some recent research (Cameron et al., 2006) analysing regional data suggests that there is no disequilibrium in the housing market at present, while our own estimates, discussed on page 54 of the January Review, suggest a disequilibrium of up to 20 per cent. We assume in our forecast for the next two years or so that house price inflation remains stable at just under 4 per cent per annum, less than growth in gross disposable incomes. This allows the housing market to revert to equilibrium gradually. Recent rises in interest rates should serve to dampen house price inflation. The rise in the real mortgage interest rate since 2003, and the continued strength of lending to households, has increased the proportion of incomes absorbed by interest payments. Data from the Council of Mortgage Lenders suggest that over the period 2003 to 2005 this share increased from 11.3 per cent to 15.3 per cent. This is the highest rate since 1992.

The net wealth to income ratio is expected to have increased by 0.2 to 6.7 last year. This is despite a sharp deceleration in the growth rate of housing wealth in 2005. Instead it is the sharp rise in net financial wealth during 2005 that has pushed up the wealth to income ratio. Annualised growth increased from 5.1 per cent at the end of 2004 to 15.1 per cent in the last quarter of 2005. A moderation in the growth rate of the stock of financial liabilities contributed to the increase in net financial wealth, which was mainly brought about by rising equity prices. Looking ahead we do not expect double digit growth in net financial assets to be maintained. Our central projection is for net financial assets to grow by 12 1/2 per cent this year, slowing to around 6 per cent in 2007 and 2008.

Long-term projections

In table 14 we show the projections for the UK economy in the medium term. The behaviour of the economy over the medium term is determined in part by shocks which hit the economy, and we cannot forecast them. We are able to take account of other influences on the economy. These include the size and composition of the working age population, announced changes to the policy framework and the adjustment of the economy to any disequilibria. Our forecast of the medium term is therefore our view of the trend and the way in which the economy will adjust to any imbalances, in the absence of any future shocks.

After strong annual economic growth in 2007 and 2008 we expect the economy to return to its trend rate over the medium term. However, the trend rate itself is not immutable, and it changes over time. The oil price rises we have seen over the past three years are expected to have reduced the rate of trend growth by up to 0.1 to 0.2 percentage points for up to five years, for instance. Using the Government Actuary's Department projections for the working age population, we expect the rate of trend growth to be around 2.4 per cent in the medium term. We have assumed that the recovery in productivity growth is maintained into the medium term, with productivity growth averaging that observed over the past two decades. If productivity growth were lower this would require a rise in growth in the labour input in order to maintain the projected rate of trend growth, through for example increased participation of older workers. We have assumed a stable participation rate over the medium term, implying that ILO unemployment is around 5 1/2 per cent. With the economy returning to trend, inflation is maintained at target over the medium term with interest rates just under 5 per cent.

As mentioned before, underlying our forecast of the public finances is the assumption that spending as a share of national income is reduced over time. This allows the current budget balance to move back into surplus. Over the medium term we expect public sector net borrowing to reduce to an average of 1.7 per cent of GDP, from 3.1 per cent of GDP last year.

ACKNOWLEDGEMENTS

The forecast was compiled using the latest version of the National Institute Global Econometric Model. Thanks to Martin Weale for helpful suggestions and to Robert Metz for updating the forecast database.

The forecast was completed on 13 April, 2006.

REFERENCES

Al-Eyd, A., Barrell, R. and Holland, D. (2006), 'The role of financial markets' openness in the transmission of shocks in Europe', NIESR Discussion paper (forthcoming).

Barrell, R., Choy, A., and Kirby, S. (2006), 'Globalisation and UK trade', National Institute Economic Review, 195, pp. 63-7.

Barrell, R., Holland, D. and Pomerantz, O. (2004), Integration, Expansion and Accession, Occasional Paper 57, NIESR, London.

Cameron, G., Muellbauer, J. and Murphy, A. (2006), 'Was there a British house price bubble? Evidence from a regional panel', http://www.housingoutlook.co.uk/Papers/wasthere.pdf.

Freeman, D. (2005), 'The effect of bonuses on average earnings growth in 2005', Labour Market Trends, 113, 9, pp. 367-71.

Hurst, I. and Riley, R. (2006), 'The uncertainty of government debt projections', National Institute Economic Review, 195, pp. 58-9.

Kirby, S. and Riley, R. (2006), 'Net migration and the macroeconomy: inflation and output effects', National Institute Economic Review, 195, pp. 60-2.

NOTES

(1) Barrell et al. (2004) survey estimates of the potential scale of migration from the New Member States, and suggested that flows to the whole EU would be around 300,000 a year. Without mobility barriers elsewhere the UK would have expected only around 30,000 migrants a year.

(2) National Institute Global Econometric Model.

Table 1. Growth and inflation forecasts

CPI inflation 2006Q4 2007Q4

Central projection 2.4 2.2
Root mean squared error 0.66 0.79

Probability of 12 month CPI inflation falling
in the following ranges

less than 1 percent 1 6
1 to 1.5 per cent 7 12
1.5 to 2 per cent 19 21
2 to 2.5 per cent 29 25
2.5 to 3 per cent 26 20
more than 3 per cent 18 16
 100 100

GDP growth 2006 2007

Central projection 2.5 2.81
Root mean squared error 0.86 1.37

Probability of annual growth rate falling
in the following ranges

less than 0 per cent 0 2
0 to 1 per cent 4 7
1 to 2 per cent 24 19
2 to 3 per cent 44 28
3 to 4 per cent 24 25
more than 4 per cent 4 19
 100 100

Table 2. Exchange rates and interest rates

 UK exchange rates

 Effective Effective Dollar Euro
 (Old BoE
 series)
 1990 = 100 2000 = 100

2001 105.78 98.53 1.44 1.61
2002 105.99 100.98 1.50 1.59
2003 100.21 98.28 1.63 1.45
2004 104.10 103.49 1.83 1.47
2005 103.33 101.95 1.82 1.46
2006 101.62 99.47 1.75 1.44
2007 100.69 98.85 1.76 1.42
2008 100.10 98.58 1.77 1.41

2005 Q1 102.87 102.37 1.89 1.44
2005 Q2 104.28 103.22 1.86 1.47
2005 Q3 102.97 101.23 1.78 1.46
2005 Q4 103.19 100.97 1.75 1.47

2006 Q1 102.53 100.21 1.75 1.46
2006 Q2 101.32 99.22 1.75 1.43
2006 Q3 101.32 99.22 1.75 1.43
2006 Q4 101.32 99.22 1.75 1.43

2007 Q1 101.03 99.05 1.75 1.43
2007 Q2 100.77 98.89 1.76 1.42
2007 Q3 100.56 98.77 1.76 1.42
2007 Q4 100.38 98.68 1.76 1.42

Percentage changes

2001/2000 -1.6 -1.5 -5.0 -2.1
2002/2001 0.2 2.5 4.3 -1.0
2003/2002 -5.5 -2.7 8.8 -9.2
2004/2003 3.9 5.3 12.1 1.9
2005/2004 -0.7 -1.5 -0.7 -0.9
2006/2005 -1.7 -2.4 -3.7 -1.5
2007/2006 -0.9 -0.6 0.3 -1.1
2008/2007 -0.6 -0.3 0.5 -0.7

2005Q4/04Q4 0.8 -1.3 -6.3 2.1
2006Q4/05Q4 -1.8 -1.7 0.2 -2.5
2007Q4/06Q4 -0.9 -0.6 0.5 -1.1

 FT
 All-share
 index

2001 2681.2
2002 2224.5
2003 1978.1
2004 2250.9
2005 2587.6
2006 3083.5
2007 3210.0
2008 3317.4

2005 Q1 2473.7
2005 Q2 2479.1
2005 Q3 2661.0
2005 Q4 2736.5

2006 Q1 2961.6
2006 Q2 3087.8
2006 Q3 3128.8
2006 Q4 3155.9

2007 Q1 3176.6
2007 Q2 3197.7
2007 Q3 3220.4
2007 Q4 3245.3

Percentage changes

2001/2000 -12.0
2002/2001 -17.0
2003/2002 -11.1
2004/2003 13.8
2005/2004 15.0
2006/2005 19.2
2007/2006 4.1
2008/2007 3.3

2005Q4/04Q4 16.6
2006Q4/05Q4 15.3
2007Q4/06Q4 2.8

 Interest rates

 3-month Mortgage 10-year World (a)
 rates interest gilts

2001 5.0 5.9 4.9 4.0
2002 4.0 5.0 4.9 2.7
2003 3.7 4.7 4.5 2.0
2004 4.6 5.0 4.9 2.2
2005 4.7 5.2 4.4 3.0
2006 4.6 5.2 4.4 3.8
2007 4.7 5.3 4.6 4.2
2008 4.7 5.3 4.7 4.5

2005 Q1 4.9 5.2 4.7 2.7
2005 Q2 4.8 5.3 4.4 2.9
2005 Q3 4.6 5.2 4.3 3.0
2005 Q4 4.6 5.2 4.3 3.3

2006 Q1 4.5 5.2 4.2 3.5
2006 Q2 4.6 5.2 4.4 3.7
2006 Q3 4.7 5.2 4.4 3.9
2006 Q4 4.7 5.3 4.5 4.0

2007 Q1 4.7 5.3 4.5 4.1
2007 Q2 4.7 5.3 4.5 4.2
2007 Q3 4.7 5.3 4.6 4.3
2007 Q4 4.7 5.3 4.6 4.4

Percentage changes

2001/2000
2002/2001
2003/2002
2004/2003
2005/2004
2006/2005
2007/2006
2008/2007

2005Q4/04Q4
2006Q4/05Q4
2007Q4/06Q4

Note: (a) Weighted average of 3-month
interbank rates in other OECD economies.

Table 3. Price indices
200=100

 Unit Imports Exports
 labour deflator deflator
 costs

2001 97.6 102.3 99.5
2002 100.0 100.0 100.0
2003 102.4 100.4 101.5
2004 104.3 100.0 101.0
2005 108.0 103.4 102.7
2006 110.3 106.9 106.4
2007 112.4 108.4 107.3
2008 114.8 109.7 108.6

Percentage changes

2001/2000 3.6 0.0 -0.7
2002/2001 2.4 -2.3 0.5
2003/2002 2.4 0.4 1.5
2004/2003 1.9 -0.4 -0.4
2005/2004 3.6 3.4 1.6
2006/2005 2.1 3.4 3.7
2007/2006 1.9 1.4 0.8
2008/2007 2.1 1.2 1.2

 Whole-sale World Consumption
 price oil price deflator
 index (a) ($) (b)

2001 100.1 23.6 98.5
2002 100.0 24.4 100.0
2003 101.3 27.8 102.0
2004 103.2 35.9 103.4
2005 105.4 51.8 105.4
2006 107.5 61.4 107.8
2007 109.7 58.3 110.5
2008 112.0 57.7 113.0

Percentage changes

2001/2000 -0.6 -13.4 2.3
2002/2001 -0.1 3.4 1.5
2003/2002 1.3 14.1 2.0
2004/2003 1.9 29.1 1.4
2005/2004 2.1 44.4 2.0
2006/2005 2.0 18.5 2.3
2007/2006 2.0 -4.9 2.5
2008/2007 2.1 -1.0 2.2

 Retail price index
 GDP
 Consumer All Excluding deflator
 prices items mortgage (market
 index interest prices)

2001 98.8 98.4 97.8 97.0
2002 100.0 100.0 100.0 100.0
2003 101.4 102.9 102.8 102.9
2004 102.7 106.0 105.1 105.1
2005 104.8 109.0 107.5 107.1
2006 107.2 112.0 110.3 109.9
2007 109.7 115.6 113.4 112.6
2008 111.9 118.9 116.4 115.2

Percentage changes

2001/2000 1.2 1.8 2.1 2.3
2002/2001 1.2 1.6 2.2 3.1
2003/2002 1.4 2.9 2.8 2.9
2004/2003 1.3 3.0 2.2 2.1
2005/2004 2.1 2.8 2.3 2.0
2006/2005 2.2 2.8 2.6 2.6
2007/2006 2.3 3.2 2.9 2.4
2008/2007 2.0 2.9 2.6 2.3

Notes: (a) Excluding food, beverages, tobacco and petroleum products.

(b) Per barrel, average of Dubai and Brent spot prices.

Tab1e 4. Gross domestic product and components of expenditure
[pounds sterling] billion, 2002 prices

 Final consumption Gross capital
 expenditure formation

 Households General Gross Changes in
 & NPISH (a) gov't fixed inventories
 investment (b)

2001 670.1 202.0 167.6 6.6
2002 693.4 211.0 172.6 3.1
2003 711.1 220.4 172.6 4.6
2004 736.1 227.2 181.3 5.9
2005 748.8 233.8 187.2 2.1
2006 765.6 239.7 193.5 2.4
2007 780.0 245.1 200.4 3.8
2008 796.4 251.4 207.6 3.8

Percentage changes

2001/2000 3.0 1.7 2.4
2002/2001 3.5 4.4 3.0
2003/2002 2.6 4.5 0.0
2004/2003 3.5 3.1 5.1
2005/2004 1.7 2.9 3.2
2006/2005 2.2 2.5 3.4
2007/2006 1.9 2.3 3.5
2008/2007 2.1 2.6 3.6

Decomposition of growth in GDP (c)

2001 2.0 0.3 0.4 0.1
2002 2.3 0.9 0.5 -0.3
2003 1.7 0.9 0.0 0.1
2004 2.3 0.6 0.8 0.1
2005 1.1 0.6 0.5 -0.3
2006 1.5 0.5 0.6 0.0
2007 1.2 0.5 0.6 0.1
2008 1.4 0.5 0.6 0.0

 Domestic Total Total
 demand exports final
 expenditure

2001 1046.4 274.3 1320.8
2002 1080.0 274.9 1355.0
2003 1108.7 278.2 1386.8
2004 1150.6 290.9 1441.5
2005 1171.9 307.2 1479.1
2006 1201.3 326.1 1527.4
2007 1229.3 341.3 1570.7
2008 1259.2 357.7 1616.9

Percentage changes

2001/2000 2.8 2.9 2.8
2002/2001 3.2 0.2 2.6
2003/2002 2.7 1.2 2.4
2004/2003 3.8 4.6 3.9
2005/2004 1.9 5.6 2.6
2006/2005 2.5 6.1 3.3
2007/2006 2.3 4.7 2.8
2008/2007 2.4 4.8 2.9

Decomposition of growth in GDP (c)

2001 2.8 0.8 3.6
2002 3.3 0.1 3.3
2003 2.7 0.3 3.0
2004 3.9 1.2 5.1
2005 1.9 1.5 3.4
2006 2.6 1.7 4.3
2007 2.4 1.3 3.7
2008 2.5 1.4 3.9

 Total GDP Net
 imports at trade
 market
 prices

2001 293.2 1027.9 -18.9
2002 306.5 1048.5 -31.6
2003 312.0 1074.9 -33.8
2004 332.9 1108.5 -42.1
2005 350.6 1128.7 -43.4
2006 371.2 1156.4 -45.1
2007 382.6 1188.6 -41.3
2008 396.8 1220.6 -39.2

Percentage changes

2001/2000 4.8 2.2
2002/2001 4.5 2.0
2003/2002 1.8 2.5
2004/2003 6.7 3.1
2005/2004 5.3 1.8
2006/2005 5.9 2.5
2007/2006 3.1 2.8
2008/2007 3.7 2.7

Decomposition of growth in GDP (c)

2001 -1.3 2.2 -0.6
2002 -1.3 2.0 -1.2
2003 -0.5 2.5 -0.2
2004 -1.9 3.1 -0.8
2005 -1.6 1.8 -0.1
2006 -1.8 2.5 -0.2
2007 -1.0 2.8 0.3
2008 -1.2 2.7 2.0

Notes: (a) Non-profit institutions serving households.

(b) Including acquisitions less disposals of valuables
and quarterly alignment adjustment.

(c) Components may not add up to total GDP growth due
to rounding and statistical discrepancy included in GDP.

Table 5. External sector

 Exports Imports Net
 of goods of goods trade in
 goods

 [pounds sterling] billion, 2002 prices (a)

2001 189.7 224.0 -34.3
2002 186.5 233.6 -47.1
2003 186.0 238.2 -52.2
2004 188.5 254.4 -65.9
2005 203.3 269.8 -66.5
2006 218.5 289.2 -70.7
2007 228.5 297.3 -68.8
2008 239.7 307.8 -68.1

Percentage changes

2001/2000 2.7 5.4
2002/2001 -1.7 4.3
2003/2002 -0.3 2.0
2004/2003 1.3 6.8
2005/2004 7.9 6.1
2006/2005 7.5 7.2
2007/2006 4.5 2.8
2008/2007 4.9 3.5

 Exports Imports Net
 of of trade in
 services services services

 [pounds sterling] billion, 2002 prices (a)

2001 84.5 69.2 15.3
2002 88.4 72.9 15.5
2003 92.1 73.8 18.4
2004 102.4 78.6 23.9
2005 104.0 80.8 23.2
2006 107.6 82.0 25.6
2007 112.9 85.4 27.5
2008 117.9 89.0 28.9

Percentage changes

2001/2000 3.5 2.6
2002/2001 4.7 5.3
2003/2002 4.2 1.2
2004/2003 11.2 6.5
2005/2004 1.5 2.9
2006/2005 3.5 1.4
2007/2006 4.9 4.2
2008/2007 4.5 4.2

 Export World Terms Current
 price trade (c) of trade balance
 competitiveness (b)
 (d)

 2002=100 % of GDP

2001 96.2 97.7 97.3 -2.2
2002 100.0 100.0 100.0 -1.6
2003 100.6 104.0 101.1 -1.4
2004 103.9 113.8 101.0 -2.0
2005 100.8 121.6 99.3 -2.6
2006 101.6 130.0 99.6 -2.7
2007 100.6 136.9 99.0 -3.0
2008 100.0 144.7 99.0 -2.7

Percentage changes

2001/2000 -3.7 1.1 -0.7
2002/2001 4.0 2.3 2.8
2003/2002 0.6 4.0 1.1
2004/2003 3.3 9.4 0.0
2005/2004 -3.0 6.8 -1.7
2006/2005 0.7 6.9 0.3
2007/2006 -1.0 5.4 -0.6
2008/2007 -0.5 5.7 0.0

Notes: (a) Balance of payments basis.

(b) Ratio of average value of exports to imports.

(c) Weighted by import shares in UK export markets.

(d) A rise denotes a loss in UK competitiveness.

Table 6. Household income and expenditure

 Average (a) Compensation Total
 earnings of employees personal
 income

 [pounds sterling] billion,
 2002=100 current prices

2001 96.2 563.4 896.0
2002 100.0 588.6 921.5
2003 104.7 617.6 969.3
2004 109.2 649.1 1011.0
2005 114.0 684.5 1061.4
2006 119.0 716.0 1111.4
2007 124.0 750.2 1171.1
2008 129.2 786.8 1231.7

Percentage changes

2001/2000 4.6 5.9 6.4
2002/2001 4.0 4.5 2.8
2003/2002 4.7 4.9 5.2
2004/2003 4.2 5.1 4.3
2005/2004 4.5 5.5 5.0
2006/2005 4.4 4.6 4.7
2007/2006 4.2 4.8 5.4
2008/2007 4.2 4.9 5.2

 Gross Real
 disposable disposable
 income income (b)

 [pounds sterling] billion,
 current prices

2001 688.3 698.4
2002 710.1 710.1
2003 744.4 730.1
2004 770.0 745.1
2005 801.7 760.5
2006 838.2 777.4
2007 881.3 797.2
2008 925.3 818.6

Percentage changes

2001/2000 6.5 4.2
2002/2001 3.2 1.7
2003/2002 4.8 2.8
2004/2003 3.4 2.0
2005/2004 4.1 2.1
2006/2005 4.5 2.2
2007/2006 5.1 2.5
2008/2007 5.0 2.7

 Final consumption
 expenditure
 Savings
 Total Durable ratio (c)

 [pounds sterling]
 billion, 2002 prices per cent

2001 670.1 76.3 6.3
2002 693.4 80.4 4.8
2003 711.1 87.6 5.3
2004 736.1 94.6 4.3
2005 748.8 98.7 5.0
2006 765.6 102.9 5.1
2007 780.0 106.8 5.7
2008 796.4 110.3 6.3

Percentage changes

2001/2000 3.0 10.6
2002/2001 3.5 5.4
2003/2002 2.6 8.9
2004/2003 3.5 8.0
2005/2004 1.7 4.4
2006/2005 2.2 4.2
2007/2006 1.9 3.8
2008/2007 2.1 3.3

Notes: (a) Average earnings equals total labour compensation
divided by the number of workforce employee jobs.

(b) Deflated by consumers' expenditure deflator.

(c) Includes adjustment for change in net equity
of households in pension funds.

Table 7. National and sectoral saving
As a percentage of GDP

 Household sector Company sector

 Saving Investment Saving Investment

2001 4.5 4.4 8.1 11.6
2002 3.3 4.8 11.7 10.6
2003 3.7 5.0 12.3 9.7
2004 3.0 5.3 12.9 9.8
2005 3.4 5.5 11.4 9.4
2006 3.5 5.5 11.0 9.3
2007 3.9 5.6 10.2 9.4
2008 4.3 5.7 10.1 9.5

 Government sector Whole economy

 Saving Investment Saving Investment

2001 2.5 1.3 15.1 17.3
2002 0.2 1.4 15.2 16.8
2003 -1.2 1.6 14.9 16.3
2004 -1.0 1.7 14.8 16.9
2005 -0.6 2.0 14.2 16.9
2006 -0.2 2.2 14.3 17.0
2007 0.3 2.3 14.4 17.3
2008 0.6 2.4 15.0 17.7

 Finance from abroad

 Total Net
 factor
 income

2001 2.2 -1.1
2002 1.6 -2.2
2003 1.4 -2.3
2004 2.0 -2.3
2005 2.6 -2.3
2006 2.7 -2.2
2007 3.0 -1.7
2008 2.7 -1.7

Table 8. Fixed investment and capital
[pounds sterling] billion, 2002 prices

 Gross fixed investment

 Business Private General Total
 investment housing (a) government

2001 109.8 43.5 14.0 167.6
2002 110.2 46.9 15.5 172.6
2003 107.7 46.8 18.0 172.6
2004 111.3 49.7 20.4 181.3
2005 113.4 50.5 23.3 187.2
2006 116.1 51.2 26.2 193.5
2007 119.7 52.2 28.4 200.4
2008 123.5 53.4 30.7 207.6

Percentage changes

2001/2000 1.5 0.3 16.7 2.4
2002/2001 0.3 7.6 10.8 3.0
2003/2002 -2.2 -0.1 15.9 0.0
2004/2003 3.3 6.2 13.1 5.1
2005/2004 2.0 1.5 14.2 3.2
2006/2005 2.3 1.5 12.8 3.4
2007/2006 3.1 2.0 8.2 3.5
2008/2007 3.2 2.2 8.2 3.6

 User Corporate Capital stock
 cost profit
 of share of Private Public (b)
 capital (%) GDP (%)

2001 13.0 23.8 1902.5 444.4
2002 13.8 24.9 1935.6 471.5
2003 14.0 25.4 2001.6 462.3
2004 14.3 25.8 2051.9 472.7
2005 14.0 24.9 2115.2 480.1
2006 13.9 25.8 2178.5 490.1
2007 14.1 26.1 2243.2 501.9
2008 14.2 26.2 2309.3 515.7

Percentage changes

2001/2000 3.0 1.4
2002/2001 1.7 6.1
2003/2002 3.4 -2.0
2004/2003 2.5 2.2
2005/2004 3.1 1.6
2006/2005 3.0 2.1
2007/2006 3.0 2.4
2008/2007 3.0 2.7

Notes: (a) Includes private sector
transfer costs of non-produced assets.

(b) Including public sector non-financial corporations.

Table 9. Output and productivity
200=100

 Output

 Whole economy Manufacturing

2001 98.3 103.1
2002 100.0 100.0
2003 102.5 100.0
2004 105.5 101.8
2005 107.4 100.6
2006 110.0 101.7
2007 113.1 104.2
2008 116.2 105.9

Percentage changes

2001/2000 2.0 -1.4
2002/2001 1.7 -3.1
2003/2002 2.5 0.1
2004/2003 2.9 1.7
2005/2004 1.8 -1.1
2006/2005 2.4 1.0
2007/2006 2.8 2.5
2008/2007 2.7 1.6

 Productivity Output Capacity
 gap (a) utilisation
 Whole economy Manufacturing (industry)
 (per hour)
 per cent

2001 98.2 98.1 0.2 93.9
2002 100.0 100.0 -0.3 90.9
2003 102.0 105.0 -0.2 90.6
2004 104.5 111.6 0.4 95.5
2005 105.1 114.6 -0.2 95.8
2006 107.0 117.4 -0.2 94.9
2007 109.6 122.2 0.0 95.4
2008 112.1 126.3 0.0 95.5

Percentage changes

2001/2000 1.0 2.9
2002/2001 1.8 1.9
2003/2002 2.0 5.0
2004/2003 2.4 6.2
2005/2004 0.6 2.7
2006/2005 1.8 2.5
2007/2006 2.4 4.1
2008/2007 2.3 3.3

Note: (a) Calculated using an approximate band pass
filter on historical data and our projection of GDP:
see p. 101 of Massmann, M., Mitchell, J. and Weale,
M. (2003), 'Business cycles and turning points: a
survey of statistical techniques', National Institute
Economic Review, no. 183, January.

Table 10. The labour market
Thousands

 Workforce jobs
 Claimant Workforce
 Employees Total (a) unemployment (b)

2001 26013 29842 970 30812
2002 26133 30015 947 30962
2003 26183 30301 933 31234
2004 26396 30579 854 31432
2005 26650 30833 862 31695
2006 26706 30926 972 31898
2007 26854 31068 990 32058
2008 27028 31233 972 32205

Percentage changes

2001/2000 1.2 1.0 -10.9 0.6
2002/2001 0.5 0.6 -2.4 0.5
2003/2002 0.2 1.0 -1.4 0.9
2004/2003 0.8 0.9 -8.5 0.6
2005/2004 1.0 0.8 1.0 0.8
2006/2005 0.2 0.3 12.8 0.6
2007/2006 0.6 0.5 1.9 0.5
2008/2007 0.6 0.5 -1.8 0.5

 Underutilisation %

 Population ILO Claimant Population
 of working unemployment rate not employed
 age rate rate (c)

2001 36406 5.1 3.1 18.0
2002 36622 5.2 3.1 18.0
2003 36828 5.0 3.0 17.7
2004 37064 4.8 2.7 17.5
2005 37373 4.8 2.7 17.5
2006 37636 5.2 3.0 17.8
2007 37795 5.3 3.1 17.8
2008 37915 5.3 3.0 17.6

Percentage changes

2001/2000 0.7
2002/2001 0.6
2003/2002 0.6
2004/2003 0.6
2005/2004 0.8
2006/2005 0.7
2007/2006 0.4
2008/2007 0.3

Notes: (a) Includes self-employed, HM Forces and
government-supported trainees.

(b) Workforce jobs pius claimant unemployment.

(c) One less ratio of workforce jobs to
population of working age (multiplied by 100).

Table 11. Public sector financial balance and borrowing requirement

[pounds sterling] billion, fiscal years

 2004-5 2005-6 2006-7

Current Taxes on income 283.8 308.5 331.4
receipts; Taxes on expenditure 154.8 160.2 167.4
 Other current receipts 9.9 9.1 9.6
 Total 448.4 477.9 508.5
 (as a % of GDP) 38.1 39.0 39.5

Current Goods and services 250.6 269.1 284.0
expenditure: Net social benefits paid 138.1 143.7 150.8
 Debt interest 24.9 26.8 27.6
 Other current expenditure 38.8 37.5 41.8
 Total 452.4 477.1 504.2
 (as a % of GDP) 38.4 39.0 39.2

Depreciation 15.0 15.5 16.5

Surplus on public sector current -18.9 -14.7 -12.2
budget (a) (as a % of GDP) -1.6 -1.2 -0.9

Gross investment 31.2 34.4 39.3
Net investment 19.7 22.0 26.0
(as a % of GDP) 1.7 1.8 2.0

Total managed expenditure 487.0 514.6 546.6
(as a % of GDP) 41.4 42.0 42.4

Public sector net borrowing 38.6 36.7 38.1
(as a % of GDP) 3.3 3.0 3.0

Financial transactions 0.9 0.1 -1.3
Public sector net cash requirement 37.6 36.6 39.4
(as a % of GDP) 3.2 3.0 3.1
Public sector net debt (% of GDP) 35.3 37.7 38.7

GDP deflator at market prices (2002=100) 105.7 107.8 110.6
Money GDP 1176.8 1223.7 1287.8

Financial balance under Maastricht 3.3 3.7 3.3
(calendar year, % of GDP)
Gross debt under Maastricht 41.5 43.5 44.5
(calendar year, % of GDP)

 2007-8 2008-9

Current Taxes on income 355.1 374.9
receipts; Taxes on expenditure 175.6 183.3
 Other current receipts 9.9 10.9
 Total 540.6 569.1
 (as a % of GDP) 39.9 40.0

Current Goods and services 299.9 313.3
expenditure: Net social benefits paid 158.2 164.6
 Debt interest 29.0 30.8
 Other current expenditure 42.2 43.1
 Total 529.4 551.7
 (as a % of GDP) 39.1 38.8

Depreciation 17.4 18.3

Surplus on public sector current -6.2 -I.0
budget (a) (as a % of GDP) -0.5 -0.1

Gross investment 42.5 46.0
Net investment 28.2 30.8
(as a % of GDP) 2.1 2.2

Total managed expenditure 575.0 600.8
(as a % of GDP) 42.4 42.2

Public sector net borrowing 34.4 31.7
(as a % of GDP) 2.5 2.2

Financial transactions -0.1 -0.1
Public sector net cash requirement 34.5 31.8
(as a % of GDP) 2.5 2.2
Public sector net debt (% of GDP) 39.2 39.4

GDP deflator at market prices (2002=100) 113.2 115.8
Money GDP 1355.1 1422.7

Financial balance under Maastricht 2.9 2.6
(calendar year, % of GDP)
Gross debt under Maastricht 45.0 45.4
(calendar year, % of GDP)

 2009-10 2010-11

Current Taxes on income 394.9 416.6
receipts; Taxes on expenditure 191.8 200.7
 Other current receipts 10.4 10.2
 Total 597.1 627.5
 (as a % of GDP) 40.0 40.0

Current Goods and services 327.7 343.9
expenditure: Net social benefits paid 170.9 179.3
 Debt interest 32.6 34.2
 Other current expenditure 44.0 45.8
 Total 575.2 603.2
 (as a % of GDP) 38.5 38.5

Depreciation 19.3 20.2

Surplus on public sector current 2.6 4.1
budget (a) (as a % of GDP) 0.2 0.3

Gross investment 49.3 52.6
Net investment 33.1 35.5
(as a % of GDP) 2.2 2.3

Total managed expenditure 627.6 658.9
(as a % of GDP) 42.0 42.0

Public sector net borrowing 30.5 31.4
(as a % of GDP) 2.0 2.0

Financial transactions -0.1 -0.1
Public sector net cash requirement 30.5 31.5
(as a % of GDP) 2.0 2.0
Public sector net debt (% of GDP) 39.4 39.4

GDP deflator at market prices (2002=100) 118.5 121.2
Money GDP 1493.4 1567.3

Financial balance under Maastricht 2.3 2.3
(calendar year, % of GDP)
Gross debt under Maastricht 45.4 45.3
(calendar year, % of GDP)

Notes: These data are constructed from seasonally adjusted
national accounts data. This results in differences between
the figures here and unadjusted fiscal year data.

(a) Public sector current budget surplus is total current
receipts less total current expenditure and depreciation.

Table 12. Cumulated public sector current
budget balance
Fiscal years

 NIESR Budget 2006 (c)

 [pounds [pounds
 sterling] Average % of sterling] Average % of
 bn (a) money GDP (b) bn (a) money GDP (b)

1997-8 -1.2 -0.2 -1.2 -0.2
1998-9 9.2 0.5 9.2 0.5
1999-0 29.4 1.1 29.4 1.1
2000-1 50.9 1.4 50.9 1.4
2001-2 61.2 1.3 61.2 1.3
2002-3 48.1 0.9 48.1 0.9
2003-4 26.7 0.5 26.7 0.5
2004-5 7.7 0.2 7.7 0.2
2005-6 -4.4 0.1 -3.7 0.1
2006-7 -15.5 0.0 -10.7 0.0
2007-8 -20.5 -0.1 -9.7 0.0
2008-9 -20.2 -0.1 -2.7 0.1

Table 13. Wealth

 Household sector

 Financial Financial Net Housing
 assets liabilities financial wealth
 assets

2001 2922.3 810.4 2111.9 2162.9
2002 2680.7 923.1 1757.6 2617.0
2003 2930.3 1047.4 1882.9 2919.7
2004 3152.9 1173.2 1979.8 3271.1
2005 3552.0 1275.6 2276.4 3351.5
2006 3953.0 1389.8 2563.3 3496.2
2007 4238.2 1515.6 2722.6 3643.3
2008 4533.0 1653.4 2879.6 3797.4

Percentage changes

2001/2000 -6.3 10.4 -11.4 7.3
2002/2001 -8.3 13.9 -16.8 21.0
2003/2002 9.3 13.5 7.1 11.6
2004/2003 7.6 12.0 5.1 12.0
2005/2004 12.7 8.7 15.0 2.5
2006/2005 11.3 8.9 12.6 4.3
2007/2006 7.2 9.1 6.2 4.2
2008/2007 7.0 9.1 5.8 4.2

 Household Whole economy net
 sector financial assets (c)

 Net worth House Total Per cent
 to income prices (b) of national
 ration (a) income
 2002=100

2001 6.0 86.1 -72.1 -7.1
2002 5.9 100.0 -48.3 -4.5
2003 6.1 115.7 -65.4 -5.7
2004 6.5 129.4 -146.3 -12.1
2005 6.7 136.5 -215.8 -17.5
2006 6.8 141.5 -251.3 -19.2
2007 6.8 147.0 -282.7 -20.6
2008 6.8 152.8 -338.8 -23.5

Percentage changes

2001/2000 8.1 106.6
2002/2001 16.1 -33.0
2003/2002 15.7 35.3
2004/2003 11.9 123.8
2005/2004 5.5 47.5
2006/2005 3.7 16.5
2007/2006 3.9 12.5
2008/2007 3.9 19.8

Notes: (a) Net worth is defined here as housing
wealth plus net financial assets.

(b) Office of the Deputy Prime Minister, mix-adjusted.

(c) Net overseas assets.

Table 14. Long-term projections
All figures percentage change unless otherwise stated

 2003 2004 2005 2006

GDP (market prices) 2.5 3.1 1.8 2.5
Average earnings 4.7 4.2 4.5 4.4
GDP deflator (market prices) 2.9 2.1 2.0 2.6
Consumer Prices Index 1.4 1.3 2.1 2.2
Manufacturing productivity 5.0 6.2 2.7 2.5
Whole economy productivity (a) 2.0 2.4 0.6 1.8
Labour input (b) 0.4 0.6 1.1 0.6
ILO unemployment rate (%) 5.0 4.8 4.8 5.2
Current account (% of GDP) -1.4 -2.0 -2.6 -2.7
Total managed expenditure
 (% of GDP) 40.5 41.0 42.0 42.5
Public sector net borrowing
 (% of GDP) 3.3 3.2 3.1 3.0
Public sector net debt
 (% of GDP) 32.6 34.3 36.4 38.1
Effective exchange rate
 (2000=100) 98.3 103.5 101.9 99.5
3 month interest rates (%) 3.7 4.6 4.7 4.6
10 year interest rates (%) 4.5 4.9 4.4 4.4

 2007 2008 2009 2010-14

GDP (market prices) 2.8 2.7 2.6 2.4
Average earnings 4.2 4.2 4.4 4.4
GDP deflator (market prices) 2.4 2.3 2.3 2.3
Consumer Prices Index 2.3 2.0 2.0 2.0
Manufacturing productivity 4.1 3.3 2.8 2.7
Whole economy productivity (a) 2.4 2.3 2.3 2.3
Labour input (b) 0.4 0.4 0.3 0.1
ILO unemployment rate (%) 5.3 5.3 5.2 5.5
Current account (% of GDP) -3.0 -2.7 -2.4 -1.9
Total managed expenditure
 (% of GDP) 42.4 42.3 42.0 41.9
Public sector net borrowing
 (% of GDP) 2.6 2.4 2.1 1.7
Public sector net debt
 (% of GDP) 38.8 39.3 39.4 39.1
Effective exchange rate
 (2000=100) 98.8 98.6 98.5 98.6
3 month interest rates (%) 4.7 4.7 4.7 4.8
10 year interest rates (%) 4.6 4.7 4.8 4.9

Notes: (a) Per hour. (b) Total hours worked.