3.02 Final demand has been rising strongly since the start of this year. Until mid-year, output growth was held back by an adjustment in stocks, following excess accumulation in 1995. But output growth appears to have quickened in the second half of this year.
3.03 GDP is forecast to grow by 3 1/2 per cent in 1997. Consumer demand is likely to remain strong, reflecting high personal wealth, rising real incomes and improved consumer confidence. Surveys of investment intentions point to a further acceleration in business investment over the coming year. Exports have grown more strongly this year, and should benefit from improving European markets.
3.04 Higher import costs were tending to push up inflation in 1995. This pressure has now eased, and producer output price inflation has fallen from 4 1/2 per cent at the end of last year to under 1 per cent in October. Underlying retail price inflation is forecast to fall from around 3 per cent in the fourth quarter of this year to 2 1/2 per cent by the second quarter of next year, as lower import and producer prices gradually work through to prices in the shops.
| Forecast | ||||
| 1995 | 1996 | 1997 | 1998 H1 | |
| Real GDP growth (per cent) | 2 1/2 | 2 1/2 | 3 1/2 | 3 |
| Inflation (RPI excluding MIPs, Q4) | 3 | 3 | 2 1/2 | 2 1/2 (1) |
| Current account (£ billion) | -4 | -2 1/4 | -4 1/4 | -4 3/4 (2) |
| Percentage changes on a year earlier | ||||
| Forecast | ||||
| 1995 | 1996 | 1997 | 1998 H1 | |
| Major seven countries(1) | ||||
| Real GDP | 2 | 2 1/4 | 2 1/4 | 2 1/2 |
| Domestic demand | 2 | 2 1/2 | 2 1/4 | 2 1/4 |
| Industrial production | 3 | 2 1/4 | 2 3/4 | 2 3/4 |
| Consumer price inflation(2) | 2 1/4 | 2 1/4 | 2 1/4 | 2 1/4 |
| World trade in manufactures | 10 1/2 | 6 1/2 | 7 1/4 | 7 3/4 |
| UK export markets(3) | 9 3/4 | 6 | 6 1/2 | 7 1/4 |
3.06 World trade has grown more slowly than in 1995, partly reflecting a weakening of Asian trade growth. Oil prices have increased sharply in recent months, but non-oil commodity prices have weakened. World inflationary pressures remain subdued.
3.08 In France, GDP fell by nearly 1/2 per cent in the second quarter, following a strong rise in the first quarter. All the components of expenditure eased back, but this partly reflected one-off factors. The third quarter should see some rebound, following strong consumption growth over the summer. The low level of interest rates should help underpin the recovery, but growth for 1996 as a whole is still likely to be very subdued. As in Germany, prospects for next year and beyond look better.
3.09 After holding up well until the fourth quarter of last year, activity in Italy has since weakened. But with inflation at record low levels and recent interest rate cuts, prospects for 1997 seem brighter. The situation in the rest of Europe generally reflects that in the larger countries, with relatively low growth rates likely for 1996 but a pick-up expected next year. For the European Union as a whole, growth is expected to be around 1 1/2 per cent this year, rising to 2 1/4 per cent in 1997.
3.14 By contrast, non-oil commodity prices have weakened recently. Metals prices remain low following the collapse in copper prices over the summer, and grain prices have dropped sharply since the spring. The short-term outlook for raw materials prices remains weak and, with G7 growth projected to be around trend next year, non-oil commodity prices are unlikely to be a source of world inflationary pressure.
3.17 Following some unsteadiness over the summer, G3 long-term interest rates have fallen slightly in recent months. But the rise in long rates in the US at the start of the year has been sustained. As German long rates have drifted down since the early summer, yields in the rest of Europe have also fallen. Long-term interest rates in Japan remain low.
3.19 Despite this strengthening of final demand, GDP growth did not pick up in the first half of 1996, as firms ran off their excess stocks. However, there are now clear signs that stronger demand is feeding through to output, and GDP grew at an annual rate of over 3 per cent in the third quarter.
3.20 It is mainly service sector output that has strengthened this year, growing at an annual rate of over 3 1/2 per cent in both the second and third quarters. Manufacturing output remained broadly flat over the year to the second quarter, held back by stock adjustment. However, it then rose by 0.7per cent in the third quarter, and business surveys suggest that it will strengthen further in the coming months. After showing little change for over a year, construction output also rose in the third quarter.
3.23 Monthly indicators suggest that consumer spending has continued to grow strongly. Retail sales in the three months to October were 4 per cent higher than a year earlier, while the CBI Distributive Trades Survey shows the most buoyant annual sales growth for over eight years. New car registrations in the three months to October were up 3 1/2 per cent on a year earlier. Consumer credit rose by 16 per cent over the year to September, and the EC/GfK index of consumer confidence has risen to its highest levels since the late 1980s.
3.24 Real personal disposable income is forecast to grow by 3 3/4 per cent this year. Dividend payments, which increased by a quarter in 1995, are unlikely to rise as much this year; but real earnings are now growing more quickly, and the income tax cuts which took effect in April have added over 1/2 per cent to disposable incomes. Taking account of the tax changes announced in this Budget, real disposable incomes are projected to grow by 2 1/4 per cent next year.
3.25 Net financial wealth has grown by over 25 per cent in the past 18months as a result of strong share prices and high personal saving. Total wealth is also being boosted by rising house prices.
3.26 With rising wealth and consumer confidence, low inflation, a shift in the balance of income growth from dividend income to wages and salaries, and further consumer windfalls from pay-outs associated with building society conversions, the saving ratio is likely to fall over the next two years. It is assumed to decline from around 12 per cent in the first half of this year to around 8 3/4 per cent by the first half of 1998, although this is still relatively high in comparison with previous periods of low inflation. With real incomes rising and the saving ratio falling, consumers' expenditure is forecast to grow by 4 1/4 per cent in 1997.
3.28 Activity has also been increasing. In the third quarter of this year, the number of mortgage loans approved by banks and building societies was up by 28per cent on a year earlier, and in the three months to October turnover (as measured by particulars delivered at the Land Registry) was up by 19per cent on a year earlier.
3.29 Low mortgage rates, rising real incomes and a low house price-earnings ratio mean that houses are very affordable, and the number of first-time buyers is now increasing. A relative shortage of certain types of property on the market has tended to push up prices. However, supply should increase in the course of the next 18months, as rising prices encourage last-time sellers or those trading down to put their houses on the market and the recent increase in new housing starts feeds through to higher completions. This increase in supply should help to moderate the increase in house prices.
3.33 The financial surplus of industrial and commercial companies has fallen from around 2 per cent of GDP in 1994 to under 1per cent of GDP in the first half of this year. However, company liquidity remains high, and the balance of firms in the CBI survey citing a shortage of internal finance as a constraint on investment eased in October to its lowest level for over seven years. The balance of firms citing a lack of external finance as a constraint on investment remains at very low levels. Companies should therefore have little difficulty in financing higher expenditure on fixed investment and stocks.
Europe
3.07 The activity picture in Europe has brightened a little since the early summer. In Germany, growth was stronger than expected in the second quarter. However, a considerable part of the 1 1/2 per cent increase in GDP reflected special factors, and growth is expected to stabilise at a slower rate in the second half of the year. Although fiscal policy is set to be tightened significantly, the currently low level of interest rates, rising exports and some pick-up in investment should see the recovery continue in 1997.United States
3.10 Growth in the US was faster than trend through the first half of 1996, at an annual rate of 3 1/4 per cent. But growth slowed to an annual rate of 2 1/4 per cent in the third quarter, with a marked slowdown in consumer spending and housing investment. Growth is expected to continue at around its trend rate of 2 to 2 1/2 per cent from now on.Japan
3.11 In Japan, recovery now looks to be firmly established, but the take-off has not been smooth. Growth, at an annual rate of 6 per cent in the first half of the year, was inflated both by public spending and the leap year effect. With public investment set to fade, growth should start to slow in the second half of the year, but the average for 1996 as a whole should still be the strongest for five years. Private sector demand is slowly taking over as the main engine of growth. Residential investment has led the way, but business investment and consumer demand have started to follow suit. The drag from net exports is also starting to fade. Despite next year's fiscal consolidation, growth is likely to continue, although at rates significantly slower than the 4 per cent averaged over the 1980s.World trade
3.12 Growth in world trade in manufactures slowed from over 11 per cent at an annual rate in the first half of 1995 to 7 1/2 per cent in the second half, reflecting the slowdown in Europe and the US. It is estimated to have slowed further, to around 6 per cent, in the first half of 1996, as European activity remained weak and Asian trade growth slowed. World trade growth is forecast to pick up in 1997 and the first half of 1998 as European activity strengthens and Asian exports recover from their slump in 1996. UK export markets are forecast to continue growing more slowly than world trade in 1997 and the first half of 1998, reflecting faster growth in developing countries and strong intra-regional trade in Asia.Commodity prices
3.13 Oil prices have risen sharply in recent months, and are now above theirearlier peak in the spring. It is difficult to explain this increase, although low stock levels and continuing uncertainty over the return of Iraq to the oil market have been contributory factors. The fundamentals of supply and demand generally seem to point to lower prices, but recent volatility means that any assumption about oil prices is very uncertain. For the purpose of the forecast, Brent oil prices are assumed to remain relatively high over the course of next year, averaging $21 per barrel for the year as a whole.Inflation
3.15 G7 consumer price inflation has been steady at around 2 1/4 per cent since the middle of 1995. Some have pointed to an inflation risk in the US, where unemployment is now below the level at which inflation has picked up in the past. But there is little evidence of inflationary pressures to date and, with growth now slowing, underlying inflation is not expected to pick up significantly from the rates seen over the past two years. Some margin of spare capacity is likely to continue to exert downward pressure on inflation in Japan and Europe. Overall, G7 consumer price inflation is forecast to remain at around 2 1/4 per cent in 1997 and the first half of1998.Interest rates
3.16 Official short-term interest rates have been unchanged since January in the US and since September 1995 in Japan, but there has been some recent mild easing in continental Europe. Following a cut in the Bundesbank's repo rate in late August, most other European central banks have reduced short-term interest rates.The UK economy
Demand and output
3.18 Demand growth slowed in 1995, partly in response to the slowdown in activity in continental Europe. The impact on output was cushioned by an accumulation of excess stocks, and GDP grew at an annual rate of around 2per cent for much of the year. Consumer demand has strengthened since the beginning of 1996, and exports have also grown more strongly. After little growth in 1995, business investment was up substantially in the first three quarters of this year.Prospects
3.21 Stock adjustment may largely have run its course. Consumers' expenditure is likely to continue to expand quickly in response to higher incomes and wealth and rising consumer confidence. With capacity utilisation rising and company balance sheets strong, this should be accompanied by a continued recovery in business investment. And exports should benefit from a strengthening of activity elsewhere in Europe. Against this background of rising demand, GDP is forecast to grow at an annual rate of almost 3 1/2 per cent over the next 18 months.Personal sector and the housing market
Consumers' expenditure
3.22 Consumers' expenditure has strengthened since the end of last year, growing at an annual rate of almost 4 per cent over the first three quarters of 1996, compared with growth of 2 per cent in 1995 as a whole. The pattern of spending has also changed. While services accounted for much of the growth in spending in the first half of 1995, it is spending on durable goods which has led the way so far this year. This is consistent with rising consumer confidence, strong growth in consumer credit and a recovering housing market.Housing market
3.27 The recovery in the housing market is now well established. According to both the Halifax and Nationwide indices, prices have been rising since the middle of 1995, and in October were over 7 per cent higher than a year earlier. Rising house prices have helped to reduce the number of households in negative equity to less than half the peak level at the end of 1992.Housing investment
3.30 Private housing investment, which includes both new housebuilding and improvements to existing properties, is forecast to grow only slightly this year. The pick-up in housing starts in recent months, as housebuilders have responded to the recovery in the market, should be reflected in stronger housing investment in 1997.Financial position
3.31 As housing investment rises next year and the saving ratio falls, the personal sector's financial surplus is projected to fall from over 6per cent of income in 1996 to around 2 3/4 per cent of income in the first half of 1998.Corporate sector and investment
Profits
3.32 Profits increased by around a third between 1992 and 1994. They grew more slowly from the beginning of 1995 as productivity growth temporarily slowed. But both profits and the rate of return on capital remain high by historical standards.Investment
3.34 Business investment remained little changed as a percentage of GDP between 1993 and 1995, but it has increased sharply so far this year. Although the quarterly profile has been erratic, in the first three quarters of 1996 it was on average 6per cent higher than a year earlier.
| Percentage changes on a year earlier | ||||
| Forecast | ||||
| 1995 | 1996 | 1997 | 1998 H1 | |
| Business(1) | 1 | 6 | 9 1/4 | 7 3/4 |
| Private dwellings and land(2) | -1 | 4 1/2 | 9 1/4 | 3 3/4 |
| General government(3) | -3 3/4 | -9 3/4 | -10 3/4 | 0 |
| Whole economy | - 1/4 | 3 | 6 1/4 | 5 3/4 |
3.38 Stock adjustment has been underway in manufacturing since the beginning of this year, and this held back manufacturing output at a time when demand was strengthening. Whole economy stockbuilding fell sharply in the second quarter, taking almost 1 percentage point off GDP growth, but it changed little in the third quarter.
3.39 Stock-output and sales ratios remain high in both manufacturing and retailing. With consumer demand strengthening, there should be little incentive for retailers to run off stocks. Destocking in retailing and wholesaling in the third quarter probably reflected stronger than expected demand. Business surveys indicate that there could be some further stock adjustment in manufacturing, but this is likely to be modest. It is assumed that the stock adjustment is complete by the end of this year, and movements in stockbuilding make little contribution to the forecast of GDP growth next year.
3.41 The slowdown in Europe does not appear to have held back UK exports this year as much as had been feared. The volume of non-oil goods exports to European Union countries grew at an annual rate of 5 3/4 per cent in the first half of the year, and rose further in July/August. Exports to other countries were 11 1/2 per cent higher in the third quarter than a year earlier. Exports of cars have been particularly buoyant - in the three months to August they were around a third higher than a year earlier. Exports are expected to continue to grow quite strongly as the recovery in continental Europe gathers pace. Exports of manufactures are projected to grow broadly in line with UK export markets.
3.42 Imports of goods have also been rising more quickly this year, and in the three months to August were 8 per cent higher than a year earlier. Imports of basic materials have been weak because of lower stockbuilding, but imports of consumer goods have picked up sharply in recent months. With domestic demand strengthening, import volumes are expected to continue to grow fairly quickly next year.Trade and the balance of payments
Competitiveness
3.40 Cost competitiveness tends to fluctuate with the exchange rate in the short term. It is likely to have deteriorated as sterling has appreciated this year, reversing the improvement associated with the depreciation of sterling in 1995. However, to the extent that firms adjust profit margins, temporary fluctuations in cost competitiveness need not be fully reflected in export price competitiveness. Export profit margins have been healthy in recent years.Export volumes of goods
Import volumes of goods
| Percentage changes on a year earlier | £ billion | |||||
| Volumes | Prices(1) | Non-oil goods balance | ||||
| Exports | Imports | Exports | Imports | Terms of trade | ||
| 1995 | 8 1/4 | 4 3/4 | 5 1/4 | 8 | -2 1/2 | -15 3/4 |
| Forecast | ||||||
| 1996 | 7 1/4 | 8 1/4 | 1/4 | - 1/4 | 1/2 | -18 |
| 1997 | 6 1/4 | 7 3/4 | -2 | -3 1/2 | 1 1/2 | -18 3/4 |
| 1998 H1 | 7 | 7 3/4 | 1/2 | 1/2 | 0 | -20 1/4 (3) |
Investment income
3.45 The surplus on investment income increased from £7 3/4 billion in 1995 to £12 billion (at an annual rate) in the first half of this year. With profits on heavy foreign direct investment in the UK in recent years beginning to build up and interest rates relatively low abroad, the surplus could fall back a little next year, while remaining historically high.
| £ billion | |||||||
| Manufactures | Oil | Other goods | Services | Total goods & services | Transfers and IPD(1) | Current balance | |
| 1994 | -7 1/2 | 4 | -7 1/4 | 4 3/4 | -6 | 3 3/4 | -2 1/2 |
| 1995 | -8 | 4 1/4 | -7 3/4 | 7 | -4 3/4 | 3/4 | -4 |
| Forecast | |||||||
| 1996 | -8 1/4 | 5 1/4 | -9 3/4 | 6 1/2 | -6 | 4 | -2 1/4 |
| 1997 | -8 3/4 | 5 1/2 | -10 | 7 3/4 | -5 1/2 | 1 1/4 | -4 1/4 |
| 1998 H1(2) | -10 | 5 1/4 | -10 1/4 | 8 1/2 | -6 1/2 | 1 3/4 | -4 3/4 |
[Prepared November 1996]