UK economy: GDP growth returns to positive territory

GDP will decline by 0.3% in 2012 but on a quarterly basis growth should return to positive territory in H2. The economy will expand by 1.3% in 2013 which is close to our assessment in August Nordic Outlook as well as the IMFs new forecast of 1.1%. Headline inflation fell to 2.2% in September which was the lowest print since the end of 2009. Meanwhile core inflation held steady at 2.1%. Going forward we expect inflation to edge lower and stay below the inflation target of 2% for the most part in 2013-14. The strong employment growth is surprising since GDP growth has been weak, but the Olympics have boosted the figures. Going forward, we expect employment growth to run out of steam and the unemployment rate to edge higher again. Sluggish growth and inflation below the inflation target in the medium term suggest that Bank of England will expand its asset purchase program again before yearend.

WEDNESDAY 17 OCTOBER 2012 Mattias Brur mattias.bruer@seb.se SEB Economic Research

Key data Percentage change

2011 2012 2013 2014 GDP* Unemployment** Inflation* Government deficit**

Source: SEB

0.9 8.2 4.5 -8.5

-0.3 8.2 2.7 -8.2

1.3 8.4 1.8 -7.3

1.6 8.5 1.5 -5.8

* Percentage change, ** Per cent of labour force, *** Per cent of GDP

Economic Insights

Consumer confidence is at its highest level since 2011 but confidence in the household sector is much lower compared to most business surveys. Meanwhile in the manufacturing sector PMI fell to 48.4 in September and the services PMI fell as well but remains well above 50. That being said, since the beginning of September economic data has generally surprised on the high side. According to the housing price indices we follow the year-on-year trends have been broadly flat since 2010. But since inflation has been relatively high, in real terms UK house prices are actually deflating significantly. Reflecting the Olympic Games and the extra bank holiday, economic activity has been volatile in recent months. But compared to May the last data point unaffected by distortions both industrial production and exports are weaker today. A GDP bounce-back in Q3 notwithstanding, what this is suggesting is that the underlying trend is still weak.

Economic Insights

GDP is 14% below the level it would have reached had the severe recession in 2008-2009 not occurred and the economy continued to grow at its long-run rate. Nevertheless, according to OECD the output gap is 4.2% of GDP and according to the OBR it is just 2.6%. In our view the output gap is at least as big as the OECD estimate suggests. In other words, the UK economy has probably a potential to grow above trend for several years without inflation taking off. Despite continuing job cuts in the public sector, overall employment is heading higher since private sector employment has risen by 800,000 over the last year. Recently, however, indicators of employment in the private sector have weakened which is suggesting that private sector employment growth is slowing down. The strong employment growth is surprising since GDP growth has been weak, but arguably the Olympics have boosted the figures. Going forward, we expect employment growth to run out of steam and the unemployment rate to edge higher.