ECONOMICS RESEARCH

UK | 6 April 2011

UK ECONOMIC OUTLOOK Crunch time for policymakers

There is a palpable nervousness about the near-term economic outlook. Household confidence is low as disposable incomes are being eroded by high inflation and the governments fiscal austerity measures begin to take effect. Government demand is due to switch from being supportive of GDP in Q1 to detracting from it in Q2 (Figure 1). Moreover, we expect the Bank of England to respond to high inflation by raising the policy rate in Q2. We believe the fall in GDP in Q4 was a blip rather than a sign of more fundamental weakness, and expect growth to have rebounded in Q1. Even so, underlying demand momentum remains subdued and we forecast growth of just 1.8% in 2011 as a whole. Even in the medium term we see growth settling at only around 2% per year, well below its long-run average of 2.5%. The outlook for household demand is especially weak. We expect unemployment to remain high, limiting growth in pay and generating a second consecutive annual fall in real disposable income. Although we do not believe that limited access to bank finance will hinder investment, an investment-led recovery seems highly unlikely. Goods exports is a bright spot, however, and we expect the economy to benefit from supportive contributions from net trade. Inflation is likely to remain well above target throughout 2011, reflecting increases in indirect taxes and the ongoing effects of high oil prices. We continue to believe that high inflation will be temporary, and expect it to return close to target in 2012. However, there is a risk that a persistent adverse shift in the global inflation environment leaves the MPC unable or unwilling to engineer the necessary offsetting weakness in domestic demand, and that above-target inflation becomes more firmly entrenched. Figure 1: Fiscal and monetary squeeze expected to start in Q2 11
pp q/q 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15
Source: Haver Analytics, OBR, Barclays Capital

Chris Crowe Simon Hayes Blerina Uruci

www.barcap.com

Govt. growth contribution Bank rate, RHS

forecast

% 7 6 5

Average govt. contribution

4 3 2 1 0

THIS DOCUMENT WAS ORIGINALLY PUBLISHED ON 6 APRIL 2011. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 10

Barclays Capital | UK Economic Outlook

Crunch time
Prospective government cuts and higher interest rates have made people nervous about the economic outlook

Ever since last Junes Budget the question has been raised whether the economy would be sufficiently strong to withstand the governments fiscal austerity plans. We are about to find out. The surprise drop in Q4 GDP has added to concerns that the government might be cutting too far too fast, and household confidence has weakened considerably as the fiscal adjustment has begun to bite in earnest. Adding to the dismal outlook, persistently high inflation has not only eroded real incomes, but has led more MPC members to contemplate tightening policy in spite of still-fragile demand. Such is the unhappy economic conjuncture, and nervousness about near-term economic prospects among policymakers, households and companies is palpable. Our expectation is that the economy will continue to recover but at a lacklustre pace. We believe there is sufficient momentum in private activity to offset both the contraction in government demand and moderate increases in interest rates. The demand outlook is subdued, however, and we expect growth of just 1.8% in 2011 following last-years 1.3% expansion. Even in the medium term we expect growth to settle at only around 2%, some way below the economys long-run average rate of 2.5%. The UKs inflation problem is unlikely to go away in the near future. Pipeline inflationary pressures show little sign of abating, and we expect CPI inflation to remain around twice the target rate for the rest of the year. Our central expectation is that it will then fall back close to the 2% target. However, the global inflation environment appears to have shifted, and with the MPC hesitant to act there is a risk that above-target inflation becomes more firmly entrenched in the economy, notwithstanding sluggish demand. In this article we set out our latest forecasts for GDP growth, inflation and monetary policy. In addition to our normal quarterly forecasts, which currently extend to Q4 12 (Figure 13), for the first time we also present our annual forecast to 2015 (Figure 14).

We think the economy will continue to grow, but at a subdued pace, and we expect inflation to remain high

Q4 GDP drop expected to unwind

We expect GDP to rebound in Q1 as a number of erratic influences from Q4 unwind

We estimate that the economy grew by 0.7% q/q in Q1 11, as the impact of the bad weather in December on the Q4 outturn was unwound (Figure 2). We anticipate that a 0.6pp q/q contribution came from net trade, thanks to the unwinding of some large erratic items on the import side in Q4 and continued strong growth in exports. We think that a bounce-back in consumption demand, following the 0.3% q/q decline in Q4 10, and a similar recovery in investment, added a further 0.2pp q/q each to overall growth. In addition, we expect that government consumption made a 0.1pp q/q contribution. Offsetting these positive forces, we expect some unwinding of the extremely strong stockbuilding activity during 2010, with lower inventory accumulation subtracting 0.5pp from q/q growth in Q1. Our overall estimate for GDP growth in Q1 11 is somewhat stronger than the evidence from recent business surveys. Our composite PMI points to growth of 0.6% q/q while the BCC survey for Q1 maps into growth of just 0.1% q/q. However, these surveys failed to signal the extent of the weakness in GDP in Q4, and the BCC said its Q1 survey contained a lingering downward effect from the bad weather in December.

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Barclays Capital | UK Economic Outlook

Consumers wilt under pressure

Households face some severe headwinds and we expect consumption to be very weak

The outlook for household demand appears very weak. Not only does recent momentum appear weak consumption is estimated to have grown by just 0.2% y/y in Q4 10 but households face some severe headwinds. In fact, weak consumer sentiment has been a major feature of the data in recent months. Consumer confidence indicators began to trend down in early 2010, and fell further in Q1 11 (Figure 3), and uncertainty about the effects of the governments austerity measures seems to have been a key driver. As the implications of the governments plans become increasingly clear, it is possible that consumer sentiment will recover. However, it also seems possible that households have not fully factored in the impact of the proposed measures, in which case we may see further declines in sentiment in Q2 as job losses and tax increases take effect. The third GDP release for Q4 10 reported a surprisingly large drop in consumption of 0.3% q/q, which subtracted around 0.2pp from overall GDP growth. We expect that some of this weakness reflected the impact of Decembers bad weather, and expect a largely mechanical recovery in consumption growth to have occurred in Q1. However, we forecast consumption growth to moderate in Q2, and for growth over 2011 as a whole to be a very weak 0.6%. Over the medium term we expect consumption growth to accelerate somewhat, reaching around 1.7% in 2015, but still some way below its long-run average of 2.6%. A key driver of our pessimistic view of consumption is real household income, where we expect a decline of 0.4% in 2011 following the 0.8% fall in 2010 (Figure 4). Households have not seen consecutive years of decline in real disposable income since the 1970s. Although we expect annual household income growth to become positive in 2012, we anticipate that the rate of growth will remain well below its historical trend as unemployment stays high, maintaining downwards pressure on wages.

We expect the unemployment rate to remain high for several years

The labour market is likely to be key to the path of consumer spending. As has been well documented, unemployment did not rise during the recession by anywhere near as much as might have been expected, given the size of the drop in GDP. However, the corollary is that we should not expect unemployment to fall rapidly as the economy recovers. In fact, given the prospective public sector job cuts, we expect the unemployment rate to remain at around 8% for the next several years.

Figure 2: Contributions to GDP growth 2010-12

% q/q 1.5 1.0 Hhld consumption Stockbuilding Net Trade Investment Gvt consumption GDP

Figure 3: Consumer confidence

Index 120 100 80 Nationwide (lhs) GfK (rhs) Balance 0 -5 -10 -15 -20 -25 -30 -35 -40 -45 07 08 09 10 11

0.5
60

0.0 -0.5 -1.0 2010 2011 BarCap forecasts 2012

40 20 0

Source: Haver Analytics, Barclays Capital

Source: GfK, Haver Analytics, Barclays Capital

15 April 2011

Barclays Capital | UK Economic Outlook

Planned public sector job cuts are likely to offset private job creation

The planned public sector job cuts are not only material, but contrary to popular belief they are scheduled to be back-loaded within the governments deficit reduction plan. The latest forecasts by the Office for Budget Responsibility imply that around 20,000 jobs will be shed in the current fiscal year, but that this will rise to 90,000 in 2013-14 and 190,000 in 201415. The OBR has downplayed its ability to predict the precise timing of cuts, but this profile of building public sector job losses explains why we do not forecast the unemployment rate to decline as GDP growth improves in the medium term. In fact, we remain concerned that there may be an upside risk to our unemployment profile. Productivity remains well below pre-crisis levels, particularly in the services sector, which accounts for more than 80% of total employment. As a result, there is a risk that firms might decide to shed workers in order to return productivity to closer to pre-crisis levels. This would push unemployment significantly higher than our current forecast of around 8%. However, so far we have seen few signs of this risk materialising, as surveys of hiring intentions have shown no marked deterioration. The housing market outlook is also germane to consumer demand, as both are affected by household sentiment and because changes in housing wealth appear to be an important driver of household savings. The recovery in the housing market seen during the first half of 2010 lost momentum in H2, when prices began to drift downwards once again. This seemed consistent with the weakening in consumer confidence over the period. However, there have recently been signs of a renewed pick-up in the housing market, with the Nationwide house price index registering a couple of months of unexpected rises and house-builders reporting a surprising strength of interest in new house purchases. It is too early say whether this is a sign of stronger momentum or, as seems more likely, normal volatility in the data. We expect the housing market to stay subdued for the remainder of the year.

If households increase savings the growth outlook will be even weaker

Another risk to our consumption forecast is that households could choose to save more. We currently expect the household savings rate to remain around 5% over the next few years. However, given that household debt remains high relative to incomes there is an ongoing risk of an autonomous shift in savings behaviour. Such a shift would materially weaken our consumption forecast, and therefore the outlook for GDP growth. However, our base view remains that households will be unwilling to rebuild their savings substantially as long as real wage growth remains weak. Figure 5: Retail sales volumes and values, ex auto fuel
Forecasts % 3m/3m 2.5 Avg. 1956-2006 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 Volumes Values

Figure 4: Real household disposable income

% y/y 10 8 6 4 2 0 -2 -4 56 60 64 68 72 76 80 84 88 92 96 00 04 08 12
Source: Haver Analytics, Barclays Capital

05 05 06 06 07 07 08 08 09 09 10 10 11
Source: Haver Analytics, Barclays Capital

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Barclays Capital | UK Economic Outlook

One potentially brighter observation is that although consumer spending has declined in real terms since 2008, nominal expenditure has increased: at the end of last year household expenditure was about 3.0% lower than at the start of the recession in real terms, while in nominal terms it was 6.1% higher. Similarly, the recent retail sales data appear much stronger in nominal terms than in real terms (Figure 5). This discrepancy which mechanically reflects the high rate of consumer price inflation has two competing interpretations. The positive spin is that household demand is more robust than we think, and that if it were not for the rise in VAT and higher import prices real spending would have been significantly stronger. The second interpretation, however, is that households have been slow to adjust their spending as prices rose, and that real demand will be even weaker in the future. As such, although the strength of nominal demand may indicate that the consumer outlook is not as downbeat as we think, we are not yet inclined to take it as an unadulterated positive.

Business investment is a follower, not a leader

There is substantial scope for a recovery in business investment but we do not expect an investment-led recovery

Business investment fell by more than a quarter between mid-2008 and the end of 2009, and remains almost 17% below its peak. There is therefore substantial scope for recovery. However, firms remain unsure about the strength of future demand, and investment intentions remain subdued (Figure 6). While manufacturing firms have been performing relatively strongly on the back of rapid export growth, consumer-facing firms in the services sector face uncertain trading conditions. A review of past recoveries shows that investment has typically responded with a lag to the pick-up in aggregate activity rather than leading it. Figure 7 shows the investment to GDP ratio in each of the last four recessions relative to its level in the last quarter of the recession. An investment-led recovery would be characterised by the lines moving decisively into the north-east quadrant of the chart. This quadrant is, however, almost completely empty. Concern is often raised that weak bank lending to companies will hold back the recovery. However, the vast majority of business investment is conducted by large firm that have substantial access to non-bank sources of finance. Also, historically, business investment has been closely related to profits growth as retained earnings are also a key source of finance. Profits growth has been rapid recently as firms have successfully passed on cost increases, and we expect business investment to recover by around 8% in 2011. More generally, in the absence of binding financing constraints we would see business investment as a likely amplifying factor to GDP growth over the next few years.

Figure 6: Investment intentions remain subdued

% y/y 30 20 10 0 -10 -20 -30 90 92 94 96 98 00 02 04 06 08 10 BarCap survey-based estimate Official estimate

Figure 7: Investment/GDP, relative to end of recession

pp 5 4 3 2 1 0 -1 -2 -3 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 1973-75 1990-91 1980-81 2008-09

quarters from end of recession

Source: Haver Analytics, Barclays Capital

Source: Haver Analytics, Barclays Capital

15 April 2011

Barclays Capital | UK Economic Outlook

Goods exports strong but net trade otherwise disappointing

The disappointing net trade performance reflects weak services exports and strong imports

The UKs net trade performance has been disappointing. Sterling has been about 25% below its pre-crisis average in trade-weighted terms since the end of 2008 and yet net trade is estimated to have subtracted 1pp from GDP growth in 2010. It is important to distinguish, however, between the behaviour of exports in particular goods exports and that of imports. Goods export growth has been healthy: export volumes rose by 2.6% q/q in Q4 and by 10.5% y/y. Exports of services have been weaker, up by just 0.4% q/q in Q4 and -1.6% y/y. This goods-services differential accords with the very different reports emanating from the manufacturing and service sector surveys, with the former buoyant and the latter subdued. According to Bank of England estimates, the weakness in services exports relates primarily to exports of financial services, for which demand has yet to show a significant recovery. Even so, we expect further firm growth in exports, with growth of close to 9% in 2011, moderating to around 8% in subsequent years. In the near term this is consistent with upbeat surveys of export orders while in the medium term it is sustained by our expectation that global activity will remain solid. Imports jumped by 3.2% q/q in Q4 10, boosted by an erratic component (aircraft purchases). We expect a corresponding weakening in imports in Q1 11, leading to a sizable GDP contribution from net trade. More generally, however, import growth was surprisingly strong throughout 2010, showing little sign that import demand had weakened in response to higher import prices. The configuration of UK production appears to have made it difficult or impossible for firms to switch input purchases from overseas to domestic producers. As domestic demand strengthens which happens only gradually in our forecast we therefore expect to see import growth picking up, limiting the size of the overall net trade contribution as the economy recovers.

The government demand squeeze starts

Government demand is due to switch from being supportive of demand to subtracting from it

Despite the intense media focus on the effects of government cuts on the economy, the contribution of government consumption to aggregate demand is not expected to turn negative until Q4. Government consumption is projected to be a drag on growth for each of the next four years, however, marking the largest decline since the data began in the 1950s. As a share of GDP, we project government consumption to drop to 19.6% in 2015, from an estimated 23.4% in Q1 11, taking it from well above its average over the past 40 years to significantly below (Figure 8) although still some way above of the low of 17.6% seen in 1998. The projected peak-to-trough fall in the ratio of 4.1pp over six years is larger than the 3.8pp fall over a six-year period in the mid-1990s and the 3.3pp drop over eight years seen in the 1980s. The more material effect on GDP in the near term comes from the planned cuts to government investment. This years cuts in government investment are scheduled to be the largest in the next five years, and we expect it to fall by nearly 13% in 2011. Although this is a small component of aggregate demand, typically accounting for only around 2% of GDP, the size of the drop means the drag on growth is non-negligible, shaving around 0.2-0.3pp off annual growth this year. Overall, we expect government demand (consumption and investment) to have made a small positive contribution to growth in Q1, but to make a negative contribution from this point onwards.

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Barclays Capital | UK Economic Outlook

The inflation problem persists

We expect CPI inflation to stay around twice the target rate for the rest of the year

Inflation was above target for the whole of 2010, and rose to 4.4% y/y in February, driven largely by rising prices of petrol and food. We expect inflation to close to twice the 2% target rate until the end of this year, as higher petrol and utility prices and persistently high services inflation combine with duty increases for alcohol and tobacco (Figure 9). However, many of the factors underlying the current high rate of inflation the January VAT increase and other tax changes, higher commodity prices and the delayed impact of the devaluation of sterling in 2007-08 are expected to drop out of the annual calculation, taking inflation back closer to target. Over the medium term we expect that the continued spare capacity in the economy, combined with the modest series of rate hikes that we expect from Q2 onwards, will exert downwards pressure on inflation. We expect CPI inflation to return to target by around the middle of next year, although we expect RPI inflation to fall by less, to around 4%, during 2012, owing to the effect of rising interest rates on mortgage interest costs. The key risk to this forecast is that inflation expectations, which have been trending upwards as inflation itself has continually come in ahead of expectations (Figure 10), may feed into increased wage pressure and pricing behaviour. Although still tentative, there is some evidence that private sector pay settlements have begun to edge upwards (Figure 11) and business surveys show that firms pricing intentions remain elevated. Should these developments become more concrete, the MPC can of course respond by tightening policy more aggressively. However, by this point they would already be behind the curve.

...to the discomfort of the MPC

We expect the MPC to increase Bank Rate by 25bp in May, although further weak activity data may delay tightening

The policy dilemma facing the MPC is well known: persistent above-target inflation argues for a tightening in policy but a fragile demand outlook suggests that caution is warranted. Money market investors expect the MPC to raise Bank Rate by 50bp this year but are uncertain about timing. At the time of writing, a 25bp rate rise is about 70% priced in for May and fully priced in for July. Our hat is hung on a May hike for a number of reasons: We believe that the frequency with which the MPC has been forced to revise up its inflation forecast has made it increasingly

Figure 8: Government consumption

% GDP 24 23 22 21 20 19 18 17 16 55 59 63 67 71 75 79 83 87 91 95 99 03 07 11 15
Source: Haver Analytics, Barclays Capital

Figure 9: Inflation
CPI RPI % y/y % y/y
Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 2010 Oil $ 3.5 3.0 3.4 3.7 3.4 3.2 3.1 3.1 3.1 3.2 3.3 3.7 3.3 79.8 3.7 3.7 4.4 5.3 5.1 5.0 4.8 4.7 4.6 4.5 4.7 4.8 4.6 Jan 11 Feb 11 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 2011 Oil $

CPI RPI % y/y % y/y

4.0 4.4 4.1 3.9 4.2 4.2 4.4 4.3 4.7 4.5 4.2 3.4 4.2 5.1 5.5 5.2 5.0 5.2 5.3 5.5 5.5 5.9 5.8 5.5 4.8 5.3 Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 2012 Oil $

CPI % y/y
2.6 2.2 2.3 2.2 2.2 2.1 1.8 1.7 1.6 1.7 1.8 1.9 2.0

RPI % y/y
4.2 3.8 4.0 4.0 3.9 4.0 3.7 3.6 3.6 3.7 3.9 3.9 3.8

Average

112.0

111.0

Source: Haver Analytics, Barclays Capital

15 April 2011

Barclays Capital | UK Economic Outlook

uncomfortable with its prior view that inflation will fall significantly below target in 2012. Although many of the causes of the current high rate of inflation are beyond the MPCs control, the danger is that an environment has been created in which firms believe they can increase prices at a faster rate either to push through cost increases or to raise margins. Similarly, there is evidence that some workers are seeking to resist the squeeze in their real income. Moreover, the fact that the ECB is likely to begin tightening poses risks to UK inflation via the currency should the MPC remain inactive, and the contrasting behaviour of the two central banks provides further ammunition to those who question the MPCs commitment to the inflation target. Even so, a May rate hike is far from certain. As noted earlier, recent indicators of household spending have been weak, and the MPC is likely to be concerned that the extra pressure on household incomes from higher interest rates might make a bad situation worse. It is easy to envisage a course for the data that would dissuade a majority of MPC members from voting for higher rates in May. The markets hesitancy to price fully a May hike therefore seems appropriate. Whatever the timing of the first rate increase we believe that volatile data and a subdued underlying demand outlook mean that interest rates will rise only gradually and in small steps. We expect Bank Rate to rise to 1.25% by the end of the year and to 2.5% by the end of 2012, and to reach a neutral level of 4.5% by mid-2014. Although it is possible that rate normalisation is even more gradual than we forecast, the bigger risk in our view is that rates are increased more quickly. We think this risk is particularly pronounced in 2012, if growth in the latter part of this year turns out to be solid and inflation fails to fall as quickly as the MPC expects.

One final concern: the risk of entrenched inflation

If the recent turnaround in global inflationary pressures persists, UK inflation could be higher for longer

Although the MPC has ample scope to tighten monetary policy should the inflation situation become more worrying, we believe there are reasons for some residual concern about the medium-term inflation outlook. For much of the period that the Bank of England has been targeting inflation goods price inflation has been low or negative. This, in turn, largely reflected a supportive global inflation environment as manufacturing production was relocated to China, although it was also the result of a strong currency (sterling appreciated by around 25% in 1996/97, an appreciation that persisted for the following ten years). Imported inflation was generally negative. Taking goods price inflation as largely Figure 11: Wage pressure growing?
Private Sector Core Earnings BCC pay pressure (RHS) REC perm. staff salaries (RHS) Jan. 11

Figure 10: Bank of England inflation expectations survey

% 5.0 1yr 4.5 4.0 3.5 3.0 2.5 2.0 1.5 05 06 07 08 09 10 11 2yr 5yr

% y/y 6 5 4 3 2 1 0 01 02

% bal. 65 60 55 50 45 40 35 30 25 20 15 11

03

04

05

06

07

08

09

10

Source: Bank of England

Source: BCC, Haver Analytics

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Barclays Capital | UK Economic Outlook

exogenous, driven by global markets, one might characterise the MPCs actions over this period as ensuring that domestic demand was sufficiently strong to generate robust services inflation (Figure 12). Import price inflation and consumer goods price inflation have turned positive once more. The recent preponderance of above-target inflation rates could therefore be viewed as the result of a failure by the MPC to generate weaker inflation in domestic services to compensate for the strengthening in goods inflation. Indeed, the committees previous actions to support growth may have embedded excessive inflation expectations in the minds of service sector wage and price setters, making it all the more difficult to bring inflation down in the sector. Of course, to some degree this has been deliberate as the factors behind the rise in goods inflation have largely been viewed by the MPC as one-off factors. However, given the ongoing strength of global commodity prices, there is reason to believe that we may be entering a sustained period in which global inflationary forces are more pronounced. If this is the case, the MPC will need to lean down on domestic demand to weaken services inflation if the overall inflation rate is to remain on target.
The tightening needed to force domestic services inflation down may prove politically difficult

Although this policy prescription is the product of benign logic its implications may be rather unpleasant. Suppose that consumer goods inflation were to settle at around 2%. Consumer services inflation would also need to be around 2% for the target to be met. Consumer services prices tend to evolve at a similar pace to service sector wages, so the MPC would have to hold services wage inflation at around 2% for a sustained period, about half of its average pace prior to the recession. We would question the feasibility of this: the short-term historical relationship between service sector activity and services wage inflation suggests that the MPC would probably have to force the sector into recession. As the committee is unable to target services specifically, having only one interest rate at its disposal, other sectors that are more sensitive to interest rates such as construction and manufacturing would pay a heavy price for this adjustment. If the global inflation environment is sufficiently malignant, therefore, the required adjustment in the domestic economy to keep overall inflation on target might be deeply damaging, and politically discomfiting, while failure to act might mean that above-target inflation becomes embedded in the economy.1 Figure 12: Goods and services CPI inflation
% y/y 7 6 5 4 3 2 1 0 -1 -2 -3 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Services Goods

Source: Haver Analytics, Barclays Capital

1

See our note Global inflation shift demands an inflation target rethink, 15 March 2011, for more discussion of how the inflation targeting framework might be adjusted to cope with such a scenario.

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Barclays Capital | UK Economic Outlook

Figure 13: Quarterly Outlook 2010-12

% Change q/q Real GDP Real GDP (saar) Real GDP (y/y) Private consumption Public consumption Investment Inventories (q/q cont.) Net exports (q/q cont.) Nominal GDP Industrial output Employment Unemployment rate % CPI inflation y/y Core CPI y/y Current account (% GDP) Govt. balance (% GDP)* Bank Rate Q1 0.2 0.8 -0.4 -0.2 0.5 3.9 0.5 -0.8 1.9 1.1 -0.2 8.0 3.3 2.9 -2.6 ... 0.50 2010 Q2 Q3 1.1 4.3 1.5 0.5 0.2 0.1 0.5 0.2 0.7 1.1 0.6 7.8 3.4 3.0 -2.1 ... 0.50 0.7 2.9 2.5 -0.1 -0.5 3.6 0.6 -0.1 1.1 0.4 0.6 7.7 3.1 2.7 -2.4 ... 0.50 Q4 -0.5 -1.9 1.5 -0.3 0.4 -1.8 0.4 -0.5 0.5 0.7 -0.2 7.9 3.4 2.8 -2.9 ... 0.50 Q1 0.7 2.6 2.0 0.3 0.6 1.4 -0.5 0.6 1.7 0.4 0.3 7.8 4.1 3.2 -2.3 ... 0.50 2011 Q2 Q3 0.6 2.2 1.5 0.1 0.3 1.0 0.0 0.2 1.3 0.3 0.1 7.8 4.1 3.1 -2.0 ... 0.75 0.6 2.5 1.4 0.3 0.2 0.9 0.0 0.2 1.2 0.3 0.1 7.8 4.5 3.2 -1.8 ... 1.00 Q4 0.6 2.3 2.4 0.3 -0.3 0.9 0.0 0.3 1.0 0.3 0.1 7.9 4.0 3.1 -1.5 ... 1.25 Q1 0.6 2.5 2.4 0.4 -0.4 1.5 0.0 0.2 1.3 0.6 0.2 7.8 2.4 -1.3 ... 1.50 2012 Q2 Q3 0.5 2.1 2.4 0.4 -0.4 1.5 0.0 0.1 1.2 0.7 0.1 7.8 2.2 -1.1 ... 2.00 0.5 2.1 2.2 0.4 -0.4 1.5 0.0 0.1 1.2 1.0 0.1 7.8 1.7 -1.0 ... 2.50 Q4 0.5 2.0 2.2 0.3 -0.4 1.4 0.0 0.1 1.2 1.2 0.1 7.8 1.8 -0.8 ... 2.50 Calendar year average 2010 2011 2012 ... ... 1.3 0.6 0.8 3.0 1.4 -1.0 4.2 2.0 0.2 7.9 3.3 2.9 -2.5 -9.9 0.50 ... ... 1.8 0.5 0.9 3.2 0.3 0.6 4.7 1.9 0.6 7.8 4.2 3.2 -1.9 -7.7 1.25 ... ... 2.3 1.4 -1.0 5.2 0.0 0.8 4.9 2.4 0.5 7.8 2.0 ... -1.1 -6.1 2.50

* Fiscal year forecasts, 2010 = FY 2010-11

Source: ONS, Barclays Capital

Figure 14: Annual Outlook 2009-15

Outturn 2009 Output at constant market prices Gross domestic product (GDP) GDP Levels (2009=100) Expenditure components of GDP at constant market prices Household consumption Business investment General government consumption General government investment 1 Net trade Inflation CPI RPI Labour market Employment (millions) 2 Average earnings ILO unemployment Claimant count (millions) Memo items (% GDP) 3 Output gap PSNB Bank rate (end of period)
4

Forecast 2010 1.3 101.3 2011 1.8 103.1 2012 2.3 105.4 2013 2.0 107.6 2014 2.0 109.7 2015 2.0 111.9

-4.9 100.0

-3.2 -18.9 1.0 16.9 0.9 2.2 -0.5 29.0 1.6 7.6 1.53

0.6 2.6 0.8 3.2 -1.0 3.3 4.6 29.0 1.3 7.9 1.50

0.5 7.8 0.9 -12.7 0.6 4.2 5.3 29.2 2.2 7.8 1.45

1.4 7.4 -1.0 -8.2 0.8 2.0 3.8 29.4 2.9 7.8 1.46

1.5 6.7 -1.8 -5.4 0.6 1.7 3.6 29.5 3.5 7.9 1.48

1.6 5.7 -2.4 -1.8 0.7 1.8 3.6 29.6 4.5 8.1 1.55

1.7 4.9 -1.9 2.9 0.6 1.9 3.5 29.6 4.9 8.4 1.62

-4.0 11.1 0.5

-3.0 9.9 0.5

-2.1 7.7 1.25

-1.1 6.1 2.5

-0.7 4.5 3.5

-0.6 3.3 4.5

-0.6 2.1 4.5

Note: 1: contribution to GDP growth, 2: wages and salaries/employment, 3: % potential output, 4: fiscal years; excluding the impact of financial interventions. Source: ONS, Barclays Capital

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Analyst Certification(s) We, Simon Hayes, Chris Crowe and Blerina Uruci, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgibin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

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