United Kingdom: Risk Assessment
Business Climate Rating1
Dynamic growth for 2014
Growth was sustained in 2013 (+1.7%), driven by a resurgence of household consumption and a positive inventory effect, with the services (services to firms) and construction sectors as the leading contributors. In 2014, household consumption remains the leading contributor to growth.
The unemployment level however remains high compared to the long-term average (6.6% at the end of April 2014 compared to 5% from 2000 to 2008). But the trend is nonetheless positive and the Bank of England (BoE) committed to maintain an expansionist monetary policy as long as unemployment remains at 7% or higher, with stable inflation at 2% (±1%). According to the latest forward-looking statement from the central bank, monetary policy is unlikely to be tightened before the first quarter of 2015. In this context, households and investors will continue to benefit from historically low interest rates in 2014. Although household debt is at a very high level (130% of disposable income in October 2013), average net worth is also high (700% of annual income), boosted by stronger property prices (+8% in 2013, +26% year on year in London at the end of Q2 2014). Consequently, consumer confidence is strong. However, there is an important risk of real estate bubble in the UK which could lead to a sharp slowdown of the economy (especially of consumption) if the bubble is to burst. Consumption is moreover driven by a decline in savings (5.1% of disposable income in 2013 against 7.3% in 2012). The finance minister Mr Osborne argued in January 2014 in favour of an 11% hike in the minimum wage in the UK by 2015. Furthermore, the state is also supporting the construction sector via stimulus measures in the property market (Help to Buy). In 2013, the government ploughed almost 1% of national wealth, i.e. close to £17 billion, into infrastructure construction and home-building projects, at the same time announcing its intention to prioritise the improvement of the road network. This sector will therefore remain on a positive trend in 2014. In the manufacturing sector, production remains 15% below the pre-crisis level, similar to the beginning of the 1990s. Business manager surveys carried out in January 2014 reflect rising confidence in the UK economy over the medium term. With a strong rate of production capacity utilisation (82%), economic activity will be supported by an increase in investments, particularly the renovation of fixed capital. Loans to SMEs will continue to grow in 2014, as the BoE will help SMEs to get funds by offering cheap liquidities to the lending banks through the “Lending for Lending Scheme” which was modified in this regard in the fall of 2013. Furthermore, corporate tax was reduced by two points in April 2014 (21%). In 2014, the State will cut welfare benefits (excluding healthcare, education and retirement pensions), so as to reduce charges weighing on companies (lower employer contributions) and to lower the top income tax band (to 45% compared to 50% previously). Inflation will remain slightly below the 2% inflation target.
Stronger exports in 2014
The uptick in economic activity in the euro zone (47% of exports) will accentuate positive input to growth from external trade. Growth will accelerate within the UK’s two main trading partners, Germany and the US (each representing 11% of exports). Furthermore, although British products enjoy limited price elasticity, they will nonetheless benefit from a relatively weak pound. Indeed, the exchange rate at the end of June 2014 was effectively around £0.8 for 1€, compared to £0.65 from 2000 to 2007, i.e. over 20% lower. Although the UK has several high tech industrial sectors (pharmaceutical, automotive, aeronautics), the current account balance remains highly dependent on financial services and services to firms. The global trade deficit to GDP is approximately 7 points, whereas the services trade balance stands at a 5-point surplus. London remains the world’s leading financial market. A more rapid pace of growth among developed economies will boost UK financial services. In this context, the current account deficit will contract slightly in 2014.
The banking system remains over-dimensioned
Banks constitute a weak point in the economy. In absolute value terms, the UK banking system is effectively the third-largest in the world, after the US and Japan (£11,000bn representing 900% of GDP). In order to limit systemic risk resulting from a default or a recapitalisation of one of the majors, the UK banks have had to streamline their balance sheets. They have therefore reduced their balance sheets by almost 20% and amassed deposits in order to limit refinancing risk. The two major nationalised financial institutions in particular (RBS and Lloyds) are ahead of schedule in terms of implementing the restructuring plans imposed by the European Commission. However, banks with the strongest domestic market presence remain heavily exposed to property risk. The BoE announced that it will introduce a measure aimed at slowing down the growth in high risk mortgage loans in October 2014. At most 15% of the loans granted shall concern households receiving less than 4.5 times the amount of their monthly repayments. This measure is however preventive of a bubble risk, as these risky loans currently account only for 11% of total loans.
- Bank of England’s flexible monetary policy
- Hydrocarbons production meeting three quarters of energy needs
- Economy highly dependent on financial services and property market
- Disagreement within the government coalition over European question
- High public debt and deficit levels
- High private debt
- Weak banking system
- Significant share of young people in the unemployment figures, possible source of social tensions