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Green Budget: The Economic Outlook January 30 th 2008

This report provides a detailed analysis of the economic outlook, including forecasts for GDP growth, consumer spending, and household debt. It also highlights potential risks and offers alternative GDP growth scenarios.

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Green Budget: The Economic Outlook January 30 th 2008

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  1. Green Budget: The Economic Outlook January 30th 2008 David Miles, Chief UK Economist David.Miles@morganstanley.com Morgan Stanley does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.Please see important disclosures at the end of this report.

  2. Summary • A worse outlook than for some time: our central forecast is for two years of below trend growth • Weaker consumer spending for the next few years • Slower growth in the economies of the UK’s major trading partners • We forecast weaker GDP growth than the Treasury in 2008–09 and 2009–10. Thereafter, we project slightly stronger growth than the Treasury

  3. Figure 4.1. Economic growth and inflation since 1957 Source: ONS

  4. Near-term outlook: consumer spending key

  5. Figure 4.3. Saving rate 12 Overall 10 Excluding change in net equity of households in pension schemes 8 6 Saving rate (%) 4 2 0 -2 Q1 2007 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 1995 Q1 1996 Q1 1997 Sources: ONS; Morgan Stanley Research.

  6. Figure 4.4. Household gross financial liabilities 175 1995 2005 150 125 100 % of disposable income 75 50 25 0 UK US Germany France Italy Spain Sources: Eurostat; Federal Reserve; BEA; Morgan Stanley Research.

  7. Figure 4.6. Debt servicing and interest rates 18 Debt servicing a % of disposable income (MIRAS adjusted) 16 Bank of England base rate 14 12 10 Per cent 8 6 4 2 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2004 2005 2006 2007 1988 1989 1990 2002 2003 Notes: Debt servicing is interest payments b y households and regular payment of mortgage principal. MIRAS is mortgage interest tax relief (phased out during the 1990s). Sources: Bank of England, ONS; Inland Revenue; Morgan Stanley Research.

  8. 7 Real household sector consumer spending 6 Average since 1956 5 4 forecast % change over year 3 2 1 0 Q1-98 Q1-99 Q1-00 Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-07 Q1-96 Q1-97 Q1-06 Q1-08 E Q1-09 E Figure 4.2. Real consumer spending growth Sources: ONS; Morgan Stanley Research. E = Morgan Stanley Research fo recast

  9. Inflation and interest rates

  10. Figure 4.14. Cyclical fluctuations in the UK economy since 1972 HP Filter (lambda=1,600) 6 Output is above 5 HP Filter (lambda=6,000) trend 4 HMT output gap (PBR 2007) 3 Christiano-Fitzgerald 2 1 0 Output gap (% of potential output) -1 -2 -3 -4 Output is below -5 trend -6 -7 Q1 1972 Q1 1977 Q1 1982 Q1 1987 Q1 1992 Q1 1997 Q1 2002 Q1 2007 Sources: ONS; HM Treasury; Morgan Stanley Research.

  11. Long-term prospects: The supply side

  12. Risks and forecasts

  13. Figure 4.12. House prices relative to average household disposable income ratio 7.0 Average house price divided by average disposable income per household 6.0 5.0 4.0 3.0 2.0 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 1983 Q1 1984 Q1 1985 Q1 1986 Q1 1987 Q1 1988 Q1 1989 Q1 1990 Q1 1991 Q1 1992 Q1 1993 Q1 1994 Q1 1995 Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Notes: Average house price uses HBoS series. Average disposable income uses aggregate disposable income of the household secto r divided by the (interpolated) number of households. Source: ONS, HBoS, DCLG, Morgan Stanley research

  14. Figure 6.14: The effective mortgage spread 150 0 Effective mortgage spread (LHS, a) 120 0.02 Herfindahl index(b) (RHS, c) 90 0.04 Index Basis points 60 0.06 Increased 30 0.08 competition 0 0.1 2000 2001 2002 2003 2004 2005 2006 2007 Sources: Bank of England and Bank calculations (a) Effective interest rate on the stock of outstanding mortgages relative to an appropriate funding rate. For floating - rate. For floating - rate mortgages, that is ass umed to be Bank Rate. For fixed - rate products, swap rates of similar maturities are used (averaged over the relevant horizon and lagged one month). (b) The Herfindahl index is a measure of concentration in an industry or sector. It is calculated as the sum of the squares of market shares for each firm. (c) Inverted scale.

  15. Table 6.8 Bank Securitisation of Mortgage Loans Total mortgage loans outstanding Securitised Securitised 2006 (£bn) (£bn) (%) HBOS 219.0 72.7 33 Abbey 101.7 29.1 29 Lloyds TSB 95.3 14.9 16 Northern Rock 77.3 47.2 61 RBS 69.7 15.7 23 Barclay s 61.7 12.6 20 HSBC 37.4 3.7 10 Alliance & Leicester 38.0 3.4 9 Bradford & Bingley 31.1 6.7 22 Total 731.2 206.0 28 Source: Company data, Morgan Stanley Research

  16. Figure 4.17. Alternative GDP growth scenarios Morgan Stanley pessimistic case real GDP projection 4.5 Morgan Stanley central case real GDP projection 4.0 HM Treasury (real GDP growth assumption used in fiscal projections) 3.5 3.0 2.5 % change year-on-year 2.0 1.5 1.0 0.5 0.0 2011-12 2012-13 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 Sources: HM Treasury; Morgan Stanley Research.

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