UNITED KINGDOM. United Kingdom

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1 UNITED KINGDOM Growth has slowed, and is projected to be 1¾ per cent in 216. Uncertainty about the outcome of the end-june 216 referendum, which could lead to an exit of the United Kingdom from the European Union (Brexit), has undermined growth. This projection assumes that the United Kingdom remains in the European Union, in which case growth is projected to pick up in the second half of 216 and then stabilise in 217. The unemployment rate has fallen to around 5%. The current account deficit has reached 7% of GDP, the highest level on record, increasing vulnerabilities. Fiscal consolidation is planned to continue, but its pace will ease to below 1% of GDP per year over the projection horizon, which is appropriate given a weaker economic outlook. Capacity pressures have abated and should remain contained, but the recent exchange rate depreciation will push up prices. This projection assumes interest rate normalisation will start in early 217. Productivity has been exceptionally weak since 27, and reviving it is essential to sustain growth and living standards. Fiscal decentralisation and greater infrastructure investment would support capital stock accumulation and better use of resources. Better matching of skills to jobs and higher skill levels would also lift productivity. Financial conditions have improved for businesses, but as markets tighten more rapid exit of nonviable businesses would make room for new, more innovative businesses. Economic activity has weakened Following recent robust GDP growth driven by vibrant domestic demand, rising uncertainty about the outcome of the referendum on the membership of the United Kingdom in the European Union, and a possible exit (Brexit), has led to a significant slowdown in economic activity. Business investment has contracted as businesses have put their spending decisions on hold and hiring intentions have weakened. Financial United Kingdom Q-o-q % changes 1. Uncertainty is affecting growth Index 211 = 1 5 The current account deficit is at a record high % of GDP GDP growth Economic policy uncertainty¹. Oct Nov Dec Jan Feb Mar Apr Trade balance Primary and secondary income balance -6 Current account balance The newspaper-based economic policy uncertainty index is constructed based on the number of articles that appear in The Times of London and the Financial Times and refer to economic policy uncertainty. It is normalised to a mean of 1 prior to 211. Source: National Institute of Economic and Social Research; and OECD Economic Outlook 99 database

2 United Kingdom: Employment, income and inflation 1 2 markets have also increasingly started to price in the risk of Brexit. The exchange rate has fallen and the cost of protection against its future volatility has increased. Equity prices have so far been resilient, as many listed companies are global, but rising investors fears have pushed up the cost of protection against sovereign default. The labour market has remained strong, with record high participation rates and the unemployment rate falling to about 5%, low by historical standards. However, productivity growth has been sluggish. The current account deficit has increased further, to 7% of GDP, driven by lower returns on external assets relative to the return on domestic assets held by foreigners, and to a lesser extent by further losses of the market share of exports. Consumer price inflation is still weak, but has edged up from recent lows. United Kingdom % of GDP Budget revenues have flatlined Expenditure Revenue Inflation has edged up Y-o-y % changes 6 Headline inflation Core inflation¹ Excludes energy, food, alcohol and tobacco. Source: OECD Economic Outlook 99 database; and Office for National Statistics

3 United Kingdom: Financial indicators 1 2 Weak productivity has been holding back wage growth. In April 216, the new statutory minimum wage for workers aged 25 or more, the National Living Wage, was increased by 7.5%. Further hikes are planned to gradually lift it by about 35%, to 6% of median hourly earnings, by 22. For those with jobs, this should increase incomes and reduce poverty, but the effects on employment need to be closely monitored. Efforts to improve the skills of low-productivity workers also need to continue, in order for more people to enjoy the benefits of the economic recovery. The authorities plan to support the development of vocational skills by introducing an apprenticeship levy on large businesses. United Kingdom: Demand and output

4 United Kingdom: External indicators 1 2 The macroeconomic policy mix will continue to shift The government has confirmed its commitment to reach a budget surplus of.5% of GDP by 219, mainly by spending reduction. Stripping out cyclical effects, the authorities expect to cut the deficit by around.8% of GDP per year in This is less than planned before, which should ease the impact of consolidation on growth. At the same time, monetary policy is set to remain highly supportive, and the first interest rate increase is assumed to take place only in early 217. Persistent very supportive monetary policy risks creating bubbles, and house prices have continued to rise rapidy, reducing affordability, notably in London. In response, the Bank of England has raised counter-cyclical capital requirements. However, there is also a need to boost housing supply by relaxing planning regulations in order to make housing more affordable again. Further policy reforms could help to strengthen aggregate productivity performance and better spread the advantages of growth to more people. Stronger infrastructure investment would reduce bottlenecks. Releasing more land for housing would make it possible for more people to afford housing near their jobs thereby reducing skill mismatches, which would improve the quality and productiveness of work. Lending to small and medium sized enterprises has started to recover, which is positive for the emergence of new high-growth and innovative businesses, but it is also important to support corporate restructuring. The government has started important reforms to transfer greater responsibilities to major cities, which is welcome as local governments can be more responsive to people s needs and it may help to raise productivity and incomes in lagging regions. Growth is projected to pick up after the referendum This projection assumes that the United Kingdom remains in the European Union. Growth is set to be weak and volatile in the first half of 216 owing to the impact of the referendum on spending decisions, mainly of businesses. However, GDP growth will 231

5 strengthen in the second half of 216 as uncertainty dissipates, and stabilise at 2% in 217. This growth will be enough to keep the unemployment rate low. Theoutcomeofthereferendumisamajorriskfortheeconomy.AvoteforBrexit would heighten uncertainty, raise the cost of finance and hamper investment. According to OECD estimates, GDP growth could be lower by.5 percentage point in 217 and 218 and by 1.5 percentage points in 219. The Bank of England could stabilise the financial sector through liquidity support, but refinancing of public debt could become more costly. The large current account deficit may also be harder to finance, which could force a costly adjustment. Higher productivity growth would sustain economic activity and wages, and improve public finances more than projected. Stronger demand from the euro area would limit the extent of the current account deficit by supporting exports, but this could be offset by further headwinds from emerging markets. 232

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