London Econoomic Outlook

Executive Summary

* The London economy slowed in 2005, though the latter six months of 2005 saw London stage something of a recovery in growth. The return to strength occurred as a result of financial and business services activity.

* In 2005 Q4, there were also encouraging signs of a recovery in consumer spending.

* Employment growth in London exceeded our expectations. The latest data shows that employment growth in London outpaced that of the UK. On balance, the majority of firms in the service sector expect to increase employment further.

* London's share of total output growth for the UK increased as a result of its strength in financial and business services, yet overall output growth is down slightly on the previous year. As growth nationally picks up in 2006 and 2007, we believe London will benefit disproportionately to the rest of the UK regions.

* The manufacturing sector will see further employment decline, yet London will benefit in terms of manufacturing output growth as consumer spending returns to trend with increased stability in the housing market from 2007.

Fig. 1: London and UK Annual GVA Growth (%) 1990-2010

GVA, 2005-2010 (% growth, p.a.)

2005 2006 2007 2008 2009 2010

London 2.9 3.5 3.1 3.1 2.8 3.0

UK 1.8 2.3 2.3 2.5 2.4 2.6

Consumer Spending, 2005-2010 (% growth, p.a.)

2005 2006 2007 2008 2009 2010

London 2.1 2.4 2.6 2.7 2.8 2.9

UK 1.8 2.0 2.2 2.3 2.4 2.5

Employment, 2005-2010, (% growth, p.a.)

2005 2006 2007 2008 2009 2010

London 1.9 1.0 1.0 0.8 0.6 0.7

UK 1.0 0.6 0.5 0.5 0.4 0.6

RPI Inflation, 2005-2010, (% growth, p.a.)

2005 2006 2007 2008 2009 2010

London 2.8 2.7 2.6 2.7 2.8 3.0

UK 2.8 2.8 2.7 2.8 2.8 3.0

Global Economic Overview

London continues to be exposed to international economic conditions to a greater extent than other UK regions as a result of its function as an international financial services centre. The performance of the US and eurozone economies will have a significant impact on the prospects for London. Strong growth in the global economy translates into increased activity in financial markets, with increased activity in London's financial and business services (FBS) sector.

Fig. 2: Global GDP Growth, Q4 2001 - Q4 2005

The US economy recorded quarterly growth of 1% in Q3 2005, up from 0.8% in Q2, despite ongoing energy price rises (the price of a barrel of West Texas Intermediate peaked at almost $70 in late August), and rising short-term interest rates. However, the advance estimate shows growth slowing sharply to just 0.3% in Q4. The slowdown appears to have been broad-based, although there was a particularly sharp fall in household consumption growth.

In the eurozone, GDP grew by 0.6% in Q3 2005, up from 0.4% in Q2. Net exports and an upswing in investment spending underpinned the improvement, aided by a softer euro and stronger-than-expected global growth. Consumer sentiment is improving, albeit very slowly, given ongoing concerns over high unemployment rates and the impact of higher oil prices on real disposable incomes. Although we expect softer eurozone growth in Q4 due to slow domestic demand in Germany and France, we still expect an upswing in growth in 2006, driven by continuing strong export growth and improving domestic demand. The latter is expected to play a greater role in 2007. Inflationary pressures remain a concern due to higher oil prices and we expect the ECB to raise rates twice during 2006. A further rate rise next year will take the ECB base rate to 3.0% by the end of 2007. Our forecast is for eurozone GDP to grow by 1.8% in 2006, up from an estimated 1.4% in 2005. A rise to 2.0% is expected for 2007.

UK Economic Overview

GDP growth remained below trend for the third consecutive quarter in Q3 2005. However, the UK economy ended 2005 on a more positive note, achieving growth of 0.6% in the final three months of the year, the strongest for a year. If growth can be sustained at close to this rate, then last year's slowdown would have been remarkably short and relatively painless by historical standards.

In fig 3 below, we show the contribution of each expenditure component to quarterly GDP growth up to 2005 Q3 (these data had not been released for Q4 at the time of writing). The most encouraging feature is the rebound in the contribution of household consumption in Q3 following its weakness during the first half of the year. The contribution of investment also picked up in Q3, underpinned by a large increase in public investment.

Fig. 3: Expenditure Contributions to Quarterly GDP Growth, Q4 2001 to Q4 2005

Following exceptionally strong growth in Q2, export growth dropped to -0.4% in Q3. Given that import growth remained close to its Q2 level, net exports detracted significantly from Q3 growth. Partly offsetting this, however, was a large inventory accumulation, suggesting that the cooling of export demand had taken producers by surprise. For the third consecutive quarter, government consumption expenditure failed to register on the chart, confirming that the bulk of the extra money being pumped into the public sector is now being directed towards investment, rather than day-to-day running costs.

1. London Output

In our Economic Outlook from 2005 Q3, we suggested that growth in the London economy was ahead of that of the rest of the UK while remaining sluggish relative to historical rates of growth. We believe the worst of the downturn in the UK economy has passed insofar as it affects the economic output of London. Our current thinking is that growth in the capital will accelerate away from that of the UK over the coming year, driven by sectors concentrated in London such as the financial and business services sector.