Nothing below this point Subtitle Nothing below this point Green Budget: The Economic Outlook January 30 th 2008 David Miles, Chief UK Economist 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.

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 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

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 3 Figure 4.1. Economic growth and inflation since 1957 Source: ONS

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 4 Near-term outlook: consumer spending key

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 5 Figure 4.3. Saving rate Q1 1995Q1 1996Q Q1 1998Q1 1999Q1 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q Q Saving rate (%) Overall Excluding change in net equity of households in pension schemes Sources: ONS; Morgan Stanley Research.

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 6 Figure 4.4. Household gross financial liabilities UKUSGermanyFranceItalySpain % of disposable income Sources: Eurostat; Federal Reserve; BEA; Morgan Stanley Research.

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 7 Figure 4.6. Debt servicing and interest rates Per cent Debt servicing a % of disposable income (MIRAS adjusted) Bank of England base rate Notes: Debt servicing is interest payments by 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.

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 8 Figure 4.2. Real consumer spending growth Q1-96Q1-97 Q1-98Q1-99Q1-00Q1-01Q1-02Q1-03Q1-04Q1-05 Q1-06 Q1-07 Q1-08 EQ1-09 E % change over year Real household sector consumer spending Average since 1956 forecast Sources: ONS; Morgan Stanley Research. E = Morgan Stanley Research forecast

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 9 Inflation and interest rates

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 10 Figure Cyclical fluctuations in the UK economy since Q1 1972Q1 1977Q1 1982Q1 1987Q1 1992Q1 1997Q1 2002Q Output gap (% of potential output) HP Filter (lambda=1,600) HP Filter (lambda=6,000) HMT output gap (PBR 2007) Christiano-Fitzgerald Output is above trend Output is below trend Sources: ONS; HM Treasury; Morgan Stanley Research.

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 11

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 12

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 13 Long-term prospects: The supply side

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 14

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 15 Risks and forecasts

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 16 Figure House prices relative to average household disposable income ratio Q1 1983Q1 1984Q1 1985Q1 1986Q1 1987Q1 1988Q1 1989Q1 1990Q1 1991Q1 1992Q1 1993Q1 1994Q1 1995Q1 1996Q1 1997Q1 1998Q1 1999Q1 2000Q Q1 2002Q1 2003Q1 2004Q1 2005Q1 2006Q Average house price divided by average disposable income per household 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

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 17 Figure 6.14: The effective mortgage spread Basis points Index Effective mortgage spread (LHS, a) Herfindahl index(b) (RHS, c) Increased competition 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 assumed 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.

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 18

Only Source / Footnotes below this line Subtitle Only Source / Footnotes below this line David Miles, 19 Figure Alternative GDP growth scenarios % change year-on-year Morgan Stanley pessimistic case real GDP projection Morgan Stanley central case real GDP projection HM Treasury (real GDP growth assumption used in fiscal projections) Sources: HM Treasury; Morgan Stanley Research.