Economic Overview

Laurence Sanders

World Economic Growth

Sustained recovery

USA 4.7%

Japan 4.2%

UK 3.7%

Eurozone 2.0%

( second quarter GDP year on year )

0

5

10

15

20

25

% World GDP

USA Eurozone Japan Germany UK

THE WORLD ECONOMY

The High Growth Economiesgrowth rates

China 9%

India 8%

Russia 7%

Australia 4%

( latest data, year on year)

Commodity Prices Brent Crude ( spot) - $28 / barrel September 2003 $42 / barrel September 2004

Commodity prices lower % of total costs than in previous decades

UK output prices ( August yoy) - 2.6%

Economic Cycles

Typical UK cycle is now 5 /10 years - there are also 25 and 50 year cycles

Slowdown in winter 2001/02

Currently sustained recovery

Strong growth forecast 2005

Return to trend growth in 2006 / 07

UK Economic Growth: 1984 - 2004

UK EconomyOverview

Economic Growth 3.7%

Underlying Inflation (CPI) 1.3%

Average Earnings 3.8%

Unemployment 2.7%(international measure 4.7%)

UK Economy

Gross Domestic Product: £1100 billion

Fourth largest economy in the world

World’s third largest trading nation

Trend Growth: 2.7% per annum

UK EconomyStructure

Gross Domestic Product £1100bn

Service Sector 72% of which financial sector 24%

Industry 27% of which manufacturing 18%

Agriculture 1%

Forecast:the UK economy

2005 2006

Economic Growth 3.0 2.5

Core Inflation 2.0 2.0

Unemployment 4.7 4.9

Average Earnings 4.9 4.6

UK Base Rates

Set by the Monetary Policy Committee:

New Target: CPI

- Consumer Price Index

CPI excludes mortgage interest; rates

CPI target : 2% ( plus / minus 1% )

– HICP target 2.0% + / - 1%

UK Base Rate: 1997 - 2004

Forecast:UK Base Rates

End 2004 End 2005 End 2006

Base Rate

Forecast5.00% 5.25% 4.75%

Market View 5.00% 5.25% 5.00%

Longer Term Interest Rates

Key driving forces:

International long term rates, notably US

G7 growth rates, especially the USA

G7 inflation prospects

Strong correlation with equities

A Comparison of Fixed and Equity Price Movements

Period Rate Forecast end 2004 end 2005 end 2006

2 year 5.30% 5.40% 4.70%

5 year 5.40% 5.50% 4.70%

10 year 5.50% 5.50% 4.70%

The UK Housing Marketkey forces

Interest rates - both short and longer tem

Personal Disposable Income:– average earnings

– unemployment

– taxation

Housing supply

The Housing Market andthe UK Economy

New houses built - 2003 180,000

Owner Occupation Ratio over 70%

Forecast Gross Mortgage Lending 2004 £280 billion

Forecast Net Mortgage Lending 2004 £110 billion

House Price Forecast

Average house price ( mortgaged property ): year on year

4Q 2004 4Q 2005 4Q 2006

15.0% 5.0% 5.0%

Nationwide House Price Index: 1996 - 2004

Barker Review

Additional 120,000 houses a year required for UK house inflation equal EEC average

of CPI plus 1.1% pa ( very optimistic)

Additional 70,000 houses a year reduces UK house inflation to CPI plus 3% pa

( more realistic longer term)

Several years before balance housing supply/ demand

Miles Review

Housing finance industry - in many ways efficient and innovative

Long term fixed rate mortgages intrinsically NOT superior to fixed

No compulsion re fixed rate mortgages

Greater borrower awareness of interest rate risk

Risks to forecasts

US and UK recoveries stall

Geopolitical problems - impact on oil prices

Corporate governance shocks

Deflation - in USA or Eurozone

Conclusion - the optimistic view

Consensus forecast is for stronger growth in 2005 / 2006

Fiscal and monetary policy in G7 geared to long term sustainable recovery

Enlargement of EEC will stimulate European growth

Housing market will be supported by excess of demand over supply, economic recovery and historically low interest rates