For the first time since this government came to office in 1997, the outlook for the economy appears uncertain. The Chancellor was very much on the defensive when he presented his pre-Budget statement to the House of Commons. As expected, this contained forecasts of activity for 2002 and 2003 which were substantially downgraded on his April 2002 projections. For once, Mr Brown was guilty of optimism and consequently he has had to announce much higher estimates of government borrowing.
For a man who had not previously had to face up to economic failure, the subsequent press comment was almost unanimously critical. However, although the Treasury’s short-term forecasts at the time of the Budget were wide of the mark, much of the criticism seems to have been overdone.
Certainly the consequences of the errors have been exaggerated out of all proportion and the economic stability of which Mr Brown is justifiably proud has not been threatened, at least in the short term.
For 2003, the official view now is that the economy will grow by a more realistic 2.5%-to-3% – down from the previous 3%-to-3.5%. This is not too far out of line with the consensus of independent forecasts (including HSBC), which has pencilled in growth of around 2.5% for the year. As important as the fact that this represents a hike on the 1.6% achieved last year, is that built in to all the numbers is a much-needed rebalancing of activity.
In the coming months, the reliance on household spending will start to fall as the private consumer becomes constrained by two factors. Firstly, the surge in borrowing has been pushed about as far as it can reasonably go. Debt levels in the personal sector now exceed 100% of incomes. Although base rates at 4% mean that repayments on this borrowing account for a lower share of disposable incomes than lower debt levels did several years ago, it’s in nobody’s interest to stoke debts even further. Consumer spending, therefore, must grow more in line with income growth, which implies a slowdown.
In addition, an increase in wage levels will come under pressure when the increase in National Insurance Contributions announced in the last budget take effect this April. Employees will pay an extra 1% and the old earnings ceiling has been removed, though it’s likely that employees will pay for this indirectly as pay increases are reduced to take the new NIC rates into account.
In common with most forecasters, Mr Brown is anticipating that this gap will be filled by bigger contributions from both exports and business investment. This in turn suggests a sharp upturn in world trade and a recovery in the global economy. But it was the over-optimistic forecasts for international activity that forced the Chancellor into the major revisions to his original forecasts.
The evidence for a global upturn is encouraging, but far from conclusive.
The authorities in the key markets of the US and the EU have loosened monetary policy and, while there are signs of faster growth, confidence is still fragile. Should the world economy not respond to the policy initiatives, the UK could undershoot expectations.
All these small differences between forecasts and out-turns have a sizeable impact on Mr Brown’s expected spending and revenue. To keep his spending plans on track, he has announced extra borrowing of £20bn over the two years. But, given that the UK is a £1 trillion economy and that borrowing is only around 30% of GDP (one of the lowest ratios in the EU) an extra £20bn barely registers on the Richter scale. It certainly doesn’t threaten current taxes or interest rates.
A real worry is that this is the start of a downward slope. The Treasury is assuming the falling-off in tax receipts is a result of the slowing of activity in the UK. If, however, there are structural rather than cyclical factors behind the tax shortfall, faster GDP growth will not close the fiscal gap at the rate the Chancellor expects. With his borrowing capacity much more limited, he will have to face up to the higher tax/lower spending conundrum.
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All of this is for a later agenda. In the coming months, the UK can look forward to continuing low inflation, GDP growth edging up towards the trend rate (2.5%) and unemployment hovering around the one million mark.
With some rebalancing of activity, there’s no compelling case for moving interest rates in either direction. This might be a boring scenario, but businessmen around the world will be casting covetous eyes in Britain’s direction wondering why their economy can’t be more like ours.