Most economic forecasts this year have been upbeat. Even February’s increase in base rates can be interpreted in a positive light since it reflected the Monetary Policy Committee’s view that activity was strengthening to the point where there was a risk of inflation returning.
A key factor in the Bank of England’s decision was accumulating evidence of an upturn in the global economy and an improving international environment featured in Gordon Brown’s forecasts for 2004. In his pre-Budget statement, the Chancellor had pencilled in export growth of 5.5% this year and 7.25% next year.
This is certainly a challenge; a rate of export growth the UK has managed only once in the past seven years or so, and then the environment was much more favourable. Whether it is a realistic forecast will depend largely on two key factors. First is the exchange rate, and here the message is mixed. Against the euro, the pound has weakened over the past year or two and is back at the launch price of 70p. This should be good news for those British companies trying to export to Euroland, which is not the case for those looking for customers across the Atlantic. The weakening dollar has been one of the dominant features of the world economy in recent months, and it may fall even further below the current 11-year lows of $1.85-1.90. Certainly, it will be a long time before it returns to the $1.60 mark, a rate that many British businesses feel is ‘normal’, which will make selling into the US difficult.
The second key factor for exporters is the likely level of demand in these overseas markets. Here, the message is equally mixed but the wrong way round for British companies. In the US, there are clear signs of life. Interest rates of 1%, huge tax cuts and a weak dollar have led to upwards revisions to the outlook in the US in this presidential year.
GDP growth of about 4% looks on the cards for 2004, although the difficult issues associated with the twin fiscal and external deficits could act as a drag on activity in later years. While the short-term market prospects look good for potential British exporters to the US, the exchange rate has moved in the wrong direction and could act as a drag on sales.
In Euroland, on the other hand, the UK has gained a modest price advantage, with sterling’s weakening, but market conditions are likely to disappoint.
Towards the end of last year, eurozone growth was surprisingly strong and business surveys pointed to an upbeat 2004. The fundamentals, however, are not so encouraging. Since it was exports that accounted for much of the upturn, the euro’s strength will be a brake on activity.
The problem in the eurozone is that there have been few signs of domestic recovery. Consumption is flat, investment is down and stocks are falling.
Yet current conditions suggest that all is in place for strong internal recovery. Real interests rates are low, the death of the Stability Pact should allow further fiscal loosening, the stronger euro will boost wages, personal savings are high, there is pent-up demand after a period of weak consumption, and companies are in a financial position to invest again.
Few of these advantages are likely to work in Euroland’s favour to the extent that might be expected. Real interest rates have been low for a while to little effect. Certainly, by ignoring their own rules, France and Germany have given the Stability Pact a humiliating send-off, but political considerations are likely to constrain further attempts to increase budget deficits as a way of boosting demand. On the wages front, pay settlements are likely to ease in response to slow growth and high unemployment, the demographics suggest savings are not too high and investment may take a while to recover.
All in all, prospects in the eurozone look weak for this year. As in the past two years, only Spain of the bigger countries looks likely to exceed Euroland’s forecast GDP growth of 1.7% for 2004. The star performers will again be Greece, Finland and Ireland, with projected growth of twice the area’s average. This is, of course, bad news for the UK, which still looks to Italy, Germany, France and the Netherlands as key export markets.
Even if export growth disappoints Brown, and the rise in UK GDP falls short of his expected 3.25% this year, there seems enough momentum in the economy for output to rise by at least the trend rate of 2.5%. This is far better than the single currency area is likely to experience and, within the EU as a whole, the UK is the most likely winner of the Euro 2004 competition.
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