UK ECONOMIC GROWTH SET TO SLOW SHARPLY, DUE TO LARGE INTEREST RATE INCREASES
14/05/07 | 11:27
David Kern, Economic Adviser to the BCC, said:
"In reaction to large increases in interest rates, the May BCC Quarterly Economic Forecast is signalling a marked slowdown in the pace of UK economic activity, with below trend quarterly GDP growth over the period mid-2008. The new BCC forecast is signalling lower UK GDP growth than in our February forecast.
“In our new central scenario, year-on-year GDP growth is forecast to decelerate from an above-trend 3.0% in Q4 2006 to 1.9% in H1 2008. But there is a distinct risk that the UK slowdown would be sharper. The main driver of the expected UK slowdown is the cumulative effect of four increases in Bank Rate since August 2006, and the realistic prospect that interest rates may go up further.
“The squeeze on disposable incomes will weaken household consumption; strong investment spending is set to decelerate, while the strong pound will dampen export growth. Growth in public spending is expected to slow. Net exports will make a negative contribution to GDP growth, even if the pound loses some of its recent strength.
"The May 2007 increase in UK Bank Rate to 5.50%, the fourth increase since August 2006, was very widely expected, following the rise in CPI inflation to 3.1%. But the markets are sharply divided on whether additional increases in interest rates are likely. While the May increase in Bank Rate to 5.50% was needed to restore credibility, it is questionable whether additional tightening, beyond 5.50%, is objectively needed.
David Ken added: “There is no hard evidence so far that either UK inflationary expectations or wage settlements are accelerating. The Bank of England and the markets expect significant falls in inflation later this year. But, given the pressures the MPC is facing to demonstrate its anti-inflation firmness, our central scenario assumes a further increase in Bank Rate to 5.75% in the next few months."
“Indeed, one cannot rule out the possibility that Bank Rate would be raised to 6%, even though such a move would cause considerable unnecessary damage. However, once there is firm evidence that the economy is slowing sharply, and inflationary pressures are easing, we expect Bank Rate to fall during 2008.
“The May BCC central scenario is predicting a marked slowdown in annual average UK GDP growth, from 2.8% in 2006 to 2.5% in 2007 and to 2.0% in 2008. This is below our February forecast, which predicted average growth of 2.6% in 2007 & 2.3% for 2008. However, if Bank Rate goes up to 6.0%, GDP growth is set to weaken much more sharply than in our central scenario, to 2.4% in 2007, 1.7% in 2008, & a trough of 1.5% in Q2 2008.
“Household consumption is forecast to grow by 2.4% in 2007 & 1.9% in 2008, below GDP, after unusually weak growth of 1.4% & 1.9% recorded, respectively, in 2005 & 2006. Unless investment continues to grow at a faster pace than total output, there is a clear risk that GDP growth would slacken more sharply than predicted by our central scenario.
“In spite of the recent improvement, we believe that the UK medium-term budgetary outlook has deteriorated, and this is largely due to structural factors. The Government has just met the Golden Rule in the 10-year economic cycle that ended in March 2007. But frequent changes in the official estimates of the length of the cycle have eroded credibility in the current methodology for evaluating the Golden Rule. Recent tax increases (notably the higher small business tax rate), and concern over future tax increases, will remain major factors likely to dampen business confidence.
“In spite of the remarkable achievement of almost 15 years of uninterrupted growth, UK productivity remains mediocre by international standards, and is lower than that of the other G7 taken as a group.
David Kern concluded: " We acknowledge that inflation is a problem, and we accept that the MPC may have to take further action. But a degree of over-reaction is now a distinct risk. The four interest increases implemented since August 2006 must be allowed to have their effect before considering further increases. The threat of damaging monetary overkill is now very serious. Our new forecast shows that the economic climate facing UK businesses will become riskier and more difficult, and we urge the Government to reverse the Budget increase in the small business tax rate.
ENDS
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