UK economy forecast
¥ Annual CPI inflation is expected to fall to 2.3 per cent by the end of the year and to be close to the 2.0 per cent target in 2008 and 2009. ¥ The economy will grow by 2.7 per cent in 2007, boosted by buoyant business investment which will rise by 8.2 per cent. ¥ Consumer spending will increase by 2.7 per cent this year, slowing to 2.0 per cent in 2008. ¥ Small changes in monetary and fiscal policy in late 2005 and early 2006 would have prevented inflation going over the 3 per cent trigger point. ¥ The UK Government is borrowing more than most others, with only Greece, Portugal and Japan borrowing more amongst the major economies. Consumer price inflation rose to 3.1 per cent in the year to March, prompting the first explanatory letter from the Governor of the Bank of England since it was made independent in 1997. Assuming that the base rate rises from 5.25 per cent to 5.5 per cent in May, we expect inflation to be close to the 2.0 per cent target in a year's time. However, the episode suggests that economic policy has been too loose. Simulations on our model suggest that CPI inflation would now be a tenth of a percentage point lower if the Bank had raised the base rate by a quarter point to 5.0 per cent in August 2005 instead of cutting it to 4.5 per cent. Alternatively, a fiscal tightening of 1 per cent of GDP in spring 2006 would also have delivered a similar downward effect, building (unlike the monetary policy scenario) to a fifth of a percentage point by the end of this year. A surge in business investment and a pick-up in consumer spending were the two main reasons why the economy staged a healthy recovery in 2006, growing by an above-trend 2.8 per cent compared with 1.9 per cent in 2005. A continuing boom in business investment and a further recovery in private consumption will sustain growth at 2.7 per cent this year despite a downward pull, as in 2006, from net exports. After a long period in which business investment was weak, it has recently been unexpectedly strong. Corporate capital spending grew by 7.7 per cent in 2006, the fastest since 1998. The boom will continue this year, supported by high profitability and strong balance sheets, as the business capital stock adjusts to the higher supply of labour caused by the surge in migration. Consumer spending increased by 2.0 per cent in 2006, well below its historical average, but an advance on the 1.4 per cent growth in 2005. The recovery was the more remarkable given the squeeze on budgets as disposable income grew by only 1.3 per cent, the slowest since 1982. A more buoyant housing market encouraged consumers to save less. In 2007, further rises in housing wealth and a pick-up in disposable income growth will underpin even stronger consumer spending, forecast to rise by 2.7 per cent.
Year of publication: |
2007-04
|
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Authors: | Barrell, Ray ; Kirby, Simon |
Institutions: | National Institute of Economic and Social Research |
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