Slow growth: the UK’s fate for 2010

Allister Heath
THERE are many problems facing the UK economy – inflation is far too high, the crisis at BP, which accounts for one pound out of every seven paid out in dividends in the FTSE 100, is trashing the stock market, while the belt-tightening about to be announced at the emergency budget will include destructive measures such as higher capital gains tax.

But it is not all grim. The economy is continuing to grow, albeit sluggishly, and many companies are doing well, posting strong earnings, paying down debt and boasting an increasingly healthy liquidity ratio. Manufacturing is bouncing back, partly as a result of the weaker pound; gilt yields are low (thanks to healthy demand for UK government bonds from banks and building societies) and credit is more easily accessible for those who want it than is usually realised. My favourite indicator, the money supply, is growing at an accelerating rate, suggesting decent demand for goods, services and assets: the three-month annualised growth rate is now 6.6 per cent, against just 0.2 per cent in January, according to Henderson. This acceleration defies pessimists who claimed that the money supply would contract, triggering deflation and a double-dip recession, when the Bank of England stopped its gilt purchases.

It is imperative that the budget deficit be brought under control; the structural shortfall is as large as ever, even if the cyclical deficit is shrinking slowly as the result of continued growth. In the short-term, however, there will no gilts crisis: foreign investors continued to buy gilts and Treasury bills on a large scale in April, probably reflecting a flight of capital from the Eurozone as its sovereign debt crisis reached a crescendo. This could change quickly if the emergency budget turns out to be soft, of course, but as long as George Osborne and Danny Alexander come up with a tough and credible settlement for the next three years we should hopefully be just about fine.

So what are the prospects for the remainder of the year? The most likely outcome is more weak growth. Higher Vat will hurt; but its real impact could be to trigger another rise in inflation expectations – the retail price index was up 5.3 per cent over the past 12 months, the highest increase since 1991. The Bank of England could easily lose control of the price level if consumers start to believe that inflation is back for good, forcing it to jack up interest rates or engage in quantitative tightening. In terms of probabilities and impact, this is the biggest immediate danger facing the UK; the hit to consumers’ pockets from higher tax is a lesser danger.

Of course, the troubles in the global financial markets are in theory an immeasurably greater threat. The looming sovereign debt crisis has many of the hallmarks of the sub-prime debacle. On balance, however, a total disaster remains reasonably unlikely – unless the Eurozone implodes over the next few months, and there is an uncontrolled, large scale sovereign debt default, the UK won’t tip back into recession.

So much for the goodish news. The flipside is that Britain is facing years of stagnant living standards and higher taxes, weak growth and reduced competitiveness, as the tidal wave of red tape and regulation in finance and other sectors slows down the economy. The future won’t be anything like as exciting as the past 25 years – but it won’t be entirely miserable either.