Email a collegue.| Headline: | 2005 – Tough times ahead? |
| Description: | In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, takes a look at the major issues facing the UK economy in 2005.
He asks whether this will be the year when it all goes wrong. His main points are as follows: The last ten years has been a golden period for the UK economy, with the economy expanding rapidly year after year, unemployment falling from double digits to a 29-year low, and inflation and interest rates dropping to levels not seen since the 1960s. What’s more, this has occurred against a background of difficult global conditions, such as the rise in the oil price to record highs. But this golden age has been achieved at the expense of major imbalances in the economy, the backlash from which is likely to be felt over the next few years. The biggest hit of all is set to come from the housing market, which has already embarked on a major slowdown. And whereas the main driver of the economy in recent years has been robust household spending growth, this is likely to suffer as the housing market slowdown gathers pace. There is also a risk that the labour market will not help to limit the extent and impact of the housing market slowdown, as is the widespread assumption. Indeed, a look back at the relationship between previous housing market downturns and unemployment reveals that it is adjustments in the housing market that trigger rises in unemployment, not the other way around. Furthermore, whereas the Chancellor has been able to use fiscal policy to support economic growth in recent years, the prospect of higher taxes – by some £10bn per annum in the coming years in order to plug the hole in the public finances – will be a further constraint on growth. At the same time, the international environment looks likely to deteriorate again over the next year or two. Indeed, economic growth in the US is set to slow down from around 4% last year to just 2.5-3.0% for both this year and next as the policy stimulus from previous tax cuts fades. Furthermore, the euro-zone is unlikely to fare much better as the strength of the euro will contribute to a slowdown in growth to just 1.3% this year. Meanwhile, exchange rate movements may further hinder the UK economy as hopes that UK exporters might be assisted by a drop in the exchange rate have been called into question by the pound’s recent renewed strength. But while all this may have snuffed out any remaining New Year cheer, the good news is that the monetary authorities will be much better placed to respond to these problems than they have been in the past. While recent months have seen a build-up of cost pressures in response to the surge in oil and other commodity prices, these have yet to have any impact on prices in the high street. What’s more, given the strong competitive pressures in the economy, any pass-through into retail prices is likely to be only modest, resulting in a continuation of subdued consumer price inflation. As a result, the Monetary Policy Committee will be free to cut interest rates aggressively over the next year or two. We expect interest rates to drop to 4% by the end of this year, before returning to their 2003 low of 3.5% in 2006. And given that this level of 3.5% was previously reached at a time of rapid house price inflation, it is not hard to envisage interest rates falling even further alongside a major housing downturn. But while this will help to cushion the blow of a housing downturn and weak global economy, UK GDP growth is still likely to slow sharply from the 3% plus rate recorded in 2004. We expect growth of just 2.0% in 2005, with only a small improvement to 2.2% in 2006. So although 2005 may not be the year when things go completely wrong, it will probably mark the start of a more difficult period for the UK economy. |
| Date: | 22.01.2005 |
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