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Scottish Economic Report: March 2004
1.3 The UK Economy
1.3.1 Overview
The UK economy continues to show positive signs of strength. It remains in a favourable position compared to other major industrialised nations. The rate of economic growth is predicted to increase in 2004, and inflation, interest rates and unemployment are projected to remain low.
The UK growth rate in 2004, and throughout the period to 2007, is expected to remain ahead of the average annual growth rate of both OECD and the G7 group of leading industrialised nations. Key features of recent UK economic performance include:-
- Inflation has remained low, stable, and comfortably within the government's target range, both on the new and revised measures;
- Interest rates remain at very low levels historically. The Monetary Policy Committee (MPC) increased base rates by 0.25 basis points to 4.00 per cent at its February meeting;
- Manufacturing output looks likely to return to positive growth in 2004, for the first time in a number of years;
- Overall GDP rose by 2.1 per cent in 2003. In the December Pre-Budget Report, growth for 2004 was forecast at 3 - 3.5 per cent;
- Public sector debt, whilst higher than originally forecast, remains set to remain below the benchmark level of 40 per cent of GDP for the 2004-05 financial year and beyond.
1.3.2 Recent Economic Developments
The latest provisional figures from the Office of National Statistics (ONS) suggest that growth in the last quarter of 2003 was 0.9 per cent, following growth of 0.7 per cent in the third quarter of the year. Growth for 2003 as a whole was 2.1 per cent.
Within these figures, manufacturing showed a slight rise in 2003 Q3, halting a trend of decline seen over previous years. This is seen by many commentators as suggesting that the first sustained upturn in UK manufacturing since 2000 may be seen in 2004. Once again, the service sector, which grew by 2.3 per cent in the year to 2003 Q3, has underpinned and driven the overall growth observed.
Consumer confidence has continued to be strong. Retail sales, in the year to October 2003 grew by 3.1 per cent. Consumer optimism about future prospects remains strong.
Much of this additional spending has been made on credit, leading to a large consumer credit boom, and high personal debt levels. Credit expansion was further encouraged by the historically low levels of interest rates seen throughout much of 2003, but recent rises have led to concern that debt levels are unsustainable. It is possible that any continued rise in repayment rates could lead to a large rise in the number of personal bankruptcies and numbers of homeowners in negative equity. This could lead to major problems for the wider UK economy.
November 2003 saw the first rise in interest rates for almost 4 years. The MPC increased interest rates by _ of 1 percentage point in November, in order to meet the then inflation target of 2.5 per cent on the RPIX measure of inflation. Subsequently, the inflation target has been changed by the Chancellor to 2 per cent on the Consumer Price Index (CPI) measure of inflation. More detailed analysis of this change can be found in Box 1.3.
Box 1.3 Inflation Target Change |
In his Pre-Budget Report in December, the Chancellor of the Exchequer announced that the Bank of England's inflation target - the level of inflation which the Bank's Monetary Policy committee (MPC) is tasked with achieving - was to change with immediate effect. The old target was an inflation level of 2.5 per cent measured by RPIX; the new target is a 2 per cent level of inflation, as measured by the Consumer Price Index (CPI, formerly know as HICP - the Harmonised Index of Consumer Prices). The target change, which was first announced in the Chancellor's statement in June 2003 regarding the Euro, is intended to bring the UK inflation targeting regime into line with the system adopted by the European Central Bank (ECB). It will make inflation comparisons between the UK and the Eurozone easier, and can be seen as a measure to encourage convergence between the UK and European economies. While there are benefits to having a more transparently comparable measure of price changes, it is also generally accepted that CPI is a technically more robust measure of inflation than RPI/RPIX. The new statistic gives a better measure of spending patterns, and takes better account of consumers substituting cheaper goods for more expensive ones. The new target continues to be symmetrical, with the same acceptable margins as previously (+/- 1 percentage point). The existing "open letter system" has been retained, meaning that the Governor of the Bank must offer a public explanation to the Chancellor whenever the new measure of inflation rises above 3 per cent, or falls below 1 per cent. The symmetrical target avoids any incentive for the MPC to limit or "choke off" economic growth by ensuring very low levels of inflation. The target recognises the fact that negative inflation (deflation) can be as damaging as excessive inflation, as demonstrated by Japan in recent years. Although the new official measure of inflation is likely to be lower than its predecessor in strict numerical terms for the immediate outlook, this will not have any effect upon pensions, and other benefits which are uprated in line with "inflation". The Chancellor has announced that all benefits and index linked gilts will continue to be linked to RPIX for the foreseeable future. |
1.3.3 Labour Market
The UK labour market remains strong, with a level of unemployment approaching historically low levels. According to the February 2004 figure, 892,100 people (2.9 per cent) were out of work and claiming benefits. The measure preferred by the government, based on the International Labour Organisation (ILO) definition of unemployment, shows that 1,459,000 people were out of work, an unemployment rate of 4.9 per cent. The equivalent figures for a year earlier were 932,400 (3.1 per cent) and 1,515,000 (5.1 per cent) respectively.
1.3.4 Monetary and Financial Indicators
The new headline measure of inflation, the Consumer Price Index, rose by 1.4 per cent in January 2003, within the limits set by the government (see Box 1.3). Underlying RPIX inflation, which was the previous benchmark indicator, was 2.4 per cent in the first month of the year.
The MPC raised interest rates by _ of 1 percentage point in November 2003, and repeated this in February 2004, with rates now at 4 per cent. The rise in November was the first for almost 4 years.
Despite these rises in interest rates, the housing market has continued to expand and grow, albeit at a slightly reduced rate compared to the first half of the year. Figures for January 2004 showed Nationwide estimating house prices to have risen by 14.3 per cent over the preceding year, whilst Halifax data suggest a rise of 18.3 per cent. The UK government's stated policy is to encourage a "soft landing" for the housing market, where prices stabilise or fall slowly, rather than a "price crash" which some commentators have feared.
The major story of recent months on currency markets has been the strengthening of the Euro and weakening of the US dollar. The Euro has risen from $1.06 in January 2003 to record highs of around $1.28 in January 2004. Due to the Federal Reserve indicating that American interest rates are likely to remain low for a considerable period of time, the exchange rate may remain at similar levels throughout the year.
1.3.5 Pre-Budget Report
The Chancellor of the Exchequer presented his Pre-Budget Report to the House of Commons on 10 December 2003. The major headline to emerge from the report was the sharp increase in predicted levels of government borrowing, both for the 2003/04 financial year, and into the future. While the Chancellor remains optimistic about continuing to meet his two self-imposed fiscal rules 6, some commentators, including the IMF in its December Report, have speculated that the Treasury may have to increase revenues, or reduce public expenditure in order to continue to meet these rules
Another highlight from the Pre-Budget Report included the Chancellor announcing that he would meet the growth forecast of 2 - 2.5 per cent for 2003. The key set of forecasts given in the PBR for economic growth and public finances are listed in Tables 1.9 and 1.10 below. In addition, the Chancellor revealed new measures to increase Child Benefit, encourage new exploration in the North Sea, and further reduce the regulatory burden upon small businesses. A full copy of the Pre-Budget Report, and other associated material is available at http://www.hm-treasury.gov.uk/pre_budget_report. The Chancellor will announce the Budget on the 17 March 2004.
1.3.6 Future Prospects and Risks
The view of most external commentators is that the UK Economy is on a stable footing and looks set for continued growth and prosperity. International organisations such as the IMF have described the UK's performance as "enviable". 7 However, concerns persist over the continued high inflation in the housing market and the position of the public finances.
Footnotes to Chapter 1
1. Source: Global Connections Survey, 2002
2. Federal Statistical Office, Germany
3. Total Civilian Workforce
4. National Institute for Statistics and Economic Studies, France
5. Growth rates for all US data are quoted as annualised rates, following US Statistics Bureau practice. The quarterly growth rate is raised to its fourth power to arrive at the annualised figure.
6. The "Golden Rule", which states that the government should borrow only to invest over the course of an economic cycle; and the "Sustainable Investment Rule", mandating that total public sector debt should be held at a level below 40 per cent of total GDP
7. International Monetary Fund; December 2003
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