Type of Activity:

National Institute Economic Review

Title:

UK Economy Forecast

NIESR Author 1:

Simon Kirby

NIESR Author 2:

Ray Barrell

NIESR Author 3:

Tatiana Fic

NIESR Author 4:

Ali Orazgani

External Authors:

Journal name:

Volume of Journal:

Number of Journal:

206

Pages in Journal:

Date:

Wednesday, 22nd October, 2008

JEL Classification:

Keywords:

External Web Link:

Link to PDF file of full version:

Notes / Summary / Abstract:

The British economy will suffer next year as it experiences the worst setback among the G7 countries. This reflects an especially pronounced reverse to consumer spending, which will fall by 3.4 per cent in 2009, easily the biggest decline among the G7. The economy will also be dragged down by the collapse in private housing investment, which will fall by 17.1 per cent, and lower business investment, which will decline by 3.8 per cent. A sizeable contribution from net trade (mainly reflecting lower imports) is not sufficient to stave off recession in 2009.



The forecast assumes a further half-point cut in interest rates in early 2009, reducing the Bank rate to 4.0 per cent. The Bank of England has more scope to cut rates now that consumer-price inflation has probably peaked, although it will still be above the 2 per cent target until the end of 2009. However, it takes time for rate cuts to stimulate activity in normal times. And in current conditions the effectiveness of monetary policy is limited by credit rationing by banks and falling demand for loans. Even a very big cut in the Bank rate would not be sufficient to avoid a recession in the UK.



The UK is especially vulnerable to the credit crisis because of imbalances that had developed in recent years. The current account balance worsened to 3.8 per cent of GDP in 2007. Household debt rose to 170 per cent of income by the end of 2007 and the household saving ratio fell to negligible levels. The sharp fall in consumer spending next year will occur as the saving ratio rises from 0.7 per cent of disposable income in 2008 to 4.4 per cent in 2009 at a time when real income growth remains paltry.



The outlook for the public finances is poor. Public sector net borrowing will rise to 4.5 per cent of GDP in 2008–9, and then climb further to 5.3 per cent next year and 6.1 per cent in 2010–11. Public sector net debt will rise to 50.5 per cent of GDP in 2008–9. The deterioration in public sector net borrowing reflects the impact of the recession, together with weaker receipts from the financial and property sectors.