The UK: Set to 'Out-Japan' Japan?



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Chris Scicluna, Economic Research
Daiwa Capital Markets Europe Limited
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25 November 2011

With the euro area debt crisis escalating, after this week’s pitiful UK GDP data for the third quarter – with growth driven entirely by (presumably involuntary) stock-building – and ahead of next week’s Autumn Statement by the Chancellor, we have updated our UK economic forecasts. And they make very grim reading.

  • We now forecast a contraction of GDP in Q411, zero GDP growth in 2012, and growth of little more than 1% in 2013 and growth remaining below its pre-recession trend in the following two years. And the risks to that downbeat outlook, not least from the euro area debt crisis, are biased markedly to the downside.
  • This means that the level of UK real GDP will not return to its pre-recession peak, reached in the first quarter of 2008, until the second half of 2015, i.e. after the next general election. This is a woeful performance, with the level of output remaining below its pre-recession level for longer than any equivalent such period suffered by Japan during its past so-called two ‘lost decades of growth’.
  • Unemployment will continue to rise through 2012, with 3 million unemployed and a double-digit unemployment rate on the ILO measure not unthinkable. Inflation, meanwhile, will fall clearly below 2% by 2013 and beyond, meriting a further expansion of QE. As a result, we forecast a further £75bn of BoE asset purchases to be announced by the MPC early in the New Year, with probably more to come in the second half 2012.
  • In the absence of additional corrective measures, the coalition government will miss its target to eradicate the cyclically adjusted current deficit by 2015-6. While we do not necessarily think that the Office for Budget Responsibility (OBR) will be brave enough to downgrade its forecasts quite as far as we have done, it is likely still to push back the date, by a couple of years, at which it expects the government’s fiscal target to be fulfilled. So, in the coming week, the Chancellor might be tempted to follow the example set by then-Chancellor Norman Lamont in the early 1990s and pre-announce his intention to raise taxes in future years, if and when the real economy is strong enough to withstand it.
  • However, given our central economic outlook, with UK GDP set to remain below its pre-recession peak for at least seven years, announcing further fiscal tightening would risk driving growth even weaker. Yet more eye-watering fiscal austerity at a time of ongoing private sector retrenchment, rising unemployment, weak global demand and the alarming euro area debt crisis is the last thing the economy needs. Those who point to events in the euro area as justification for further austerity are wrong - UK policymakers have much greater flexibility over fiscal policy thanks to the UK having maintained its own currency. Indeed, if our forecast is right, expect increasing calls for greater coordination between fiscal and monetary policy as a tool to boost demand as we go through 2012.

 

Chris Scicluna, Head of Economics

 

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