Forecast Summary

Short-term economic prospects for the UK will depend critically on what happens to oil prices and on the government's response to any changes. Our central case assumes that North Sea oil averages £20 a barrel for the remainder of the year and that the government holds the sterling index at about 74. In the Focus we also examine the sensitivity of the forecast to changes in oil prices. The willingness of the government to let the exchange rate fall in response to the fall in oil prices means that we still expect GDP to grow by about 21/2. per cent in 1986 and we expect inflation to fall below 4 per cent by the middle of the year. Lower oil prices generate a faster growth of world output; the UK benefits from this and we are forecasting growth of nearly 3 per cent in 1987 with inflation falling further.     

The London Business School with Gower Publishing

Output has stagnated in the main industrialised countries this year but we expect the benefits of lower oil prices to show up in rapid growth from now on. The present weakness in the world economy stems from tighter US fiscal policy and the oil price shock itself. These have combined to reduce domestic demand in the United States, and hence to cut the market for Japanese exports in particular, and also to reduce expenditure by energydependent countries and companies. A further factor is that, with prices of oil-based products falling, there is an incentive to delay expenditure. We expect this impact effect of OPEC III to be short-lived and to give way to its positive effects in the second half of this year. Specifically, we expect consumer spending to lead the recovery as real incomes will be boosted by the terms of trade gain from lower oil prices - equivalent to 3 per cent of GNP in the OECD area as a whole. On the basis of oil prices holding at $15. we forecast OECD output growth of 3 per cent this year, rising to 41/2 per cent in 1987. Additionally, we expect lower oil prices to produce a significant reduction in world inflation. Zero growth of producer prices is forecast on average this year arid consumer price inflation is expected to fall to wards 2 per cent in the course of the year.     

Forecast Summary

Backed by the lowest interest rates in fifteen years and a competitive exchange rate, we see the economy moving off the corrugated bottom of last year and recovery gathering pace as this year progresses. We expect output to rise 1.4 per cent this year, 0.5 per cent more than we forecast in October when we were expecting a far more cautious approach on interest rates, and 3 per cent in 1994. Here we have factored in another 1 per cent cut in base rates to coincide with the Budget on 16 March but this may prove to be the floor, especially if, as is rumoured, the Prime Minister has vetoed tax increases in the Budget for fear of derailing a fragile recovery. By the end of the year, however, we expect the trend in interest rates to be upwards to halt a sliding exchange rate and to cap the devaluation-induced price increases that will be feeding into domestic prices by then. On this basis we believe that inflation can be contained at 4 per cent underlying this year, 5 per cent in 1994 - outside the Chancellor's target range. While we are more sanguine than before on the outlook for output and inflation, major problems remain on the PSBR and the balance of payments. Beginning in the December Budget, the Government will have to raise taxes to avoid a debt spiral on the budget deficit and channel resources into net exports. Even on the basis of a £4bn tax hike in the first of the unified Budgets, we expect the PSBR to run along close to £50bn and the current account deficit in the £15bn-20bn range.     

Forecast Summary

The January crisis, which occurred despite (or perhaps because of) signs of accelerating recovery, will not, we believe, prevent output from rising by over 3 1/2 per cent this year and by over 2 per cent p.a. over the medium term. Although the recent fall in sterling will put up prices - especially of traded manufactures - we expect retail price inflation to fall below 5 per cent after reaching almost 6 per cent this spring.     

THE 1981 BUDGET

In this Forecast Release we examine the short-term prospects for the UK economy in the light of the Budget and other developments. Compared with our February forecast the Budget has raised taxes by about £2 bn but it has also increased public expenditure by a similar amount The net effect on the PSBR, compared with our February forecast, is therefore small, especially if the Treasury's estimates for nationalised industry profits and/or public sector wages prove over-optimistic. We therefore believe that the outturn for the PSBR in 1981-82 could be close to the figure of £12 bn presented in our last forecast.
We also believe that the prospects for output and inflation are little changed The Budget by itself will have raised prices by about 1 per cent compared with our previous forecast but because we had probably over-estimated indirect tax receipts, the net effect on prices is small For output, the likely reduction in consumers' expenditure is more or less offset by higher public spending. We continue to expect a fall in output between 1980 and 1981 of 1–11/2 per cent, inflation during the year at about 10 per cent, a current account surplus of £3 bn, monetary growth of 8 to 9 per cent and a PSBR of £12 bn.     

Forecast Summary

Although hard evidence of recovery is still elusive, our forecast indicates that the trough of the recession occurred in the second quarter and that output fell 4 per cent peak-to-trough. We estimate that GDP rose 112 per cent in the third quarter - though only because of a rebound in North Sea oil production - and that for 1991 CIS a whole it will be 2 per cent down on 1990 levels. Next year GDP is forecast to rise 2 per cent but it is not until 1993 that the 1990 output peak is passed. Unemployment therefore still has a considerable way to rise - to a peak of 2.8 million in 1993. In the first year of full EMS membership, the economy has made an accelerated transition to European levels of inflation. Against a background of modest growth, it should be possible to consolidate this progress and we expect retail price inflation to average little more than 3 per cent over the next four years. Similar rapid progress has been achieved on the balance of payments where there is a trade surplus on manufactured goods for the first time since 1982. Here, however, we are less confident that the reduction in the trade gap can be sustained. In the recovery phase we expect imports to rise more rapidly than exports with the result that the current account deficit rises from £6bn this year to £8bn in 1992 and £10bn-£12bn in 1993-5.     

The London Business School with Gover Publishing

The world economy is in poor shape. OECD industrial production fell 0.5per cent in both 1991 and 1992 arid though it may now have stopped falling it is still, on our estimates, below year-earlier levels. The US recovery continues to disappoint; recession persists in Japan and Europe; inflationary pressures, already weak, are waning. Next month's UK forecast would normally be based on the world forecast published in June's International Economic Outlook, when we were looking for G7 output to rise 1.2 per cent this year, 2.5 per cent next. But this now looks on the high side and although a detailed revision to the world forecast mist wait until the December IEO, as at1 input to the UK forecast we are shading our G7 growth forecasts - to I per cent this year and 2.25 per cent in 1994. Similar downward revisions are also in train at the OECD arid IMF, according to recent press reports. The more sluggish output performance is already having mi impact on the oil price, which has fallen below £16 a barrel. Together, these developments imply lower world inflation and, particularly in post-ERM Europe, a faster easing of monetary policy than we had allowed for in June.     

WORLD OUTLOOK

After six years of steadily rising OECD output, fears of a significant rise in world inflation are now increasing. In the last year there has been a slight pick-up in inflation with producer prices up nearly d per cent. But prompt action by the Federal Reserve to raise interest rates before the presidential election appears to have damped inflationary expectations in the US and has given Japan and Germany an opportunity to tighten monetary policy without causing major currency fluctuations. It is also apparent that the other possible source of world inflation, commodity prices, is not a problem. OPEC over-production has ensured that the oil price remains weak and other commodity prices appear to have stopped rising after a brief acceleration at the beginning of the year. Nevertheless the major imbalances in world trade are declining only slowly and without a change in fiscal policy in the major economies it is difficult to believe that minor changes in monetary policy will be sufficient if the process of adjustment begins to falter. Despite these risks, we take a sanguine view of world prospects. Tighter monetary policy should effect a slowdown in world growth next year (already indicated by recent developments, particularly in the US) and this should be sufficient to control inflation which we expect to peak at just under 5 per cent at the beginning of next year. From 1990 onwards we see steady growth accompanied by low inflation.     

WORLD OUTLOOK

Over the last 12 months industrial production in the OECD area has risen by 8–9 per cent, only slightly less rapidly than in the first year of recovery from the OPEC 1 oil crisis. Much of the growth in output stems from a very rapid expansion in North America although, in the second half of 1983, output in Europe and Japan began to accelerate. We expect the recovery to be maintained during 1984 with some convergence of growth rates. For the year as a whole we are now forecasting 61/2 per cent growth of industrial production, 33/4 per cent for total GNP. By the end of 1983 the long-standing reduction in inflation had run its course and OECD consumer prices were about 5 per cent higher than a year earlier. Within the area some countries, such as France and Italy, were still reducing inflation, but this was offset by the US where inflation has been rising slowly since the summer. We expect these trends to continue in 1984, i.e. stable inflation in the OECD but accelerating prices in the US, producing in each case about 5 per cent inflation. In 1985 we are now forecasting a slowdown in the world economy. This is expected to be centred on the United States, where the problem of the Federal Budget remains to be tackled. By the time of the Presidential election the US economy will have registered two years of relatively rapid growth. This is likely to be producing upward pressure on prices and interest rates and, as a result, a pause in 1985 in the growth of output. In Europe and Japan, where output has grown more slowly, we expect the recovery to be sustained in the medium term.     

Forecast Summary

The economy is in the throes of its biggest downturn in ten years. Output has been falling and unemployment rising for nearly a year and business confidence indicators suggest no early letup. In the last 12 months total output has fallen 2 per cent with manufacturing 5 per cent lower. This, we believe, is the trough of the recession and we expect signs of recovery to be evident in the late spring. Even so, output is likely to fall by nearly 1 per cent this year and unemployment should rise well above 2 million. The benefits of recession have been slow to appear, though the trade gap is narrowing sharply. The downward pressure on prices from falling demand is balanced by rising costs as industry struggles to pass on high unit labour and interest costs. Helped by some reduction in mortgage rates and a severe squeeze on profits, we expect retail price inflation to fall to Sper cent by the end of the year and to 3–4 per cent over the medium term.     

Forecast Summary

A pause in world activity held back UK industry in the first quarter of the year and, even though we expect faster growth from now on, we forecast total output growth of only 2 per cent this year. But next year a stronger world economy and pre-election tax cuts lift growth to 3 1/4per cent. Lower oil prices and falling interest rates help keep inflation at its current level both this year and, as long as wages respond, next. In the medium term we expect the growth rate to fall back but, assuming that a fairly tight fiscal policy is pursued by whichever government is in power, we predict that inflation stays below 3 per cent     

WORLD OUTLOOK

In the course of 1984 growth rates in the major economies came together. This reflects a slowdown in the United States, and to a lesser extent Japan, from the middle of the year and continuing recovery in Europe. This convergence is expected to continue in 1985 when total output in the OECD area is forecast to increase by 3 per cent. Within this total it is likely that the US, West Germany and the UK all achieve about 3 per cent; Japan should grow more quickly, France more slowly. In spite of a rapid recovery in output from the late-1982 trough, inflationary pressures remain weak. Measured in dollar terms, non-oil commodity prices have fallen and the oil price is under considerable down wards pressure. We expect inflation to stay at about its preset level in the US, West Germany, Japan and the UK and decline further in France, Italy and other countries where policy reaction to the 1979-80 oil price shock was delayed. In the medium term we expect the world economy to experience steady growth combined with a constant or slightly increasing inflation rate. This reflects a stable policy environment and falling real oil prices. After the excesses of the 1970s and early 1980s it is possible that the rest of the decade will experience u greater stability than at any time since the 1960s.     

WORLD OUTLOOK

At the end of 1982 output in the world economy was still falling, although there were signs that the decline had very nearly run its course. We expect a radual recovery to begin in the first half o f 1983. Unlike the recovery which began in the late summer of 1980, when inflation was still in double figures, any upturn in 1983 would be set against a background of declining inflationary expectations and weak oil prices. IJ. as we expect, a falling inflation rate proves a decisive factor in keeping interest rates on a downward path, we forecast that the output will gather pace in I983 and rise reasonably strongly in 1984. Of the 4 per cent rise in industrial production which we foresee in 1984. a large part is due to the fall in real oil prices.     

The London Business School with Gower Publishing

Last year saw the most coordinated cyclical upturn in the world economy since the early I970s, with OECD output rising 4per cent, industrial production and world trade even more rapidly. The boom in demand, which followed five years of continuous expansion, has outstripped supply and prices have begun to accelerate. To tackle inflation, the G7 monetary authorities have tightened policy over the last year, reversing the short-lived drop in interest rates necessitated by the stock market crash. This tightening may have to go further, especially in Germany and Japan where the effects of a rising oil price and higher indirect taxes are being exacerbated by currency depreciation. Although the rise in interest rates came too late to stop inflation rising, it has beet pursued with sufficient vigour to prevent inflation from seriously breaching the 5 per cent level. It is on these grounds that we forecast a relatively soft lending for the world economy on output, with growth continuing at 2.5–3per cent, accompanied by a limited reduction in inflation which stays in the 4–5per cent range. Progress on current account balances is also likely to be sluggish: in the absence of a serious attack on the budget deficit, the US deficit is likely to stay in the region of $140bn a year.     

Forecast Summary

Nearly two years after the I990peak in output, the economy continues to 'bump along the bottom' of an L-shaped recession, which has turned into as severe a downturn as its predecessors in 1974-5 and 1980-1. The origins of the recession lie in the weakness of domestic demand, which has failed to respond to the 4.5per cent cut in interest rates that has taken place since we joined the ERM. It is now the turn of fiscalpolicy: public spending was raised in the Autumn Statement and, as the General Election approaches, the odds are on tax cuts in next month's Budget. This relaxation of monetary and fiscal policy should produce recovery and we see output moving ahead from the second quarter onwards. Nevertheless, the outlook for I992 is weaker than before: we forecast a rise in GDP of a little over I per cent, rather less for manufacturing industry. In 1993 and beyond n growth rate of around 2112per cent should be possible but it is the second half of next year before output passes its previous peak. This suggests that unemployment will rise for at least another year - to a peak in the summer of I993 of 2.8 million. The combination of a stable exchange rate inside the ERM and protracted recession has produced a rapid reduction in inflation and the current account deficit. As long as the pound maintains its present parity, inflation should moderate further, to the 3–4 per cent range by the end of the year and beyond. On the trade side, in contrast, imports have already bottomed out and exports are struggling in a weak world economy. This suggests that, as the recovery gets under way, the deficit on current account will widen from last year's £6bn to £8bn this year and £10bn by I995.     

WORLD OUTLOOK

World output, which was strengthening immediately prior to last October, appears to have barely suffered in the short term from the stock market crash. Apart from an early reaction by US consumers - since reversed - demand is proving robust and in early 1988 OECD industrial production is, we estimate, 6 per cent up on year-earlier levels, with GNP more than 4 per cent higher. Indeed such is the strength of activity that the present balance of risk is not that recession is imminent but that inflation may pick up again. In the United States, where activity rates are at their highest level for eight years and unemployment is at a fourteen-year low, monetary policy has been tightened and interest rates are moving higher. The Bundesbank is keen to follow suit and the BoJ is keeping the situation under review. Nevertheless, with wages in most countries still adjusting to the low inflation rates of the last two years, there is little evidence yet that prices are accelerating.
We expect to see world interest rates edging higher in the second half of the year as recorded inflation picks lip. But we believe that underlying inflation remains low and that, even on the assumption that oil prices return to 18 a barrel, OECD consumer price inflation will peak early next year at a little over 4 per cent. Tighter monetary policy is also expected to hold back demand over the next 12 months. Consequently, we expect some weak- ness in output in the first half of next year but discount the possibility of a severe recession. GNP growth in the OECD area is forecast to decline from the 3 per cent rate of 1987–8 to a little over 2 per cent next year and to a sustainable 2½ per cent p.a. over the medium term.     

THE REAL WAGE GAP

Over the past year a gap has opened up between the growth of manufacturing productivity and that of real wages. This gap cannot persist indefinitely, but it can be closed in many different ways. The best that can happen is that wage settlements fall while output and productivity accelerate. The worst outcome would be continued stagnation of real output and no deceleration of wages, in which case the required productivity improvement would have to come about through renewed labour shedding. There are worrying signs that this has started to happen. An intermediate solution might involve a fall in the exchange rate, with some improvement in competitiveness boosting real output (so that UK producers get a larger share of buoyant consumer spending) and some rise in prices holding back real wages.
We continue to believe that the most likely outcome is a rise in output and a fall in the rate of wage settlements. In our June forecast this occurs despite a fall in the real exchange rate. In these circumstances we expect the growth of unit labour costs to fall back from its current high level so that the current 3 per cent inflation rate becomes a true "core" rate. But a moderate fall in the real exchange rate may prove hard to achieve, especially if the oil price continues to weaken. We therefore explore what would happen if the required depreciation happens more rapidly, so that interest rates have to remain high to prevent it getting out of control. In this case we would expect lower growth and higher inflation than we forecast in June.     

The London Business School with Gower Publishing

Collapsing oil prices and a falling dollar set the background to a Budget in which the Chancellor, hamstrung by lower oil revenues, was seen as having little room for manoeuvre. In fact the sharp fall in the sterling price of oil has provided him with the perfect excuse for not making significant cuts in personal income tax that were largely irrelevant to the needs of the economy. Instead of a boost to household demand we have had, thanks to OPEC, a transfer to companies in the form of a reduction in costs. This should enable them to expand output against a background of falling inflation. Our post-Budget assessment of macroeconomic prospects (Section I), made on the Treasury's assumption of a $15 oil price, shows output growing by 2 1/2 per cent this year and inflation falling below 3 per cent in 1987. We are thus less optimistic than the Treasury about output but more optimistic about inflation. How was the Chancellor able, within the confines of the Medium-Term Financial Strategy, to give anything away having lost so much oil revenue? A detailed analysis of the PSBR forecast (Section II) reveals good reasons why non-oil tax revenues should be some £3 1/2n higher than forecast this time last year. But, because we still expect public spending to be above the official figures, our PSBR forecast is £1bn higher than the Treasury's. Although the macroeconomic impact of the Budget was small (especially in relation to that of the fall in oil prices which preceded it), it continued the process of tax reform. We focus, in Section III, on the new proposals to deal with the problem of the pension fund surpluses to which we drew attention in the November issue of Financial Outlook. We conclude that the proposed measures could have a larger effect on tax revenues in the longer term than is indicated by the Treasury's Budget estimates.     

WORLD OUTLOOK

The recent weakness of the world economy does not undermine the relatively optimistic forecast for 1987 which we presented in May. At that time we suggested that activity would be sluggish for most of this year as a result of the impact effect of the OPEC III oil price collapse. But we also argued that by the end of the year there would be clear signs of a consumer-led recovery as the personal sector adjusted to the real income gains and lower inflation benefits of the lower oil price and the reduction in nominal interest rates which followed. There is mounting evidence of rising consumer spending, particularly in Europe and it is something of a puzzle that output has not risen to meet this demand. The explanation is partly that producer confidence has lagged behind that of consumers, so that demand has been met from stock, and partly that spending has been supplied from countries outside the OECD, especially the NICs in the Far East. Nevertheless, we are convinced that our earlier view of OECD output prospects next year remains the most likely though, in recognition of the growing importance of non-OECD competition, we have adjusted the output forecast down slightly. OECD GNP is expected to rise 2.6 per cent this year, with an acceleration to over 4 per cent in 1987 arid 1988. Moreover, we believe this can be achieved without a rebound in inflation, which is forecast to be stable at about its present level of 2 1/2 per cent.     

WORLD OUTLOOK

Unless the international debt situation or the crisis in the US domestic financial system worsens or there is a further lurch into protectionism, we expect world output to advance more rapidly over the next 2 months than it has over the last year. We argued in May that the world recovery was pausing, just as it did in 1977, and that conditions were falling into place for a pick-up in output. The requirements were seen as a lower dollar, to improve US competitiveness and to alleviate protectionist pressures, and stronger domestic demand elsewhere, to offset the resulting loss of US markets. Since then the case for a lower dollar has been recognised by the Group of Five Finance Ministers, interest rates have fallen and, at the G5 meeting, West Germany and Japan tentatively revealed a further modest stimulus. Output optimism is underpinned by the fall in world inflation to levels not seen since the early 1970s which, our forecast suggests, will be consolidated over the next 12 months. This reflects falling real oil and non-oil Commodity prices and decelerating earnings, which makes a further tightening of policy unlikely. In these circumstances the prospects for output are improving and over the next 12 months we forecast an increase in OECD output of 4per cent.