UK Economic Prospects and Policy Dilemmas

Our current forecast, largely unchanged from that published in the October 1992 Economic Outlook, is for a gradual recovery in economic activity during 1993, gathering pace in the course of the year. Unemployment continues to rise through the year, and inflation remains subdued. The main risk to the forecast lies in the possibility that a continued decline in property values may check reviving confidence and lead the banks to restrict lending.
The principal policy dilemma lies in the very high level of public sector borrowing, likely to rise to around 7.5 per cent of GDP on unchanged policies. The Government will need to signal its willingness to act to cut the PSBR by higher taxes or reduced spending plans. This will allow interest rates to remain low for longer, and offers the best prospects of maintaining a competitive pound and reducing the burgeoning current account deficit. There is room for a further cut in interest rates in the Budget to boost confidence and recovery, but rates may need to rise towards the end of the year if the higher prices resulting from the sterling devaluation start to feed into wage claims.
The Government should also consider seriously the need for reform of the institutional framework for policy making, to help restore credibility weakened by the manner of sterling's departure from the ERM. These should include greater openness about official thinking on monetary policy, and greater autonomy, within a new framework of accountability, for the Bank of England.