Forecaster revises down UK outlook

Posted on August 3, 2012

The UK economy will shrink by half a per cent this year and grow only anaemically next year as it grapples with the weakness of its biggest trading partners, the National Institute of Economic and Social Research has forecast.

The institute predicted the economy would contract by 0.5 per cent this year and grow 1.3 per cent next year, a significant reduction from its forecast three months ago of zero growth this year and 2 per cent next year.

    “The deterioration in the UK economy has been more pronounced than even we expected,” Niesr said. “Private sector adjustment has been exacerbated by fiscal consolidation and a dysfunctional financial system.”

    Niesr’s forecasts are gloomier than those of the International Monetary Fund and most private sector economists, which still predict a small amount of growth this year.

    Simon Kirby, a Niesr economist, said the lower forecast for this year reflected domestic problems and was not because of the eurozone crisis. British companies were finding it harder than expected to compete with imports and consumption was weaker than predicted.

    However, he said the growth revision for next year reflected his expectation of weakening demand in both the US and the eurozone for the UK’s exports. Indeed, Niesr thinks net trade will make no positive contribution to economic growth either this year or next year. “It makes rebalancing very difficult from the perspective of the current account,” Mr Kirby said.

    The Bank of England responded to the darkening economic outlook last month by restarting quantitative easing. The BoE’s Monetary Policy Committee on Thursday voted to keep policy steady but many economists expect more monetary stimulus in the months ahead.

    In a separate paper, Niesr said that fiscal austerity would have been less painful if it had been delayed by three years until the economy was better placed to withstand it. Delaying fiscal consolidation would have increased output and reduced unemployment for most of this decade, researchers concluded.

    The finding rested on the assumption that early deficit reduction could not reduce long-term interest rates as it normally would because they had no room to fall further, a problem that would be avoided if action was delayed.

    Dawn Holland, an economist at Niesr, said that implementing austerity now meant “there isn’t the room for manoeuvre in interest rates that you would expect in normal times and this significantly magnifies the effect of the contraction.”

    The detrimental effects of early consolidation were amplified by an increase in the long-term unemployed who lost skills and contact with a working environment, the institute said.

    In the simulations, the Niesr paper also assumed that bond markets would not have forced the government to pay any penalty in higher borrowing costs for delaying austerity for three years.

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