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In the latest issue of the Deloitte Economic Review, Economic Adviser, Roger Bootle, considers the prospects for the UK economy over the next couple of years. His main points are as follows:

• The UK economy appears to have built up a reasonable head of steam in recent quarters. But at the same time, concerns have grown over the threat of a slowdown in the US economy and the impact of higher UK interest rates. What, then, should we expect for 2007?
   
• There certainly appears to be scope for the UK economy to grow fairly rapidly over the coming quarters. This partly reflects the apparent existence of some spare capacity after the recent rises in unemployment.
   
• More importantly, the economy’s potential growth rate may have risen, reflecting faster growth of the workforce. My best guess is that potential growth could be as high as 3.25% per annum over the next couple of years. 
   
• The fact that the economy looks as though it can grow more rapidly now, however, does not mean that it will. One obvious cloud on the horizon is a downturn in the US economy.
   
• I expect US growth to slow to 1.5% this year, on the back of a housing downturn. As well as the direct adverse effect on US demand for UK exports, a US slowdown could also dent UK business confidence and equity prices.
   
• With the euro-zone also likely to grow a bit less quickly than last year, I think that the UK’s external sector is likely to make a negative contribution to GDP growth in 2007 of 0.5% or so.
   
• Against this background of a less favourable global environment, a crucial question is whether the domestic economy will be strong enough to compensate. Hopes of a more meaningful recovery in consumer activity have been fuelled by the recent housing recovery. Meanwhile, falling inflation later this year should boost households’ spending power.
   
• But the support to the economy from strong public sector spending is waning, while the recent rises in interest rates have pushed up debt servicing costs. I expect a relatively modest acceleration in consumer spending from around 1.9% in 2006 to 2.5% in 2007.
   
• Of course, for a change, companies could come to the rescue instead. After all, high rates of return and low financing costs are supportive of a further recovery in investment.
   
• But the slowdown in the US economy could undermine firms’ confidence about increasing their capital spending, while sluggish profits growth means firm might not have the resources to invest. I expect a mild slowdown in investment growth from a likely 5.5% or so in 2006 to something more like 5% in 2007.
   
• The upshot is that GDP growth looks set to slow from 2.7% in 2006 to around 2.2% this year. Even in 2008, further adjustments in the consumer and government sectors should keep growth below-trend, at 2.5%.
   
• There are key risks in either direction, though. On the upside, the US slowdown could turn out to be milder than we expect, while UK households might prove once again to be rather more robust than expected. But equally, the investment recovery could fade, or interest rates stay higher for longer than we anticipate.
   
• If things turn out as I expect, however, inflation will fall some way below its target in 2008. Although lingering inflation concerns are likely to prompt at least one more rise in interest rates, I expect rates to fall to 4.5% by the end of 2008.

For more information download the report and access our podcast.

Ends

Notes to editors
This press release has been prepared by Roger Bootle, Economic Adviser to Deloitte.  If you have any questions regarding the views in it, please contact Roger Bootle directly on 020 7823 5000 or via email on business@capitaleconomics.com.

This press release contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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