Economic Review - Q1 2011
A bumpy road to recovery
In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, turns his attention turns his attention to how the economic recovery will fare during the new year. His main points are as follows:
- We doubt that the economic recovery is on the secure footing required for it to maintain its recent pace. It could take until well into 2013 for the economy even to get back to its pre-recession levels of activity.
- On the face of it, the UK appears to be getting quickly back onto its feet. However, a look at what has driven this strength creates some cause for concern. The recent surge in construction output looks unlikely to last. And the positive contribution from government spending will of course fade.
- Admittedly, the fiscal tightening will be spread over several years. And many of the major welfare cuts do not come in until 2013.
- But the squeeze will still get well underway in 2011. Departmental spending is set to fall by over 4% in real terms in 2011/12 – and the Government seems to have no plans, for now at least, to scale back the cuts. Public sector employment is already falling. And VAT and national insurance contributions will soon rise.
- Given all this, the recovery’s prospects clearly hinge on the private sector’s ability to continue to pick up steam. Perhaps the first hope is that the direct adverse effects of the fiscal squeeze on the private sector are offset by support from other sources. Private sector employment, for example, has risen strongly in the past few months.
- But we doubt that this will last when firms still have scope to raise productivity significantly and parts of the private sector are vulnerable to cuts in government procurement spending.
- Meanwhile, high inflation will further squeeze households’ real incomes – which we expect to fall by over 1% next year.
- At least there are now tentative signs of are-balancing towards the external sector.
And the recoveries in the US and Germany are progressing well. But against that, the euro-zone’s peripheral economies – the destination of about 15% of UK exports – will continue to struggle.
- And although business investment could grow quite strongly in 2011, it is simply not a big enough part of the economy to have a significant effect on overall GDP growth.
- The overall economic recovery might manage to keep up its momentum for a little while longer – especially if consumers take time to adjust their spending in response to the tax rises. However, we expect growth then to slow to pretty sluggish rates. We expect GDP growth of just 1.5% in both 2011 and 2012.
- But at least the UK has turned a corner. And, although a difficult couple of years lie ahead, growth should eventually accelerate. It will also be more soundly-based than the growth seen over the past decade or so.
- Moreover, the prolonged fiscal tightening means that monetary policy can remain extraordinarily loose to compensate. We do not expect interest rates to rise until 2013 at the earliest.
For further information, please download our full report 'Economic Review: A bumpy road to recovery'. (PDF)
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View other economic material from Roger Bootle, including his monthly economic updates.
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