UK exports and world trade, 1980-2013

The UK ITEM Club, an economics panel sponsored by Big 4 accounting firm Ernst & Young says in its October forecast that its expects a weak GDP performance in 2010, following an uncertain recovery in the second half of this year. The forecast says GDP growth will struggle to reach 1% in 2010. The weakness of domestic demand puts downward pressure on consumer prices but this is offset by downward pressure on the exchange rate, helping to rebalance the economy in subsequent years.

Professor Peter Spencer, chief economist of the ITEM Club said: “We have come a long way since this time last year. Let’s not forget how bad things were. World equity markets are now at their highest for a year, facilitating new issues and sparking a revival of M&A activity, while businesses and consumers are feeling more up-beat, and even the UK housing market is apparently turning up.

“But with consumers repaying debt and fiscal policy inevitably tightening in the UK after the election, it is difficult to see any serious potential for a sustained recovery in domestic demand.  There could still be substantial pain to come for corporates and consumers. For a sustainable recovery the UK economy needs world trade to pick up and there is still not much sign of that happening.”

The forecast says while the Bank of England’s quantitative easing (QE) programme has prevented the economy from going into freefall, doubts have been raised over the efficacy of the programme, with scant evidence that the new money is finding its way through into the money supply or lending. Instead the banks appear to have used much of the money to rebuild reserves and improve liquidity and many commentators believe that QE will be extended next month. 

Consumers remain firmly in retrenchment mode, according to the outlook. Despite real household disposable income growing by 0.9% in the second quarter, rising unemployment concerns have led to a cautionary approach and subsequently consumer spending has recently fallen for a fifth consecutive quarter. The low interest rates that have been enjoyed by some existing household borrowers have allowed many to repay debt. ITEM forecast that low interest rates will remain for the mid-term future.

The pound remains weak, providing a significant boost to UK competitiveness. “UK plc is in poll position to take advantage of the weak sterling, but for the devaluation to be effective a sustained pick up in world demand is required,” says Spencer.

Bumpy road ahead

Spencer concludes: “The outlook for the next 12 months is certainly looking more positive than the last year but it is going to be a bumpy ride, particularly once the government starts to cut back. Policy will begin to tighten in early-2010 with the restoration of VAT to 17.5%; an end to the stamp duty holiday on housing; an increase in NICs; the introduction of the new 50p tax and a programme of spending restraint.

“But these measures only provide a fraction of the extra income needed to close the government deficit and the Chancellor’s plans are reliant on optimistic growth projections being fulfilled. Whoever forms the next government faces a once in a generation challenge.”