Recent developments and summary of the forecast.

Britton, Andrew ; Pain, Nigel ; Young, Garry 等

The growth of output is continuing in the first half of the year at a moderate and steady pace. The preliminary estimate for gross domestic product in the first quarter shows an increase of 0.7 per cent, which is 2.6 per cent on a year earlier. If oil and gas are excluded the increase is just 2.0 per cent. This rate of growth is not quite in line with the long-term trend, suggesting that little if any of the slack created by the recession has been taken up. The CBI survey of manufacturing and some labour market indicators however would seem to be consistent with a rather more rapid recovery and it is possible that the recent figures for GDP will eventually be revised up.

Unemployment fell by over 30,000 in both February and March, continuing the downward trend of last year. In the first quarter the inflow of claimant unemployment averaged 330,000 a month whilst the outflow averaged 354,000. Compared with most of last year the inflow has been reduced whilst the outflow remains much the same. The number of unfilled vacancies at job centres averaged 141,000 in the first quarter compared with 121,000 a year ago (and compared with over 250,000 at the peak of the last cycle). The data for employment have been revised, bringing the official figures more closely in line with the Labour Force Survey. (A revision of this kind was anticipated in the Appendix to the UK Economy article in the November Review last year.)

The figures for imports and exports remain puzzling. For trade with countries outside the EC the volume figures (excluding oil and erratics) show a small fall in exports and a small rise in imports in the first quarter. This follows a fall in exports to the EC recorded in the fourth quarter of last year. It is difficult to reconcile this picture of weakness in export markets with the survey evidence, but clearly if it is correct it indicates that the growth of output has been mainly based on domestic demand. (It is anticipated that some revisions to the trade data may be published during this month.)

Despite the continuing recovery the rate of inflation remains very moderate. In the first quarter the all-items retail prices index was just 2.4 per cent up on a year earlier, with the underlying index excluding mortgage interest payment up by 2.7 per cent. When the winter sales were over prices of clothing and household goods in particular rose quite sharply, but this was offset by reductions in other items, for example telephone charges. The evidence of competitive pricing in a wide variety of goods and services continues despite the recovery of customer demand. The rise in house prices remains very modest, despite the improved activity in the housing market.

Cost pressures also remain weak, thanks to the slow growth of wages and an increase in productivity. The underlying growth of earnings edged up from 3 per cent in the fourth quarter of last year to 3 1/2 in January and February, and there is some evidence of a slight increase in wage settlements. At this stage in the recovery an increase in the growth rate of earnings is to be expected, if only from higher bonuses and overtime.

Policy Assumptions

It is by no means easy to decide what is the best assumption to make about the future course of monetary policy on this occasion. In the February Review we followed our usual convention of projecting interest rates in line with the forward rates implied by the yield curve. That indicated a small further fall in short rates during this year, followed by some increase from the fourth quarter onwards. However the rates for the end of next year reached only 6 per cent.

Since then sentiment in the markets has changed and long-term yields have risen, implying significantly higher forward rates over the next few years. It seems that the markets are now anticipating both the possibility of higher inflation in the medium term and a greater determination by the authorities to counter it with tighter monetary policy. This follows rather closely the behaviour of rates in America, since the Federal Reserve signalled a willingness to see short-term rates rise.

The perception of policy in this country has been changed by the publication of the minutes of the regular meetings between the Chancellor and the Governor of the Bank of England. The Bank appears to be reluctant to see any further cuts in interest rates, and prepared to countenence increases. The political situation of the Government will ensure that any resistance it may wish to mount to a tightening of policy on economic grounds is almost certain to be misinterpreted, and hence counterproductive in terms of market confidence. The recent acceleration of the growth of the monetary aggregates, to which the Bank has given some prominence in its Inflation Reports, will make a tightening of policy later this year difficult to resist. In the first week of May when these forecasts were compiled the path of future rates implied by the yield curve showed short rates rising to just over 6 per cent at the end of this year, about 7 1/2 per cent at the end of 1995 and up to 9 1/2 per cent in the medium term. We decided on this occasion to assume that the markets have over-reacted in recent months so far as the medium term is concerned, but not the short term, and base our monetary policy assumption on a more moderate rise in interest rates in 1996 and subsequent years. The path which we have adopted is shown on Chart 3 and Table 10 below.

For fiscal policy our assumptions are unchanged since the February Review. The tax increases enacted in the two Budgets of last year are taken into account, but otherwise tax rates remain constant. Following our usual convention, tax allowances and specific duties are uprated each year in line with prices. On the expenditure side we assume that public sector earnings will rise by about 2 1/2 per cent this year, and thereafter they will revert to their previous relationship to earnings growth in the private sector. We have again assumed a steady growth in the volume of public consumption at about 1 1/2 per cent a year, whilst the forecast for grants to the personal sector depends on the level of activity and the rate of inflation. Thus our forecasts are not constrained to produce the totals for spending or for borrowing implied by the Medium-term Financial Strategy. In fact we are forecasting a PSBR of [pounds]35.3 billion for the present financial year, a little below the Treasury figure of [pounds]38 billions, followed by a further significant fall in 1995-6.

Summary of the Forecast

We expect output growth this year of a little under 3 per cent, with consumer spending continuing as the main component of the growth in demand, despite the effect of the tax increases, already in place. In most respects the components of expenditure will follow the pattern which is normal at this stage of the cycle. Stockbuilding will increase and the growth of fixed investment will accelerate a little. The growth of export volume will be relatively weak this year, so that net trade will be reducing the growth rate of output. For next year the outlook is now for slightly slower growth, mainly because of the higher level of interest rates which we now assume. This path for output would be consistent with a continuing fall in unemployment this year, although at a slower rate than we have seen over the last twelve months. By next year we expect unemployment to level off at a little over 2 1/2 millions.

We expect the underlying rate of inflation to remain low for most of this year and next, but a slight increase is forecast above the current rate. For the end of this year we have revised our forecast down to 3.0 per cent, well inside the 1-4 percentage range. Next year may see a further increase, but our forecasts now show the rate inside the range following the assumed tightening of monetary policy.

The effective exchange-rate index is assumed to remain at about its present level, depreciating fractionally, in line with the uncovered arbitrage condition. The current account of the balance of payments is expected to remain in deficit to the extent of about 2 per cent of GDP this year and next. On page 19 below we discuss the medium-term outlook for the balance of payments and conclude that it is not at the present time acting as a constraint on the growth of output--although in other circumstances it might do so.