UK Growth Expected to Decline

The British economy continues to wrangle with very weak growth even as consumers are being hammered by surging prices. The result is an inflation rate double the target “ideal” of two percent annual inflation. And while the last few years have not been a walk in the park, there appears little prospect for immediate relief.

In a speech delivered in mid December, Charles Bean, Deputy Governor for Monetary Policy and member of the Monetary Policy Committee (MPC), noted that the economy is showing signs of improvement, but cautioned that “it may be some while yet before normality is restored”.

That assessment was made four months ago and one would be hard-pressed to see any progress since then. Indeed, for the first quarter of the year, the situation may have actually worsened.

For four straight quarters in 2010, Gross Domestic Product made positive gains yet for the first quarter of this year, GDP actually fell by 0.5 percent. Despite this, the government still expects growth for the full year to be in the range of 1.7 percent – this may prove to be a bit optimistic.

Last week, the International Monetary Fund (IMF) reduced its outlook for the UK from 2 percent growth to 1.7 percent. The Organization for Economic and Development (OECD) cut its position even deeper dropping its earlier 1.7 percent prediction to just 1.5 percent. This makes it unanimous – the 2011 perspective for the British economy is actually bleaker now than at the beginning of the year.

Adding to the quandary is that consumer prices are rising at a much faster rate than overall growth. According to Britain’s Office for National Statistics, consumer prices rose another four percent in March following a 4.4 percent increase in February. The resulting inflation is rapidly outpacing gains in salaries and wages and is seriously undermining consumer buying power.

Consumer Price Index – Annualized Rate

Nov 2010 – 3.2%
Dec 2010 – 3.3%
Jan 2011 – 4.0%
Feb 2011 – 4.4%
Mar 2011 – 4.0%

Will Get Worse Before It Gets Better

Like several other developed economies, England faces a huge deficit made worse by the recession’s double whammy of reduced tax revenues and greater expenses arising from monetary stimulus to support the economy. Truth be told however, Britain has struggled with deficits for many years now and the situation has finally reached the point where it can no longer be ignored. Even with higher revenues expected this year, the budget shortfall for the current year is estimated at £140 billion (US$228.5 billion).

In its last budget, the government outlined plans to introduce significant spending cuts to the tune of £83 billion (US$133.5 billion) over the next four years. This is thought to be sufficient to balance the budget assuming higher government revenue as the economy recovers. This also assumes that the spending cuts will not impact those revenues and this is where things tend to get a bit sticky.

For the past six months, Bank of England Governor Mervyn King has argued against hiking interest rates to deal with the mounting inflation. King defends his position by blaming rising food and energy costs for a “temporary” spike in consumer prices suggesting that “core” inflation is actually quite low. King also suggests that as the impact of government’s spending cuts take effect, overall growth could decline even further.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.