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State of the UK Economy 2006

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Since the last recession ended in the autumn of 1992 the British economy has experienced the longest period of uninterrupted economic growth since records began. After strong growth of 3.2% in 2004, in 2005 economic growth was lower than predicted at only 1.6%, however growth is expected to pick up to 1.8% in 2006 and 2.4% in 2007. Source (National Office of Statistics)

The significant feature of UK economic growth is that we appear to have avoided the boom and bust economic cycles which characterised the post war period. Since 1992 economic growth has usually been relatively close to the long run trend rate of 2.5%. This increased stability should help long term investment decisions.

However one drawback to the economic growth is that many economists argue that it is unbalanced. The manufacturing sector has continued to under perform with the main impetus for growth often coming from consumer spending. For example in the late 1990s the sharp rise in the housing market fueled consumer spending. Also with interest rates at 4.5% (in 1991 they reached 15%) consumers have been encouraged to borrow even more. This has led to a fall in the savings ratio to a record low of 4.0% in 2000 (compared to 12% in 1980). Since 2000 the savings ratio has recovered a little to 4.7% but it still remains very low with record levels of spending on credit cards. This means the UK economy would be very sensitive to any rise in interest rates which may occur in the coming 24 months.

Unemployment

Unemployment has fallen significantly since 1992 where the claimant count reached over 3 million unemployed. However after reaching an all time low in 2004 unemployment is now starting to gradually increase. The Office for National Statistics (ONS) said that the number of people out of work rose by 72,000 to 1.49 million or 4.7% in the three months to October. Using the governments less reliable measure of unemployment (those claiming benefits Ė JSA) unemployment stands at 902,000 in November, the tenth month in a row that it has risen. More worryingly is the fact that the number of economically inactive people has risen to an all time high. This puts pressure on government finances (Pay more benefits and receive less tax). The future prospects for unemployment remain uncertain. If growth continues to be below trend further job may be lost, particularly in the beleagued manufacturing sector. However if growth does pick up this upward trend may come to an end. Also many economists argue that the natural rate of unemployment in the UK has fallen due to increased labour market flexibility and successful supply side policies of the 1980s and 1990s. The unemployment rate in the UK still compares favourably to EU economies like Germany and France where unemployment is close to double figures.

Inflation

Inflation in the UK continues to be close to the governments target, despite the continued high prices of oil. In December the CPI fell to 2.% down from over 3% at the end of 2004. This could lead to the prospect of future interest rate cuts, although the MPC disappointed business at the last meeting of the MPC by keeping interest rates at 4.5%. With regard to prospects for next year some analysts fear that if there was a significant fall in the supply of oil from Iran (due to political reasons) the price of oil may continue to rise to $100 a barrel. At these levels it is quite likely that it would then feed through into cost push inflation. However at the moment such forecasts remain conjecture. Also there remain many powerful downward pressures on inflation such as price competitiveness of China, weak wage growth in the labour market and a moderation in the housing market.

Government finances

Despite 15 years of economic growth the government has been forced to borrow more than anticipated. The Pre-Budget Report forecast for 2005/6 is net borrowing of £37.0 billion. (The deficit on current budget showed a deficit of £4.0 billion, for December 2005 ) This indicates the government is close to breaking its golden rule for borrowing and the chancellor may be forced to raise taxes or cut spending if the finances donít improve. As a % of GDP public sector debt has risen from 30% in 2001 to 37% in 2005. However this is significantly lower than other OECD countries such as

Germany: 4.2% of GDP

France: 4.2% of GDP

USA: 4.9% of GDP

Japan: 7.4% of GDP

(2003 financial years )

http://www.statistics.gov.uk/cci/nugget.asp?id=206

Current account deficit

Current account deficit widen in the last quarter of 2005 to 3.5% of GDP, partly due to insurance payments resulting from Hurricane Katrina. This is the largest deficit for a long time. In the long term a rising deficit could cause constraints on lower interest rates and growth, although like the US the UK has been able to shrug off current account deficits without many ill effects

Conclusion

Despite moderate rises in the unemployment rates the general prospects for the UK economy remain positive. With a backdrop of low inflation and steady economic growth it is quite likely economic growth will pick up creating more jobs by 2007. If inflation continues to be close to the governments target it is also quite likely interest rates will be able to come down a fraction. The main cause for concern with the UK economy is the relative weakness of the manufacturing sector and industry in general. This makes it difficult to reduce the current account deficit and may cause more job losses in certain sectors of the economy.

- R.Pettinger 13/02/06


About the Author

Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys writing essays on Economic and he edits an Economics Blog focused on UK and US economies: http://www.economicshelp.org/econ.html.


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Article Published/Sorted/Amended on Scopulus 2007-04-01 23:54:06 in Economic Articles

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