Mid-year economic forecast

7 July 2009

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Following on from our economic forecast at the beginning of 2009, the FPB's economics adviser, Professor Phil Whyman, takes a look ahead at the what to expect from the economy in the months and years ahead.

The economic destabilisation caused by the credit crunch has had a devastating effect upon the global economy, with particularly severe consequences for export-orientated economies as consumer demand fell due to the limitation of credit, unemployment increased and the financial sector tipped the real economy into recession.

Though the trend of these events could be forecast, the scale has taken many by surprise.

Government predictions are for the UK economy to shrink by 3.5% in 2009 and recover slowly in 2010 registering an increase of 1.25%, before resuming above trend growth in 2011 with a 3.5% increase in activity.

Other forecasters are more cautious. The British Chamber of Commerce predict -3.8% in 2009 and +0.6% in 2010, whilst the CBI suggest growth rates of -3.0% in 2009 and +0.7% in 2010. These estimates

are close to the consensus of a panel of economists, whose predictions are -3.7 and +0.7 accordingly.

Therefore, the broad view seems to be that the economy will begin to recover in Spring 2010 and produce a modest net rate of growth by the end of that year.

There are, however, outliers to this consensus. Nobel Prize winning economist, Paul Krugman, believes that the UK economy might already be out of recession (since statistics always lag events), and, if this were the case, one might anticipate a faster growth rate next year than even the Treasury have forecasted. On the other side, the International Monetary Fund (IMF) predicts a larger 4.1% fall in GDP in 2009, and a smaller fall of 0.4% in 2010.

There are conflicting indications as to which of these points of view is correct. Inflation continues to decline, albeit not as fast as anticipated, which is a sign that the economy is declining more slowly than it has been but remains in decline. Moreover, the recent rise in oil prices, caused by speculation and not any surge in demand, is likely to have a negative impact upon any green shoots of recovery.

Unemployment

Unemployment is still rising rapidly, and it is estimated that it will peak between 2.8 and 3.1 million in a couple of years time (it always lags economic activity), which will have a depressing effect upon demand. However, the fall in the value of the pound will have a beneficial effect, by encouraging exports and making imports rather expensive. The effects of this devaluation may be slow to materialise since other economies remain in recession. However, there are tentative signs that the USA is faring better than anticipated.

Housing market

Evidence from the housing market seems to show some stabilisation of prices, although there were a few months of price rises during the last period of sustained house price decline in the early 1990s. Therefore, I believe that it is premature to expect other than a further significant decline in house prices, to push them closer to a level relative to average earnings. Finally, government policy has also had a significant positive effect upon the economy, preventing further decline by maintaining spending, and the Bank of England's quantitative easing policy should provide further stimulus.

Financial sector

The final piece of evidence relates to the financial sector and continued problems with access to credit, particularly problematic for small businesses. The Bank of England has discussed the possibility of banks having to make another call upon shareholders (or government) for capital, and recent increases in the differences between savings rates and mortgage costs would suggest that banks will wish to rebuild balances for a while longer, before access to credit will be eased.

On the balance of these pieces of evidence, my own growth forecast is -0.4% for 2009, recovering very slowly in 2010 (+0.5%), before returning to above-trend growth in 2011 (+2.8%).

Economic conditions will remain difficult, but should begin to improve during the second half of next year. Interest rates are likely to begin to rise again, a few months before this point, and the Bank of England will begin to reverse quantitative easing at about the same point. However, unemployment will continue to rise, and a lot will depend upon government making sure that quality training is available to all who lose their jobs, alongside other measures to maintain their links with the world of work, to prevent a lost generation as occurred during the 1980s.

About the author

Phil Whyman is Professor of Economics at the University of Central Lancashire and an adviser to the FPB. Professor Whyman teaches Economic Theory and Economic Policy and also undertakes research and consultancy for government, corporations and charitable bodies, advising on various aspects of economic policy.

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