Thursday, 2 February 2012

NIESR's UK and World Economy forecast


Our latest forecast is published today: here are the highlights.


The World Economy

•   Our baseline forecast is for global growth of 3.5 per cent in 2012. Growth will accelerate to 4 per cent in 2013, representing a downward revision of about ½ percentage point in each year compared to our last forecast.

•   This assumes a delayed but ultimately successful resolution of the Euro Area crisis.   Nevertheless, we expect a mild recession in the Euro Area as a whole, as well as in the UK.

•   We forecast growth of about 2 per cent in the US this year, while China and India, although slowing, will continue to drive world growth.

The financial instability resulting from the Euro Area crisis, combined with fiscal austerity measures, continues to have a substantial negative impact on growth in Europe and to a lesser extent in the US. Monetary policy remains loose and, since October, we have seen further easing of monetary policy, through the use of a variety of different policy instruments, in the US, UK and Euro Area.

Our central forecast assumes that EMU remains intact, and that a decisive agreement will be reached by the second half of 2012 that will ensure European sovereigns are able to meet their borrowing needs at reasonable rates of interest.  The combination of this path for interest rates, tight lending conditions, and fiscal tightening in many Euro Area countries results in a mild recession in the Euro Area as a whole. However, there are substantial upside and downside risks to this scenario.

Recent data have been encouraging, and we project moderate growth in the US and Canada. In Japan, post-earthquake reconstruction will support growth, albeit still in a deflationary environment. In China, there is some evidence of rebalancing from exports to consumption, and we project only a gradual slowdown.



The UK Economy

•   The economy will contract very slightly (0.1 per cent) this year but grow by 2.3 per cent in 2013.

•    Consumer price inflation will fall back to 2.2 per cent this year and 1.4 per cent in 2013.

•    We expect the cyclically adjusted current budget to return to balance in 2016–17.

•   We expect unemployment to continue to rise this year to about 9 per cent, and to remain elevated throughout the forecast period.

The UK economy remains weak, and over the near term we do not expect economic conditions to improve. We expect output to be flat this year, as both the private and public sectors continue simultaneous deleveraging.  Meanwhile, while net trade provided the only significant positive contribution to growth in 2011, the Euro Area, the UK’s largest trading partner, is likely to enter recession.

We therefore forecast a return to technical recession in the first half of this year, as households continue to retrench, credit conditions remain tight, and businesses are reluctant to invest given uncertainty about both domestic and foreign demand.  Assuming a successful resolution of the euro crisis, we expect growth to pick up in the second half of the year, and to accelerate somewhat in 2013.

However, the output gap will be closed only very slowly, with unemployment rising to about 9 per cent this year and remaining high throughout the forecast period.  Even in 2014, it will still be over 7 per cent, compared to the OBR’s estimate that the structural unemployment rate is about 5.25 per cent. Unemployment at this elevated level for such a long period is likely to do permanent damage to the supply side of the economy, with large long-run economic costs.   Our central forecast is that inflation will fall below the 2 per cent target in the second half of this year.

The UK economy currently suffers from deficient demand; the current stance of fiscal policy is contributing to this deficiency. A temporary easing of fiscal policy in the near term would boost the economy.  The credible commitment to a sustainable fiscal policy over the longer term provides the Government with the flexibility to provide a clearly defined and temporary boost to near-term demand. An increase in government investment would not have a significant impact either on long-run sustainability or – given the way they are defined – the likelihood of the Government meeting its fiscal targets.


The detailed forecast is available here (£)

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