NIESR's UK forecast, August 2012

NIESR's quarterly forecast for the UK economy is published today. Highlights: 

• The economy will contract by 0.5 per cent this year, but grow by 1.3 per cent in 2013.

• Consumer price inflation will fall below the 2 per cent target by the end of 2012.

• Unemployment will peak at 8.6 per cent in 2013.

• We expect the cyclically adjusted current budget to be in surplus in 2016–17.

The deterioration in the UK economy has been more pronounced than even we expected. We estimate that the ‘Jubilee effect’ reduced estimated growth in the second quarter by 0.4 percentage point, with a corresponding boost to be expected in the third quarter. This implies that underlying growth is still negative. But focusing on a ‘double dip’ distracts from the more important trend; the level of output has effectively been flat over the past two years. This is largely due to domestic economic factors; private sector adjustment has been exacerbated by fiscal consolidation and a dysfunctional financial system. The divergence between poor growth figures and relatively strong labour market performance remains a puzzle, although other countries, for example Germany, have also experienced very weak productivity growth.

Going forward, growth will be restrained by weak demand in the world economy and in particular the Euro Area. We expect output to fall by 0.5 per cent this year and to grow by only 1.3 per cent in 2013, rising to 2.4 per cent in 2014, although there are downside risks from the Euro Area. More positively, we now expect unemployment to peak at only 8.6 per cent in the second quarter of 2013. The output gap will be closed only slowly, with significant spare capacity throughout the forecast period. We expect borrowing this year to exceed the OBR forecast by a significant amount, but this is largely a cyclical rather than a structural phenomenon, and we expect the cyclically adjusted current budget deficit to be eliminated in 2016–17, consistent with the government's revised target.

The continued weakness of the UK economy reflects both a lack of demand and the supply-side constraint of an unreconstructed banking system. The announcements of policies to support demand are welcome. The Funding for Lending scheme, the National Loan Guarantee Scheme, and UK Guarantees are all welcome, although the design of the schemes means significant deadweight losses are likely. Having a clear plan for the financial infrastructure the UK economy requires would be far better than this piecemeal approach.

It remains the case that there is scope for a less aggressive path of fiscal tightening. The government should consider on-balance sheet funding of key projects, concurrent with a comprehensive restructuring of banks and key funding markets.  

NIESR's forecasts for the UK and world economy are based on our global macroeconomic model, NiGEM (see here for subscription information).  Forecasts are published on our quarterly journal, the  National Institute Economic Review,  available from Sage Publications Ltd (http://ner.sagepub.com./) at subscription@sagepub.co.uk.