1998 will see slower growth but, in spite of policy complications, it should be possible for the economy to achieve a smooth landing
1998 is the year when the economy slows. Or rather, this has to be the year when it slows. If it does not, then before too long base rates will be heading back into double figures and the Clarke/Brown boom will have been added to the catalogue of recent British economic disasters, major and minor. If airline pilots were like economic policy-makers, very few would ever be allowed off the ground. Pilots achieve smooth landings, day in and day out, as a matter of course. We expect nothing less. But getting a sluggish economy airborne is difficult enough, while bringing it back safely down to earth is an infinitely more difficult matter.
And this time, of course, there is an added complication. All economic policy is, to a certain extent, an experiment. The current experiment is with the Bank of England's operational independence. We do not know whether, in its determination to do its job of keeping inflation at 2.5%, the bank will be overzealous. Still less do we know whether, with monetary policy operated by the bank, and fiscal policy by the chancellor at the Treasury, the right hand will know what the left is doing.
Why its downhill from here
There are four reasons why the economy should slow to something like its trend rate of growth between 2% and 2.5% in 1998, from 3.5%-plus in 1997. The first will be familiar to many readers. Sterling, on average, was more than 15% stronger in 1997 than the previous year. Britain is an open economy in which currency effects are important. This either means that exports will grow at a slower rate, or that the profitability of exports will be sharply squeezed. Both have important knock-on effects on investment and jobs. The pound's 1997 strengthening will be a significant drag - as we have already seen in the survey data on export orders (see above) - on growth in 1998.
Second, interest rates rose in November to their highest level since late 1992, and thus broke out of the narrow range they have occupied since the previous government switched from exchange rate targeting to inflation targeting. Current interest rate levels need to be put into perspective. In the '80s, the lowest base rate level was 7.5%. Not so long ago, a rise of one-and-half percentage points in interest rate levels, spread over a fairly long period, would have been regarded as a mere gnat's bite. Things are different now. The rise has occurred even as inflation has remained low. Real interest rates have therefore risen significantly and this can be expected to dampen the economy further.
Third, the business cycle will - sooner or later - exert itself. A recovery that began in the spring of 1992 is already a mature one, although this one has been unusual in that it has had twin peaks in growth. …