Prospects for the UK Economy
Barrell, Ray, Choy, Amanda, Kirby, Simon, Metz, Robert, Pomerantz, Olga, National Institute Economic Review
The production of this forecast is supported by the Institute's Corporate Members: Abbey plc, Bank of England, Barclays Bank plc, Ernst and Young LLP, Marks and Spencer plc, The National Grid Company plc, Nomura Research Institute Europe Ltd, Rio Tinto plc, Unilever plc and Watson Wyatt LLP.
UK quarterly national accounts have undergone a re-basing to 2002 prices, together with a comprehensive revision to past data. The revised data paint a significantly different picture of the UK economy from that on which we based our last forecast. It now seems that the economy decelerated in the second half of 2004 and into the first quarter of 2005 (see chart 1), whereas the previous data indicated a more robust outcome for the second half of 2004, with greater momentum carrying over into 2005. The preliminary estimate of GDP suggests that the below-trend growth continued into the second quarter of this year. The previous data indicated that the UK was operating at full capacity, while it would now seem that we are moving into a period where there is some spare capacity in the economy. The preliminary outcome for the first half of the year suggests that growth has been low at around 0.8 per cent, and this points to a much weaker outcome for the year as a whole. Our central projection is for growth of 2 per cent this year, and this is dependent on stronger growth in the second half of this year, with strong export growth and a more balanced economy. The HM Treasury forecast released in Budget 2005 projected strong growth this year of between 3 and 3 1/2 per cent.
The revisions to data have not changed our estimate of when the economic cycle started, although they do seem to have influenced the Treasury's estimate. Our estimate for the beginning of the last full cycle remains at 1999, as can be seen from the estimate of the output gap presented in chart 2. Box A evaluates the Treasury's current estimate of the output gap together with our latest estimate using a consistent data series. In light of the data revisions and our revised forecast we now estimate the cycle to have ended at the end of 2003, rather than in 2004.
Box A In light of the revisions to the National Accounts, the Treasury have re-evaluated their estimate of the output gap (see HM Treasury 2005) and re-estimated the start and end points of the economic cycle. These are needed for the evaluation of the Golden Rule, which requires they borrow only to invest over the economic cycle. The Treasury had previously estimated that the current economic cycle started mid-1999 and on their forecast was due to end in fiscal year 2005-6. However, the re-evaluation of the output gap in light of data revisions has led them to the conclusion that the economic cycle actually started in the first half of 1997. The Treasury have not produced a new forecast so it would seem that they are currently working on the basis that the economic cycle now covers the period of the first half of 1997 to fiscal year 2005-6. Chart 3 shows the Treasury's latest output gap estimate and also our estimate of the output gap that results from putting the data and our latest forecast through an approximate band pass filter (see Massmann et al., 2003). Both estimates use a series for Non-oil GDP at basic prices in mn [pounds sterling] provided by the ONS, rather than GDP at market prices as in chart 2. It is regrettable that the data series the Treasury uses in order to determine the period over which the economic cycle lasts is not easily available. Our estimate of the start of the last economic cycle remains unchanged at mid-1999. However, the Treasury's method of calculation produces an estimate that adds two more years of back data to the economic cycle. Our estimates suggest that by 2004 the economic cycle had come to an end, and that we are currently in a new economic cycle. The Treasury's method of calculation is first to determine the mid-points of cycles through the analysis of a variety of series including business survey indicators and indicators of inflationary pressure such as price indices and average earnings (see HM Treasury, 1999). …