Amidst all the UK turmoil on the streets, world markets have continued to plunge on the back of fears about banks, government debts, and slowing growth.
So far markets have believed the UK government’s oft stated intent to get the deficit down and to control its finances. The UK government can now borrow at some of the lowest sovereign interest rates in the world. No-one doubts the UK’s commitment to meet all the payments, or her ability to do so.
That good news does not mean the UK economy is running to plan. The Bank has been forced into yet another reduction in its forecast growth for 2011 and 2012. Slowdown in the USA, turmoil in Euroland, and attempted slowing in the emerging economies, make an export led recovery that more difficult. The Bank has also drawn attention to the big squeeze on real incomes in the UK, a squeeze made far worse by the Bank’s failure to keep inflation down to the target level or anything like it. This squeeze cuts domestic demand.
The Bank’s figures for the first quarter of 2011 show that the public sector contributed a positive 1.1% to growth. The government increasd public spending significantly, leaving it growing more quickly than inflation. The extra money needed was all borrowed. The private domestic sector cut output by 2%, thanks to the real income squeeze. The overall positive outturn came from net exports added to the public sector. Net trade contributed plus 1.4%, giving overall growth of 0.5% despite the large fall in the domestic private sector.
So the UK economy followed a course rather different from that described in much of the media. Public spending and borrowing added to output, the private domestic sector subtracted from output, thanks to inflation, tax increases and the debt overhang.
Looking forward, the OBR and the Bank are now saying there will be less output and therefore less tax revenue in the early years of the 5 Year Plan. The government has to decide whether this is a temporary phenomenon, allowing them to borrow a bit more and await fast growth in the second half of the period, or whether it is likely to persist. If the latter, then the government has to look again at the way it is going to get the deficit down.
Either way, it would be wise for the government to go easy on hiring new staff, on adopting new projects or signing up to new commitments. This is not a good time to expand spending further. It would give the government greater flexibility and more protection if spending started to undershoot targets.
For every 1% undershoot on the growth forecast the government will lose around £6 billion of annual revenues. If the government loses 1% of growth this year, and does not recoup that, it will lose more than £25 billion of revenues over the Parliament and the period of the recovery plan.