Economic recovery: Lopsided

Date: 13/03/04

GORDON BROWN will find it hard to resist saying “I told you so” when he presents his budget on March 17th. A year ago, the chancellor of the exchequer was derided for over-optimistic growth forecasts; now they appear quite reasonable. The economy expanded by 2.3% in 2003, bang in line with the Treasury's central prediction. The Bank of England is currently expecting growth of almost 3.5% in 2004, the upper limit of the chancellor's forecast.

But Mr Brown should go easy on the self-congratulation. The government has been hoping that the recovery will not just strengthen activity but will also restore balance to the economy, making it less reliant upon a consumer boom fuelled by gains in housing wealth. A month ago, Mervyn King, governor of the Bank of England, said that consumer spending was likely to slow as house-price inflation abated and that the outlook for exports had brightened. As a result, “a long overdue rebalancing of the economy is now in prospect.”

There was scant evidence of that in figures released this week. Exports and industry were weak while the housing market has flared up again. Britain's trade deficit in goods and services widened from £3.1 billion in December to a record £4.6 billion in January. The deficit in goods deteriorated to a record £5.6 billion. Merchandise exports declined sharply, especially to America, raising fears that the strength of sterling against the dollar is already taking its toll.

The downturn in exports has hit Britain's long-suffering industrial sector. Recent surveys of manufacturers have signalled a strong upswing. However, manufacturing output rose in January by a meagre 0.2%; in the three months to January production was flat compared with the previous three months.

Unwelcome weakness in the external sector of the economy is being matched by unwelcome strength on the home front. The official index of house prices recorded a sharp fall in inflation from over 25% at the start of last year to 8.3% in December. However, it rose to 9.7% in the year to January. The Nationwide building society and the Halifax bank have already reported a further acceleration in February.

Mr Brown's worry is that his growth forecast will come true this year but for the wrong reason. Growth will continue to rely upon the consumer, rather than on business investment and exports. That is fine as long as it lasts. The danger is that the higher that house prices rise, the more likely and the more damaging an eventual setback becomes.

This danger was underscored on March 5th by the International Monetary Fund in its annual appraisal of the British economy. The IMF said that the principal risk to a strengthening recovery was the possibility of “a hard landing in house prices and consumption”. It estimated that house prices are over-valued by 30-35%.

The nightmare for Mr Brown is that a hard landing may materialise next year when the Labour government is planning to hold the general election. Voters have been prepared to tolerate Labour's disappointing record in improving the public services because the economy has performed well. They may turn nasty if the housing market goes belly-up.

Article suggests that the UK economy remains worryingly unbalanced with weak exports, manufacturing and business investment, and a strong consumer and housing boom.

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