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2008: Looking ahead

• Evan Davis | Notes on Real Life |
• 28 Dec 07, 09:46 AM

Tis the season for predictions again. Yesterday you'll have read my reflections on what I said this time last year - and whether it was useful or not. But now it's time to look ahead...

If you asked how I鈥檇 like 2008 to go, given where we are now, I would be looking for

• a consumer slowdown;
• offset by a rise in exports;
• driven by a falling pound.

The overall economy would slow, but only to 1.5 to 2.0 per cent growth.

There are two interesting questions about 2008, that should tell us whether that scenario is achievable.

The first is whether the seed of inflation has already been planted in the economy and is now going to grow into a significant problem. If it has, economic life will be very much more complicated than my scenario outlines.

If we have already let inflationary pressure start building, then we can鈥檛 allow a falling pound to drive up prices, so we can鈥檛 promote more exports, so any slowdown in domestic spending is unable to be offset and becomes more serious.

Or to put it another way, the authorities will need more than a mild slowdown to kill the inflation.

The second question is whether the turning point now reached in the housing market combines with banking and financial problems to form a self-reinforcing downward spiral in asset prices, confidence, spending and growth.

The key words here are 鈥渟elf-reinforcing鈥�. If we get to a point where a bit of slowing sets in motion more slowing, then the authorities will struggle to keep the economy on a desirable path. You need to hang on to your hat.

With those points in mind - here are my observations and forecasts for next year.

1. On inflation, my guess is that it will rise but then fall back and it won鈥檛 turn out to be a serious problem. I say this because a mild slowdown will be sufficient to tame the inflation, and at least a mild slowdown seems very likely. I wouldn鈥檛 say I鈥檓 sure of this, but that would be my guess. Inflation seems less of a threat than it did in 1989.

2. On the slowdown, my guess is that it won鈥檛 be self-reinforcing; but that it will be very significant. I expect the UK economy will probably grow less than most forecasters currently estimate (1.9 per cent is the current consensus). This slowdown will derive from the fact that consumers will start being more cautious, increasing the savings ratio. As a result, domestic spending and demand will grow rather modestly. I wouldn鈥檛 think consumers will stop spending in a very abrupt way - shopping habits die hard.

3. On house prices, they now appear to be falling. I expect they will continue to fall, by 5 to ten per cent over the year. This is not because of the credit crunch; it is simply that once people lose the sense that house prices are rising, they don鈥檛 want to buy them anymore and the demand for houses falls. In addition, the oversupply of city-centre flats and the inevitable sale of buy-to-let properties will lead to downward price pressure. I wouldn鈥檛 rule out the falls being much bigger, but the market tends to turn quite slowly (remember the US housing market started turning in 2006, not 2007).

4. On the pound, my guess is that it will fall alongside the dollar. The UK economy has to switch its emphasis from domestic consumption to exports; that requires the pound to fall, and the authorities will let it do so. If I鈥檓 wrong about inflation, the falling pound will cause problems and may be curtailed by interest rate rises.

Incidentally, I expect China will let its currency drift up significantly further against the dollar, and this will significantly ease the path to global re-balancing.

5. On interest rates, I expect the bank rate to fall, ending the year at 4.75 per cent. If I鈥檓 wrong about inflation or the severity of the slowdown, I鈥檒l be wrong about this too! But my view is that rates can come down to contain the slowdown to the level just necessary to deliver falling inflation.

6. The government finances will probably turn out to be worse than Alistair Darling has forecast. The current balance (borrowing in excess of investment) for the 2007/08 year should exceed the pre-budget forecast by about four billion. It will be quite a problem as the chancellor鈥檚 forecasts for future years will look more and more shaky.

Those are my forecasts and observations. But let鈥檚 face it, there is a lot to go wrong. The US could slide into recession, China could overheat, oil prices could soar or banks could collapse. I鈥檇 love to predict that these will or won鈥檛 happen, but none can be foreseen with certainty, and none can be dismissed.

Mervyn King said he wanted to make monetary policy boring. He failed in 2007, and it looks like he鈥檒l be struggling to do so in 2008 as well. My final prediction is that Mervyn will be reappointed to make it boring again 鈥� at least by 2013.

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