The International Monetary Fund (IMF) has delivered an encouraging verdict on Britain’s economic prospects. It has suggested that the government’s deficit reduction plan is “strong and credible”, that inflation is likely to remain benign and that the recovery remains on course.
The optimism of the assessment surprised many who had voiced scepticism about whether Britain’s economy could sustain the level of public sector spending cuts proposed by the coalition, but to what extent does it chime with wider opinion on the British recovery?
The IMF forecast 2% GDP growth for 2011, rising to 2.5% over the medium term. It suggested that fiscal tightening would dampen, but not stop economic recovery in Britain. The report said loose monetary policy should continue to support growth and other areas of the economy would emerge to pick up the slack created by private sector cutbacks.
It also argues – in line with Bank of England analysis – that inflation does not pose a risk. Higher inflation figures have been caused by January’s rise in value added tax, and while inflation is likely to remain over the 2% target in 2011, over time disinflationary pressures such as fiscal tightening will redress the balance. It adds that “economic slack” will keep underlying wage and price pressures in check.
”Theoretically, policymakers could print money forever, but there are institutional and political constraints”
The Fund does acknowledge that the recovery is finely balanced and risks remain to its central scenario on both the upside and the downside. There is a possibility, for example, that low interest rates, sterling depreciation and improving global demand create a faster-than-expected recovery. On the other hand, the burden of consumer and household debt remains significant, there are signs of renewed housing market weakness and there will be significant fallout from public sector cutbacks. Any of these things could stall or reverse the recovery.
It is this final acknowledgement that most reflects the schism at the heart of people’s views on the British economy. It is a split that has gone as far as the Bank’s Monetary Policy Committee (MPC). At one end of the scale is Adam Posen, an external member, who advocates a resumption of quantitative easing. He says that Britain still runs the risk of long-term stagflation. He draws his views from his study of the outcome of similar crises in Japan in the 1990s and Europe and America in the 1930s.
At the other is fellow MPC member, Andrew Sentance, who has voted for a 0.25% rise in interest rates in four successive policy meetings. He says the inflation risk is not being taken seriously and that central bank assumptions that inflation will move down towards the end of this year are flawed. (article continues below)
Experts are equally divided on whether Britain can sustain recovery or not. The report’s assumptions that consumer spending will pick up as the labour market improves and that corporates will make use of their strong balance sheets to increase investment are starkly at odds with the views of Neil Woodford, the head of investment for Invesco Perpetual. He has been vocal in dismissing ideas of a resumption in corporate spending. He says that companies will use the cash piles they have accumulated for merger and acquisition activity, which is likely to create further unemployment and therefore put more pressure on overall demand in the economy.
As such, he says any immediate resumption in consumer spending is extremely unlikely. He suggests that Britain is only half way through a five-year deleveraging process.
James Carrick, an economist at Legal & General, also says that growth is likely to be sluggish at best. He says: “Interest rates are having a positive effect, but this will start to fade in 2011. Policymakers would have to keep cutting to boost the economy and they can’t do that. The public sector cutbacks are a lot to take out of the economy in just one year. The government is hoping for a private sector boost to offset that, but it is difficult to see that happening.”
Yet at present, some of the data seems to support a more optimistic assessment of the British economy. For example, figures last week from the Office for National Statistics confirmed the economy grew 1.2% in the second quarter, its fastest pace in nine years. The strength was largely derived from a pick-up in the construction industry and strong household spending.
Last week also saw an upbeat report on high-street trading conditions from the Confederation of British Industry. Its latest survey found that a net 49% of retailers said that volume of sales rose during September. This was the highest figure since 2004 and was considerably higher than analysts’ expectations.
Even Carrick points out that Britain has a lot less far to fall than it did in 2007. The setback followed a significant surge in activity, which simply has not happened in this latest, anaemic recovery. As such, another recession remains an outside scenario – he puts it at about a one in three chance.
Gerald Smith, the manager of the Monks investment trust and deputy chief investment officer at Baillie Gifford, points out one additional risk: if things do get worse, fewer levers are available to policymakers. He says: “It is worth considering that we are reaching the limits of monetary policy. Theoretically, policymakers could print money forever, but there are institutional and political constraints. In the longer-term, the question of whether we can grow our way out of debt is still open.”
The IMF report suggests that Britain needs to maintain its policy momentum to avoid a slide in the recovery outlook. The British banking system has repaired its collective balance sheet and is substantially stronger, but needs to continue to improve. Monetary policy needs to remain flexible and accommodative, possibly embracing the resumption of quantitative easing as necessary. The coalition also needs to build a credible regulatory alternative to the current tripartite system.
As an independent assessment of Britain’s economic strength, the IMF’s report is encouraging and gives some international credibility to coalition debt reduction plans. Nevertheless, there remain several risks to its forecasts and expert opinion is still largely split on the outlook for Britain. The markets have lived with uncertainty for some time and will have to do so for some time longer.