Go west young people – Ernst & Young ITEM Club Spring Forecast

New immigration helps keep UK interest rates low

London 24 April 2006: New EU citizens as well as their koruna and zloty are contributing to a surprisingly robust UK economy, according to the Ernst & Young ITEM Club Spring forecast, on the eve of the second anniversary of the accession of the ten latest member states.

“We are on the crest of a new immigration wave,” says Professor Peter Spencer, Chief Economic Advisor to the Ernst & Young ITEM Club. “The steady flow from the most recent accession countries to the UK has proved remarkably positive for the economy, keeping interest rates a half a per cent lower than they would otherwise have been,” he says.

Spencer continues, “From Poland to Slovenia these individuals have plugged gaps in a variety of industries, from agriculture to hospitality and catering with nearly 300,000 immigrants taking new jobs in the UK in the last 3 years. Unlike previous occasions that have been confined to major urban centres, this influx has benefited many regions across the UK from East Anglia to Edinburgh.”

He adds, “As a direct result the UK workforce has become younger, more flexible and economical, easing the pensions burden and keeping interest rates lower than many commentators could have predicted. Even with a modest rise in unemployment numbers we are looking at a very favourable cost-benefit ratio.”

UK economy picking up steam
This unexpected consequence of the UK being one of only three EU countries to immediately sign up to freedom of movement of labour in 2004 is helping to drive economic growth. ITEM expects GDP growth to pick up to 2.6% in 2007 and 3% in 2008 even if interest rates stay at 4.5%, which ITEM predicts they could do at least until the end of 2006.

Consumers back in the shops
“Interest rates have stabilised at a historically low level and that has boosted consumer confidence and house prices,” says Spencer. Some would say house prices are too buoyant for comfort but, Spencer comments, “Although the strength of the housing market has made the MPC reluctant to cut interest rates to stimulate demand, the buoyancy of house prices and transactions will support consumer spending.”

Exports to the EU on the up
A renewal in consumer confidence might suggest that the UK economy continues to rely on consumer spending to underpin growth. However the economy is gradually rebalancing and exports started to outpace imports in 2005 for the first time in a decade.

According to Spencer, recent export figures have been very encouraging. “The recent spurt is due to an increase in exports to EU countries, which were up 8% on the previous 3 months. And our figures suggest this will continue to rise, particularly if there is a fall in the pound, which would stimulate the economy further,” he says.

Is there an inflationary dark cloud on the horizon?
Spencer concludes, “On the whole inflation has been performing well, due to spare capacity and competition undermining pricing power, globalisation, greater price transparency and immigration. But growth last year was weak, creating a large output gap holding down inflation. Super-trend growth is now needed to close the gap.”

Editors' notes

The ITEM Club is the only economic forecasting group to use the HM Treasury’s model of the UK economy. Its forecasts are independent of any political, economic or business bias and this independence is underpinned by the untied sponsorship of Ernst & Young LLP. ITEM stands for Independent Treasury Economic Model.

HM Treasury uses the UK Treasury model for its UK policy analysis and Industry Act forecasts for the Budget. ITEM’s use of the model enables it to explore the implications and unpublished assumptions behind Government forecasts and policy measures. Uniquely, ITEM can test whether Government claims are consistent and can assess which forecasts are credible and which are not.

The ITEM Club was founded by a group of companies who wanted to obtain economic forecasts focused on business. The Club's corporate members are all major UK or global organisations (Ernst & Young is not a member but is the sole sponsor). Members span a range of industry sectors, and have the opportunity to discuss each forecast before it is finalised so that it can take account of their current business experience. This ensures that ITEM’s forecasts and analyses are particularly relevant for business and are not just academic or theoretical.