UK economy is getting back on its feet, says ITEM

But we’re ‘not out of the woods yet’

London 23 January 2006: The UK economy is getting back on its feet showing signs of a modest recovery in 2006, according to the Ernst & Young ITEM Club winter forecast – but there are still concerns over long-term stability.

ITEM is predicting growth of 2.3% GDP in 2006, following a dismal 1.7% growth rate in 2005. This pick up is hardly surprising given the strength in price of houses, equities and other assets. Retailers also appear to have had a much better Christmas than many predicted.

But the positive news doesn’t end there. The ITEM forecast shows that the Consumer Price Index (CPI) has fallen back towards its target much earlier than ‘anyone had dared hope’, leaving the Monetary Policy Committee (MPC) free to cut interest rates if necessary.

However, Peter Spencer, Chief Economic Advisor to the Ernst & Young ITEM Club, adds a cautionary note, “We are certainly not out of the woods yet,” he says. “Growth is still well below par – just hitting the EuroZone average – and with consumer spending dropping and the pressure piling on exports to take up the slack, we could be in for a bumpy 2006.”

Exports need a bit of encouragement
If exporters are to live up to expectations and set the pace of growth this year they will need to markedly improve performance, which continues to disappoint.

Spencer believes that a fall in the pound would help (as UK interest rates are overtaken by those in the US) to aid growth in exports and investment – potentially into the Middle East and Europe. This would underpin a predicted modest revival in UK exports this year, partly due to the rapid growth in markets like OPEC where the UK is strong.

Spencer explains, “If the UK is to reach 3% growth in 2007 exports (and investment) must take up the slack in the economic rebalancing act as consumers continue to save rather than spend. However, it is difficult to see how this can successfully be achieved with sterling at present levels.”

Consumers cut back on the plastic – even in run up to Christmas
As economic pressure on the consumer eases, the ITEM forecast shows that UK householders appear to have resolved to shed their excess debt, with spending rising by only 1.3% in 2005 – the slowest for ten years.

“Over the last year households have reduced their borrowing and increased savings. UK consumers have also cut back on their use of plastic even in the run up to Christmas – unlike their US counterparts,” says Spencer. “People have learned that it is very difficult to get out of debt in a low inflation environment.”

He adds, “But debt still remains at historically high levels, which means there is much less scope for households to support their spending through increased borrowing. And with house prices unlikely to rise by more than two or three per cent through 2006, we see little scope for the significant real capital gains that encourage high levels of equity market withdrawal.”

MPC will need to make tough calls this year
Spencer also suggests that people may want to set aside more money for their retirement in 2006, which would lead to a sharper than forecast rise in the savings ratio. This could have all sorts of implications for projected GDP forecasts and makes the MPC’s task even more difficult this year.

“The outlook is still very uncertain. UK business and consumer confidence remains fragile. We expect interest rates to remain at 4½ % until the end of the year, but another rate cut cannot be ruled out,” Spencer concludes.

Notes to Editors
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.