UK economy has stalled at a dangerous junction and new measures are needed to put growth back on track, says ITEM Club report

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London 19 October 2011: The UK economy has stalled, according to the latest quarterly forecast from the EY ITEM Club, with business investment and exports, the key drivers of the recovery now stuck in neutral.

In a report out today, the ITEM Club says that uncertainty across the Eurozone, which is predicted to grow by 1.6% this year, and a slowing world economy, is undermining business confidence and investment decisions, putting the brakes on UK growth.

At this critical juncture, ITEM says that the Bank of England’s injection of an additional £75bn of Quantitative Easing (QE) is unlikely to put the recovery back on track and that the government should also be looking to use targeted monetary and fiscal measures to support growth.

ITEM Club has downgraded its GDP forecast to just 0.9% this year (down from the 1.4% it predicted three months ago) and 1.5% in 2012 (down from 2.2%), before moving up to 2.5% in 2013.

Bright spots in the economy have dimmed to a flicker

Peter Spencer, chief economic advisor to the EY ITEM Club, comments: “It’s worse than we thought. The bright spots in our forecast three months ago - business investment and exports - have dimmed to a flicker as uncertainty around Greece and the stability of the Eurozone increases.

“With the UK recovery grinding to a halt, new measures are now needed to help stimulate growth. We think there is scope for targeted tax reliefs and spending measures to help put us back on track. In the meantime, businesses need to be much more aware of the economic risks and have contingency plans in place given the current volatility.”

The report predicts that business investment will be flat this year and exports will increase by just 6%, much less than looked likely three months ago.

QE unlikely to re-start economic growth

ITEM Club warns that the additional £75bn of asset purchases announced by the MPC earlier this month is unlikely to be the silver bullet to the UK’s economic woes. Long term gilt rates are already at all-time lows and, given the current uncertainty in the market, asset prices may not respond. Even if the extra cash does make it into company coffers, there is little incentive for corporates to rush out and spend whilst the level of demand, from both home and abroad, is so unstable.

Instead, Spencer says the Bank of England should consider using monetary policy to lower interest rates by another 25 basis points. “The MPC have  self imposed an interest rate floor of 0.5%, however we think they could afford to trim rates by another 25 basis points or more, particularly with inflation set to come back to target next year. It would provide a boost to borrowers and potentially help to stimulate consumer spending during the difficult months ahead.”

Unemployment set to soar

The report is also calling for more targeted support for the labour market.  Employment levels held up relatively well during the recession because companies held onto staff by moving them on to short time working.  They have since expanded their workforces with temporary and part time workers. However if demand disappears, the private sector could see sizeable job losses. ITEM forecasts that the UK’s unemployment rate will increase to 2.7 million by the spring of 2013.

Ahead of the Chancellor’s autumn statement in November, ITEM is urging the government to use savings in the austerity budget to support employment with measures such as cutting employer National Insurance Contributions for under 21s.

Spencer comments: “There isn’t a lot of wiggle room, but lower debt repayments resulting from low interest rates, should enable the Chancellor to make some savings in the austerity budget. We would like to see any savings put to good use to support employment, by cutting employer NICs and, if things go badly wrong in Europe, following Germany’s example by supporting short time working. These policies were used very successfully to maintain employment in Germany during the last recession.

“With the public sector cuts starting to feed through in the UK, it’s vital that the private sector labour market continues to stay afloat,” he added.

Cut stamp duty to support growth says ITEM Club

The ITEM Club says that there is also an opportunity for the Chancellor to support UK growth by stimulating the housing and construction industries. During the depression of the 1930s, when interest rates were also very low, house building boomed. Spencer says that the Chancellor might be able to take advantage of the same conditions whilst also providing some protection to the sector if Greece defaults and interbank lending freezes up again, for example by cutting stamp duty, particularly for first time buyers.

“To help buffer the UK from strengthening headwinds from the Eurozone, the Chancellor needs to look to the tax system and measures that still remain within his control. The housing market is an important driver of the construction industry and consumer spending. Cutting stamp duty, particularly for first time buyers would, in our view, be money well spent. The Chancellor should perhaps also consider putting up sin taxes to pay for this kind of tax cut.”

Light at the end of the tunnel for consumers

There is however some good news. Amongst the gloomy headlines, ITEM says that there is light at the end of the tunnel for UK consumers who will benefit from lower commodity prices and inflation, coupled with rising disposable incomes next year. The forecast shows household disposable incomes increasing by 1.2% next year, and consumption increasing by 0.7%.

Spencer explains: “The silver lining to our forecast is for consumers. Tremors from the sovereign debt crisis are feeding through into lower commodity prices. Copper and iron ore prices are already down 30% over the last quarter and we expect to see some spectacular falls in producer input costs by the end of the year.  CPI inflation will start to cool next January, helping our bank balances to feel a little healthier.”

Concluding he adds: “However we are still facing some major ‘ifs’ and ‘buts’. The risks to the forecast are huge. We have based our figures on the assumption of an early resolution of the crisis gripping the Eurozone, which may prove optimistic in view of the very slow progress made until now. In that case, the outlook for the UK would inevitably be a lot worse.”

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