Economic View: The harbingers of boom

The present two-steps-forward-one-step-back world economy will be the norm for the next five years
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Things are going to get better. That would seem to be the big news of last week. US economic growth shot past forecasts to reach 2.4 per cent annual rate in the second quarter, and the OECD concluded that while the eurozone would experience only "subdued" economic growth this year, in 2004 growth would pick up to about 2 per cent. Add in forecasts that Japan might grow by as much as 1.3 per cent this year and more than 1 per cent next - which by Japanese standards is brilliant - and suddenly the world looks a lot brighter.

But is this right? Only three months ago the consensus was that the eurozone would grow by more than 1 per cent this year; now the guess is half that. Germany was predicted to grow by 0.5 per cent; now it will be lucky to grow at all. Given that forecasts have been so wrong for this year, one has to take the projections of a modest upturn in 2004 with a strong pinch of salt.

So back to fundamentals - what ought to happen, given what we know about the economic background, the tensions and difficulties and the likely policy response. Remember that there is a natural tendency for economies to be self-healing, provided they are left to themselves and not hobbled by seriously stupid economic policies, such as those that have been instituted by Japan and Germany.

But the forecasts for next year are undoubtedly better. I have taken the numbers from JP Morgan's economic team for the graph above as they represent a good, middle-of-the-road set of market expectations. As you can see, all the large economies of the Group of Seven are expected to grow a bit, with the US and UK leading the pack.

Start with the US. On the plus side, it really has kept growth going - to such an extent that the OECD's chief economist recently acknowledged that the gap between continental Europe and America would probably continue to widen.

"Many Europeans," Jean-Philippe Cotis wrote in the "OECD Observer", "are now coming to the full realisation that, yes, economically speaking, North America and continental Europe may be growing apart."

Last week the OECD put this in standard diplomatic language when it said that meeting the EU Lisbon summit's objecting of becoming "the most competitive and dynamic knowledge-based economy in the world by 2010" was "very challenging". In other words, it is for the birds.

Still, even enthusiasts for the US have to acknowledge some grave concerns. One is that the growth momentum has been maintained by debt-financed consumer demand, which seems unlikely to continue at its present clip for much longer. (The very latest US consumer confidence figures suggest a downturn in growth.)

Another concern is the extent to which debt-financed public spending, including that on defence, is keeping things going. Again, there must be some end to that. I don't know whether the tipping point for the US Federal deficit is 4 per cent of GDP or even more. But I do know that US treasury bond yields have shot up in the past six weeks, and this suggests to me that the US markets are getting a bit touchy about the surge in Federal debt. (It also suggests to me that they may be losing faith in Alan Greenspan and the Federal Reserve, which is disturbing, too.)

Still, a combination of half-decent growth, rising profits and still-low interest rates suggest that these forecasts of US growth of more than 3 per cent next year are plausible. They may turn out to be wrong, but they are not ridiculous.

My worry about the US, actually, does not so much concern next year, which may well be OK, but 2005. It is fairly clear that by the autumn of next year, US short-term interest rates will be heading up. That will be an unsettling period for all - not just Americans.

Britain? Our Treasury forecast growth at between 3 per cent and 3.5 per cent next year. That is really at the outer edges of the plausible, for it requires everything to come right: no housing bust, continued equity take-out, strong exports to the US and to continental Europe, a rebuilding of domestic investment, and public spending seen as delivering value for money and so being sustainable. Even optimists, like myself, feel all this is too much to ask.

Much more likely, surely, is growth this year struggling to get to the 1.8 per cent in the JP Morgan forecast and struggling to reach 2.5 per cent next year. If our housing boom comes to a sudden end - not impossible - then even that modest acceleration would be unattainable.

The Continent will do a bit better. I was intrigued to see last week that the influential Ifo Institute in Germany has made a modest upward revision to its growth forecast. The tax, labour market and pension reforms in Germany, however modest, seem to have had a significant impact on business sentiment. Instead of being suicidal, German business is merely gloomy. Getting economics right is about spotting turning points and it is quite possible that the 1.7 per cent growth suggested in the graph might be achieved. It would be a huge relief if it were - and not just to Germans, for the country remains our second-largest export market after the US.

If Germany comes right, the rest of the eurozone will come right. As you can see, the UK should outpace the big EU economies for yet another year, but a broadly based recovery should be in place by next summer. And if that is right, then 2005 becomes really interesting. Could it be one of those unusual years when eurozone growth outpaces American growth?

My guess is that the present, faltering, two-steps-forward-one-step-back world economy will be the norm for the next five years. We are catching a glimpse now of slightly better times and that is fine. But they are only slightly better. The next big boom is a way off yet.