Hamish McRae: Gloomy view for Osborne but there are chinks of light

Economic View: Her Majesty's Treasury may not have got its finances straight yet but Her Majesty's subjects have made a fair fist of it

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The Independent Online

Well, there we are, and it is not great. The Bank of England's Inflation Report and the labour market stats from the Office for National Statistics are two of the three most important bits of economic data available to George Osborne ahead of his Autumn Statement on 5 December. The only other bit that matters will be the October report on public finances on 21 November, for that will give us more of a feeling as to whether the country is seriously off track for meeting the deficit reduction target or whether we are just a bit adrift of it.

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The new Inflation Report downgrades its previous forecasts for growth and upgrades those for inflation. So both are going in the wrong direction. While there are some reasons to suspect that the official growth numbers understate what is really happening and the inflation ones may slightly overstate underlying inflation, the Bank's forecast of only 1 per cent growth next year is a disappointment. Some day, some distant day, the outcomes are going to turn out better than forecast but of that happy state of affairs there as yet is little sight. The Bank thinks it will take until 2015 for the economy to hit its previous peak, reached in the first quarter of 2008.

The employment figures are now past their previous peak but while the three-month trend is still climbing and unemployment on that measure is still coming down, those labour market figures have a slightly soft feeling to them. I don't think there will be a collapse in employment, but there may well be a pause in growth through the winter.

You can catch a feeling for the way in which the various bits of the economy are growing, or not growing, from the top graph, taken from the Inflation Report. As you can see services, which in this case bundle together private and public services, are now back above their peak. But manufacturing and especially construction, are still way down.

In the bottom graph you can see the impact on our living standards. Our real household income actually peaked in the third quarter of 2010, just after the election, but that was artificial because it was supported by huge government borrowing. You can see the unsustainable nature of our consumption boom by looking at the way consumption overtook income in 2007 (the red line went above the green one).

Since 2008 British consumers have been reining back, saving part of their income, with the result that the red line is now well below the green one. Her Majesty's Treasury may not have got its finances straight yet but Her Majesty's subjects have made a fair fist of doing so.

So that is the background. Where do we go next? Have another look at that top graph and in particular at the top line on it. That is really a remarkably stable recovery, with service industries ticking up a little every quarter.

When you see a trend as solid as that, you have to believe that it would take something quite remarkable to unseat it. So I think we can assume that services, which comprise more than three quarters of the economy, will go on growing slowly but steadily in the months to come. Remember this output is supported mostly by domestic demand and other indicators of domestic demand have been reasonably upbeat in recent months.

The outlook for manufacturing, by contrast, is not at all good, largely because we are so dependent on exports and, worse, exports to Europe. At best eurozone domestic demand will be flat this year, and at worst, well, I don't think that bears thinking about because the collapse across southern Europe may become quite devastating.

For example, the Goldman Sachs current activity indicator points to a contraction of GDP running at around 1.5 per cent a year for the eurozone but this could obviously become worse if confidence, already very low, falls further.

Our problem is that while domestic demand for manufactured products is not too bad — car registrations were up 12 per cent year-on-year in October — exports will continue to disappoint given what is happening across the Channel. (Memo to people who feel the UK should leave the EU asap: sure, on a long-term strategic view less exposure to European markets would be sensible, but meanwhile we have a living to make.)

The other weak segment of the economy is construction. Here there is surely a big opportunity, with much-needed infrastructural projects and a chronic shortage of homes to house a growing population.

This is not the place to go into a critique of our underinvestment in infrastructure, the vagaries of our planning system, or indeed the weaknesses of our building industry. But as you can see from the graph the sector has grossly underperformed and it ought to be possible for there to be some recovery. There is, after all, a pile of investment funds seeking a home in infrastructure and property.

Given this uneven background, the most likely outcome through into next year will be more of the same. Some of us had hoped that real incomes would soon be rising again, with money incomes climbing by a little over 2 per cent a year and inflation dropping below.

I am afraid that looks over-optimistic, unless there is some positive external event, such as a fall in the oil price. Nor is there any lever the Chancellor can pull in three weeks' time that will change things in any significant way. He should, given his recent performance, adhere to the Hippocratic Oath, usually shortened to: First, do no harm.

There are, however, two points worth making, both of which are modestly positive. One is that real wealth is no longer being destroyed, for house prices are broadly stable and other asset prices reasonably solid.

The other is that time heals. Every month that people pay off a bit more of their debts, every month that employment creeps up, every month that consumer confidence recovers just a little, enables the economy to build a slightly better base from which to grow. And there are corners of decent growth, car sales being the best example. There are just not quite enough of them, at least not yet.