Foreign holidays put UK trade in the red

SPENDING ON foreign holidays helped send Britain's balance of payments diving into the red by pounds 3.2bn in the first three months of this year. It was the first quarterly deficit for 18 months and the biggest for five years.

Britons' appetite for holidays and business travel reflected both the strength of the pound and the general buoyancy of consumer spending. With spending on overseas trips up more than pounds 300m at pounds 4.8bn during January to March, it took the UK's travel deficit to a record pounds 1.7bn and accounted for much of a big fall in the traditional balance of payments surplus on services.

At the same time the Office for National Statistics revised up its estimate for growth in the first quarter, adding to the weight of recent evidence analysts fear will trigger another interest rate rise.

The unwelcome figures came as an influential report warned that the British economy is in for a bumpy ride, with tougher policies running the risk of triggering a recession at the same time that inflation is heading higher.

The Bank of England faces a "challenging" outlook, according to the annual health check on the UK from the Organisation for Economic Co-operation and Development. "Ensuring a smooth landing will be a difficult task," it concludes.

The OECD notes there has been a considerable tightening already in tax and spending and interest rate policy. Gordon Brown's budgets amount to the toughest fiscal tightening of any OECD country, and monetary policy conditions are also tighter than elsewhere.

No further policy tightening is necessary, it concludes, but it warns that rates will have to stay high for some time. Written before last month's interest rate rise and the announcement of faster government spending growth in the next three years, it predicts that growth will drop sharply to below 2 per cent this year and next.

However, it adds: "Currently it is very difficult to judge the strength of underlying inflationary pressures and how quickly the economy will eventually slow." It predicts a pick-up in inflation alongside the slowdown in growth due to weaker exports.

Yesterday's official figures confirmed that the strong pound is harming exports. Much of the balance of payments shortfall, the first deficit since mid-1996, was due to the lumping of payments to the EU in the first quarter. The net transfer to the EU was pounds 1.5bn, compared with a zero transfer in the final quarter of last year.

But even accounting for this distortion, the deficit on trade in goods widened, from pounds 4.2bn at the end of 1996 to pounds 4.7bn, mainly because of a sharp drop in exports.

The surpluses on trade in services and investment income declined markedly during the quarter. Investment income from overseas dived by pounds 700m, most likely due to the Asian crisis.

"The trade figures were better than expected last year. But the strong pound is pulling them down like a brick on elastic; they have now shot forward and hit us in the eye," said David Mackie at JP Morgan.

Despite this drag on growth from a weaker export performance, the ONS revised up a fraction the figures for first quarter growth. GDP was 3.0 per cent higher than a year earlier, up from the earlier figure of 2.9 per cent. Growth during the first quarter, excluding volatile oil production, was revised from 0.5 per cent to 0.6 per cent.

"We have had plenty of data that will worry the Monetary Policy Committee," said Marian Bell of Royal Bank of Scotland.

DeAnne Julius, the Bank of England expert who voted for a rate cut in May, yesterday repeated her view that recent figures did not point to the need for higher rates.

But most City analysts, taken by surprise by the Bank's decision to increase the cost of borrowing earlier this month, now expect another rate rise next month.

Recent figures for earnings, retail prices and retail sales have all added to the fear that the Bank will feel forced to move because of inflationary pressures, even though the economy is now slowing.

The OECD report warns that a slowdown will have knock-on consequences. Rising unemployment could lead to a "ballooning" cost for the Government's welfare-to-work programme.

Ensuring a smooth landing is crucial to the success of these measures, it warns.