UK economy set for low inflation, says think-tank

THE BRITISH economy is on course for a strong recovery with low inflation, according to an upbeat forecast published today by the National Institute for Economic and Social Research (Niesr).

THE BRITISH economy is on course for a strong recovery with low inflation, according to an upbeat forecast published today by the National Institute for Economic and Social Research (Niesr).

It says the health of public finances is "remarkable", and that the budget surplus will inevitably create expectations of increased spending.

The influential institute says, however, that accelerating pay claims make the tight jobs market a worry, and urges the Monetary Policy Committee to raise interest rates "sooner rather than later". Many economists expect rates to rise after next week's MPC meeting.

The report calculates that the strength of tax revenues gives Gordon Brown, the Chancellor, plenty of scope to raise public spending or cut taxes without breaching his rules for prudent fiscal policy. But it advises against this, saying growth is picking up without the need for an extra boost from government tax and spending policy.

It also says the improvement might not last beyond the course of the business cycle. "We caution against the assumption that the fiscal windfall is going to prove permanent. Buoyancy can disappear as rapidly as it appears," it warns.

The report adds that a much tighter fiscal policy combined with lower interest rates would make it easier for the UK to join the single currency at a lower exchange rate than at present.

The forecasts have been revised up in the three months since the last Niesr report, with the think-tank's economists predicting growth at 1.8 per cent in 1999 and 2.9 per cent in 2000.

Exports and manufacturing will recover sharply from the beating they have taken, but surging imports will take the balance of payments into the red to the tune of £12bn this year and next.

Pay growth is the main cloud on the horizon, and the report warns that the tight jobs market will "test the economy's ability to deliver higher productivity growth". If productivity does not improve at a faster pace, increases in earnings will prove inflationary.

Interest rates will need to climb to 6.5 per cent next year, it predicts. Ironically, however, the report also argues that the MPC has been too activist. Inflation would have been little different if rates had not been changed over the past two years, it claims.

A separate article in today's report shows that London has been enjoying the fastest population growth among the UK's cities. Northern cities have been shrinking, with skilled and professional workers the most likely to be leaving.