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Predictability gives way to year of living dangerously

1997: A preview of the year ahead; Economics
"A year of almost unparalleled predictability." This is how a leading economist summed up 1996 in one of the year-end summaries now spilling out of the City investment banks.

It certainly looks as though the results of The Independent's annual Golden Guru award for the best economic forecast, due at the end of January, will be unusually close. The past year has brought few surprises.

But 1997 is going to be a year of unusual uncertainty about the outlook for the UK economy. For starters, there will be a lot of politics around. The election campaign will affect business, investor and consumer behaviour for the next few months. It will cast a shadow over share prices and sterling.

Then if, as still looks likely, Labour wins, the economy will move into uncharted waters. It is obvious that the measures introduced by Gordon Brown will be more like Kenneth Clarke's policies than Denis Healey's two decades ago, but there are still big unknowns. What are New Labour's tax plans? Will the Bank of England get more influence over interest rate decisions?

Looking beyond the blinkers of UK politics, there is more uncertainty out in the world in the coming year. Take two examples: share prices on Wall Street; and growth on the Continent. Opinions could not be more divided about where the US stock market is heading - Wall Street pundits are predicting either a crash or another year of double-digit growth in shares. Whichever it is, London is likely to follow suit. Although the links between the stock market and the economy are indirect, a sharp fall - or rise - in share prices would influence investment and consumer confidence.

There is an almost equally deep division of opinion over the outlook for the Continental economies, the main market for British exports. The mainstream consensus is that their struggle to qualify for the single currency will not keep growth so subdued for a second year running.

Yet there are plenty of Euro-pessimists who believe that the efforts of governments on the Continent to reduce their budget deficits to meet the Maastricht criteria will make the next 12 months just as sluggish as the past year. If they are right, the strong pound will guarantee that this spills over into British exports and growth.

The uncertainties in the wider world and in the world of politics amplify the normal sorts of risks attached to economic forecasts. Forecasts for the UK this year have something for everyone. According to the summary of forecasts compiled by the Treasury, predictions for GDP growth range from 2.8 per cent to 4.3 per cent, and for the target measure of inflation from 1.8 per cent to 4 per cent. Economists see the number of unemployment benefit claimants anywhere between 1.5 million and 2 million (the current level), and base rates between 5.75 and 8.25 per cent.

Underlying these divergent predictions lie two classes of soothsayers, divided by their view about whether the economy lies in the hands of saints or sinners. Either the flexible labour market has made inflationary wage claims a thing of the past, consumers have learnt their lesson from the late-1980s boom and bust and inflation is defunct. Or not. 1997 could test these theories.

Professor Patrick Minford of Liverpool University is firmly of the view that the economy has plenty of unused capacity, Britain's export markets are weak, and without big cuts in interest rates or taxes GDP growth in 1997 will be disappointing. Job insecurity will keep pay rises down even if unemployment falls much further, he predicts.

"If I were a Tory Chancellor who had just had a nerve-racking 18 months of relative stagnation, I would welcome the resurgence of growth in the late summer with open arms and I would nurture it," he concludes.

At the other end of the range lie some of the City economists who see haunting parallels between the late 1980s and the late 1990s, particularly in consumer behaviour. For example, Kevin Gardiner at investment bank Morgan Stanley argues that real wages are rising, more people have jobs, consumer debt-income ratios are low and the windfall of building society share hand-outs and income tax cuts will stimulate spending. Inflation- adjusted spending power, taking account of taxes and mortgages, is 10 per cent higher than a year ago, and will rise faster during 1997. Like the Bank of England, he sees a classic demand-led, inflationary recovery on the horizon.

There is a lot of anecdotal evidence to support this outlook, in house prices and high street spending, in falling unemployment and disappointing retail price figures. Although few experts really believe that the UK economy is poised for a re-run of the last boom, none of them expected it last time either.

Forecasts of the UK economy 1997

GDP Target RPI Base rate

% % %

Highest 4.3 4.0 8.25

Lowest 2.8 1.8 5.75

Average 3.5 2.9 7.0

Treasury 3.5 2.5 n/a