Despite yesterday's stern warning from the Bank of England that interest rates need to rise, the conventional wisdom is that Britain is enjoying a mini-boom, a kinder, gentler 1990s version of the last one. Most economic forecasters are predicting growth in 1997 of just above 3 per cent and inflation of just below 3 per cent, with the pace of growth slowing towards the end of the year. The profession seems to believe the Chancellor when he says Britain has left the see-saw years of boom and bust behind.
However, as Clive Granger notes in the latest issue of the Journal of Applied Econometrics, a special on economic forecasts, most forecasts cluster on one side of the actual outcome. Forecasters all tend to underestimate boom-year growth together, so the actual figure turns out to be well above most forecasts rather than in the middle of them.
Given this caution from one of the world's foremost econometricians, it is worth testing the strength of the case for predicting a bumper 1997. Take the housing market first, that classic British signal of economic excess. According to the Halifax, whose house price index is used by the Office for National Statistics, the average price rose by 7.1 per cent in the 12 months to October. It revised its forecast for both this year's and next year's average rise to 7 per cent from 5 per cent. The mortgage lenders, having tried to talk up the housing market for five years, have suddenly started to try and talk it down.
Experts outside the industry are starting to predict double-digit house price rises next year, however. Stephen Lewis at London Bond Broking in the City argues that with both the broad and narrow money measures growing much faster than nominal GDP, the excess is bound to spill over into higher asset prices, including house prices. He calculates that there is excess liquidity of about pounds 30bn in the economy, or about half of the entire value of turnover in the housing market last year. Even if only a fraction of the surplus money spills over into housing, it would have a big impact on prices.
This argument might be excessively monetarist for some, but it is certainly supported by anecdotal evidence. Tales of gazumping and sealed auctions, not to mention the difficulty of finding a builder, are widespread in London and the South-east, the national weather vane for economic overheating. Mervyn King, the Bank of England's chief economist, said yesterday that house prices can be a useful early warning indicator, and developments so far confirm the Bank's view that domestic demand is picking up smartly.
The stock market is the other classic outlet for excess liquidity, and shares have certainly been performing remarkably well. Although some stock market pundits in the US have been predicting a "major correction" - or crash - for a while, it has not materialised yet and might not for months. As long as Wall Street does not take a tumble, there is no reason why shares in London should do so.
On top of that, the stage is set for a revival of popular interest in shares thanks to the building societies due to join the stock market next year. An estimated pounds 20bn-worth of shares will start being handed out to societies' members starting in January. Institutional investors will want to buy some of those shares from private investors, and it is a pretty safe bet that some will cash in their hefty gains and spend them, just as they did in the popular privatisations.
Housing and easy money made on shares would be two of the key elements in a re-run of the late 1980s. There is no reason to believe that they would not add more froth to an already bubbly consumer upturn. The return of high-spending days in the City of London would, well, make the cork fly out of the champagne bottle. Many of those toiling in the Square Mile insist that things are not what they used to be, and that for every tale of Deutsche Morgan Grenfell poaching a corporate finance wizard at a vast salary, there is a humble analyst losing his job and having to settle for a lower salary elsewhere. However, in many areas the City has had a profitable year and there is every reason to expect that bonuses, mostly paid in February and March, will be ahead of this year's.
Add this to a background of rising inflation-adjusted incomes, mortgages still near their lowest for a generation, income tax cuts for the second year running, falling unemployment, and it looks like the perfect scenario for a very old-fashioned boom. What would prevent it?
The consensus view is that the current recovery is on a smaller scale, that manufacturing is still in a fragile state, and that consumer psychology has changed. The chart shows that in the approach to the 1988 boom the profile of growth was volatile, and there were some quarters during which the rise in GDP was very modest. The pattern of growth during the past few quarters does not in itself imply anything about the scale of the current economic expansion. Forward looking indicators all point to a surge on the consumer side without tighter policies, so unless Kenneth Clarke takes the Bank's advice to heart the question of what happens to the manufacturing revival remains the only uncertainty.
Mr King said yesterday that there was a downside risk to export prospects because of sterling's strength. But that does not mean there is no need to tighten the screws a little on consumer spending. He warned: "There must be a concern as we move forward that we will see the emergence of an imbalance between domestic demand on the one hand and net exports on the other." He added: "That was what went wrong in the late 1980s."
The case for higher interest rates or a tough Budget, or both, is compelling. Without them, either the domestic economy will boom, driving us into the usual balance of payments buffers, or we consumers will behave more sensibly when the money starts to roll in this time around. Of course when my building society shares arrive in the post, I shall crack open a modest bottle of sparkling wine, but others might be less restrained.Reuse content