The Budget: 'UK will not follow sharp US slow-down'

Economic Forecasts

The Chancellor of the Exchequer promised sustained economic growth during Labour's second administration, assuming it wins the general election.

The Chancellor of the Exchequer promised sustained economic growth during Labour's second administration, assuming it wins the general election.

He insisted the UK economy was not set for a sharp slowdown in the wake of the US downturn and kept unchanged his forecast for GDP growth of between 2.25 and 2.75 per cent this year.

Mr Brown believes strong consumer spending and a rise in business investment will offset the negative impact on the export sector from the US slowdown. He said: "With the US experiencing a necessary slowing and Japan barely growing, the growth rate in the world's major economies this year is expected to halve while the world still faces volatile oil prices.

"But because Britain's economy remains stable, our Treasury forecast is that this year Britain's growth will be within a sustainable range of 2.25 to 2.75 per cent."

Some economists had expected him to bolster his reputation for "prudence" - a stance the Chancellor has all but patented over the last four years - by cutting growth for 2001.

Fraser Coutts, the UK economist for analysts 4cast, said: "It was a bit of a surprise to keep GDP the same but with an election coming you don't want to shoot yourself in the foot. I think it may be downgraded in the November pre-Budget report as a lot will happen between now and then."

The Bank of England, for example, believes GDP growth will slip to around 2 per cent towards the end of this year and stay there until early 2002, when it picks back up to just below 3 per cent by 2003.

The monthly survey by the Treasury of City economists London shows a consensus for growth of 2.4 per cent this year and 2.5 per cent in 2002.

Michael Hume, an economist at Lehman Brothers, said: "The Chancellor is making sure that he does not give the impression that we are entering a downturn. That was something he was desperate to avoid so I am not surprised at the forecast."

According to the details in the Budget "Red Book", the story is one of strong domestic demand, strong consumer spending, strong business investment but weak exports.

Consumer spending is now set to come at around 3.5 per cent this year, compared with the 2.25 per cent last year. The Red Book said: "Clear signs of a slowing to more sustainable rates are now hard to discern."

Growth in business investment has been revised up by 0.5 per cent to 2.75 per cent. The net effect is to add half a per cent on to the domestic growth which is set to come in at around 3.5 per cent, only slightly slower than last year.

But export growth is forecast to slow from 7.5 per cent in 2000 to 5.5 per cent this year, and 4.75 per cent in 2002.

Until recently, a forecast of no slowdown in domestic economic growth would have sent alarm bells ringing at the Bank of England. The Monetary Policy Committee has warned repeatedly that with government spending set to rise, the private sector must slow to allow any further cuts in interest rates.

Mr Coutts said: "This forecast may be slightly worrying for the Bank. There may be some concern with strong investment, strong government spending and strong consumer spending that three into two won't go."

Danny Gabay, at JP Morgan, said the consumer spending forecast looked as if it was based on implicit assumptions of further rate cuts. "It shows that the fact that inflation is undershooting the target this year won't go unnoticed at the Bank."

But economists were puzzled by the forecast increase in business investment. Mr Coutts said: "If you have a global slowdown and firms laying off workers then R&D budgets are one of the first things to go."

Looking further ahead, Mr Brown forecast growth of 2.25 to 2.75 per cent in 2002 - the same as in November's Pre-Budget Report - and gave an identical range for 2003.

The Chancellor also used his speech to scotch rumours that he was about to cut the inflation target that he sets for the Bank of England. Inflation has undershot the current target for 22 months in a row, raising the question of whether the UK economy has shifted into a new, more efficient gear.

Meanwhile the Harmonised Index of Consumer Prices (HICP), which is used by the 12 members of the euro currency area, has been at or below 1 per cent for the last 12 months.

But confirming the target at 2.5 per cent, the Chancellor said: "With inflation forecast to be 2.5 per cent next year, imposing a lower inflation target - as some have suggested - would mean upward pressure on interest rates and risk lower growth and higher unemployment."

This echoed comments by Sir Edward George, the Governor of the Bank, who last month said cutting the target would "damage" hopes of embedding public expectations about inflation.

Changing the target would have been seen as a move to prepare the UK for entry into the euro - something the Government is keen to play down ahead of an election.

This Budget comes against a remarkably different economic background from a year ago. Then, all the risks were on the upside. Growth was strong and house prices were surging through the roof, prompting fears that interest rates would have to rise as high as 7.5 per cent to control demand.

As it turned out, interest rates stayed on hold as economists began to accept that the economy was now sufficiently lean to accommodate record-low unemployment and surging oil prices without a leap in inflation.

After staying on hold at 6 per cent for a year, the Monetary Policy Committee moved in February to cut rates to counter the effects of a severe slowdown in the US. With inflation currently well below the Government's 2.5 per cent target at 1.8 per cent, the MPC has a large amount of leeway to cut rates again as insurance against a fall-out from the US.

However, some economists believe the domestic economy is growing too fast and that further cuts in interest rates will be restored later in the year.