Sunday, December 28, 2003
Economy shrugs off its pre-war jitters
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My end of 2003 review reveals a year of two halves ...

Britain has has ended the year in good shape and the global economy is on the up. But only a few months ago plenty of people were predicting doom and disaster.

In the early months of 2003, before the Iraq war, the stock market was collapsing and so was business confidence. Britain’s economy came close to stagnating. The first release of the gross domestic product data showed growth of just 0.1% in the first quarter. Subsequent data revised this higher but that first release provided a fair reflection of how things felt.

Nobody, it seemed, was prepared to make any economic commitments before the Iraq war and some took time to do so after it. Business investment has remained one of the economy’s weak spots all year.

Meanwhile, there was plenty of scepticism about America’s recovery. Some pundits said the US economy would not generate enough impetus to avoid a “double-dip” recession. Others warned that the recovery would not generate jobs.

As it turned out, both warnings were misplaced. America, helped by an astonishing 8.2% annualised expansion in the third quarter, is estimated to have grown by a respectable 3.1% in 2003, according to Consensus Economics. Britain, the Treasury says, grew by 2.1%, below trend but with a significant pick-up in the second half.

Japan, regarded as in intensive care earlier in the year, grew by a respectable 2.7%, economists estimate. The real weakness came closer to home, with Europe’s failure to join the recovery party. The economies of “euroland” grew by just 0.5%, according to the consensus.

Apart from Europe, growth turned out stronger than expected. But this was by no means guaranteed. The Bank of England’s monetary policy committee cut interest rates to a near 50-year low of 3.5% in July. Other central banks either cut rates or maintained accommodative policy stances. The Bank reversed its July rate cut in November, producing the first hike since February 2000.

Gradually, as growth has taken hold in recent months, and the global recovery has become established, fears of deflation (falling prices) have abated. Even Japan and China appear to be coming out of their deflationary episodes. In Britain, unusually, inflation spent some months above the official 2.5% target (on the old measure of retail prices excluding mortgage-interest payments), before ending the year at exactly 2.5%.

Two lessons stand out from the year. One is that monetary policy, if applied aggressively, works. Many doubted whether American interest rates of 1% (and UK rates of 4% or below) would lift growth. In both cases they did.

The second lesson is that the public finances always catch policymakers out. Gordon Brown’s admission in his pre-budget report that public borrowing will be 37 billion this year was welcomed as a dose of honesty. But economists still believe he is too optimistic about the fiscal outlook.

The economy is now showing tentative signs of rebalancing itself away from excessive reliance on consumer spending. It remains to be seen whether this is the story for 2004.

For the past decade, The Sunday Times’s annual forecasting table has been the premier league for economists. Those who call the economy right can look forward to the admiration of their peers.

This year the top slot goes to Credit Lyonnais, with a forecast that was just about right on every count.

For a French bank to have made the best forecast of Britain’s economy sounds like an affront to national pride. But Glenn Davies, its economist in London, is English. He has been doing well over a number of years in the tables but this is his first outright victory. Congratulations to him, and to the near misses — the Ernst & Young Item club, Dresdner Kleinwort Wasserstein and the others near the top.

What about my numbers? They weren’t perfect — 2% growth, 2.25% inflation, a 4% base rate, unemployment below 1m and a 22 billion current account deficit — but they were good enough to score a perfect 10, up there with this year’s winner. My only exuberance was on the stock market, which I said would rise 20%. It hasn’t quite made that but, given where it was just before the Iraq war, it has done pretty well.

From The Sunday Times, December 28 2003

The table below shows the 2003 forecasting rankings. The forecasts in each case are for GDP growth (%), inflation Q4 (%) the current account of the balance of payments ( billion), unemployment, Q4 (millions) and base rate, end-year (%). The score for each forecaster is out of 10, with the scoring system explained at the end of the table.

Outturn 2.1 2.5 -24.25 0.92 3.75 (10)
1. Credit Lyonnais 2.3 2.3 -21.5 0.95 3.75 (10)
2. Ernst & Young Item 2.1 2.3 -16.0 0.97 4.0 (9)
3. Dresdner Kleinwort 2.2 2.0 -24.5 0.96 3.75 (9)
4. CBI 2.4 2.5 -23.1 0.99 4.25 (8)
5. Schroders 2.3 2.6 -26.0 - 4.0 (8)
6. UBS Warburg 2.4 2.4 -17.0 0.93 4.0 (8)
7. Williams de Broe 2.5 2.5 -29.0 0.86 4.4 (8)
8. Standard Chartered 2.3 2.0 -22.0 1.00 4.0 (8)
9. Barclays Capital 2.1 2.5 -15.1 1.06 4.7 (7)
10. Experian-BSL 2.3 2.4 -10.1 1.00 4.25 (7)
11. Bank of America 2.4 2.4 -18.5 - 3.25 (7)
12. HSBC 2.4 2.6 -16.0 0.97 4.0 (7)
13 West LB 2.5 2.5 -17.0 0.92 4.5 (7)
14. IMF 2.4 2.6 -23.0 0.99 - (7)
15. Deutsche Bank 2.5 2.4 -24.3 1.00 4.25 (7)
16. Global Insight 2.5 2.4 -22.1 - 4.75 (7)
17. ABN-Amro 2.5 2.3 -20.0 1.00 4.5 (7)
18. Daiwa 2.2 2.0 -11.5 1.00 4.0 (7)
19. Fortis Bank 2.6 2.4 -21.0 0.89 4.0 (7)
20. RBS Markets 2.6 2.7 -19.9 0.99 4.4 (7)
21. CSFB 2.5 2.5 -18.0 1.00 4.5 (6)
22. EIU 1.9 2.3 -11.7 1.00 4.25 (6)
23. Goldman Sachs 2.6 2.5 -20.5 1.00 4.6 (6)
24. Lehman Brothers 2.6 2.5 -27.2 1.00 4.75 (6)
25. Morgan Stanley 2.7 2.5 -23.0 0.90 4.5 (6)
26. National Institute 2.5 2.2 -16.3 1.06 4.0 (6)
27. Capital Economics 1.8 2.0 -22.0 1.10 3.5 (6)
28. OECD 2.2 1.8 -23.0 0.97 4.2 (6)
29. Oxford 2.6 2.1 -20.8 0.96 4.5 (6)
30. Liverpool 1.9 2.2 -29.8 1.14 4.70 (5)
31. Treasury 2.75 2.25 -24.0 - - (5)
32. Bridgewell 2.2 3.2 -16.8 0.96 5.0 (5)
33. EC 2.5 1.2 -19.8 0.95 3.7 (5)
34. Isis Asset Managers 2.7 2.4 -18.0 1.00 4.25 (4)
35. Hermes 2.8 2.4 -18.0 1.00 4.5 (4)
36. Cambridge Econ. 2.3 1.7 -20.1 1.10 4.3 (4)
37. J.P.Morgan 3.1 2.5 -23.3 - 4.75 (4)
38. ING Markets 1.8 1.7 -25.6 - 4.0 (4)
39. Merrill Lynch 3.2 2.5 -20.0 - 5.0 (4)
40. Citigroup 2.6 3.6 -26.3 0.81 4.9 (4)
41. CEBR 1.3 1.8 -22.4 1.12 3.0 (3)
42. Lombard Street 3.1 3.1 -20.5 0.91 4.75 (3)
43. Econ. Perspectives -0.4 1.9 -15.0 1.15 4.5 (1)

SCORING SYSTEM: GDP growth: 3 points for 1.9%-2.3%, 2 points for 1.6%-2.6%, 1 point for 1.4%-2.8%. Inflation: 3 points for 2.25%-2.75%, 2 points for 2%-3%, 1 point for 1.8%-3.2%. Current account: 1 point for within 5 billion of outturn. Unemployment: 1 point for below 1m. Base rate: 1 point for 4% or below. Bonus: 1 point for both growth and inflation in 2%-2.5% range. Where scores are equal, forecasters are ranked according to their proximity to the growth and inflation outturns.

Comments

David

I think you forgot the effects of marginal tax cut rates in the US as a driver of economic growth. US monetary policy has been accomodative for several years. I don't think it's a great coincidence that once the Iraq war was settled (major ground combat) and the US tax cuts were accelerated the US conomy took off. Marginal rate cuts provide greater financial rewards for work and risk taking. Capital gains tax cuts and the reduction of taxes on dividends lower the cost of capital. Lower investment hurdle rates mean far more opportunities qualify for consideration. Merry Christmas and Happy New Year.

Posted by: Gary Bezowsky at December 30, 2003 03:58 AM