Sunday, January 04, 2004
Steering clear of the danger
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

This time last year I posed six questions, on interest rates, the stock market, a euro referendum, the housing market, consumer spending and tax. By luck or good judgment, all the answers turned out more or less right. So let me repeat the exercise, this time squeezing in a few more.

Will the stock market continue to rise?

Yes. Some analysts and commentators think the recovery we have seen since just before the Iraq war, 36% for the FTSE 100, is just a blip in a bear market. Stranger things have happened but that looks highly improbable. Global growth is returning to normal, which will mean something like 4% this year, and corporate earnings should continue to recover. A FTSE 100 level of 5,000 represents fair value, implying a 12% rise during 2004.

Will interest rates rise?

Yes. The Bank of England should stay its hand this week but given stronger growth it is unlikely to delay beyond February before lifting rates again. The base rate is likely to rise to 4.5% at the end of the year, against 3.75% now. There is little case for rate rises from the European Central Bank or Bank of Japan but America’s Federal Reserve should start nudging rates higher by the summer, the current 1% level doubling to 2% by the year-end.

Will the dollar fall?

Only a little. When everybody expects something to happen, it can be sensible to take a different view. Everybody is looking for the dollar to slide. The dollar has already fallen a lot but currencies have a tendency to overshoot. The likelihood is that the euro will rise above $1.30 very soon, and sterling above $1.80. But the dollar won’t weaken much further and should be strengthening in the second half. A small revaluation of the Chinese renminbi could lance the boil of dollar weakness.

How about oil prices?

They haven’t fallen in the wake of the Iraq war, as some hoped, but have stayed close to $30 a barrel. Adjusted for dollar weakness, the oil producers have kept prices within their desired target range (which used to be $22 to $28) and that looks likely to continue.

Will the Treasury revisit the question of euro entry?

No. The Treasury’s euro experts have locked away their files and moved on to other things. Gordon Brown’s promise to review progress towards convergence at the time of the budget was a sop to Tony Blair.

Will we see a new prime minister and president?

No, on both counts. One theory is that Tony Blair will hang on beyond the Hutton inquiry and tuition fees vote but hand over to the chancellor at a time of his choosing. That looks unlikely. Blair will lead Labour into the next election.

As for George W Bush, the capture of Saddam Hussein has tilted opinion in his favour on Iraq and, while I’m no fan of his economic policies, they should guarantee electoral success.

Will Brown break his fiscal rules?

No. While government borrowing will rise to 40 billion, the chancellor will be able to claim he is still on course to meet the golden rule — only borrow to fund investment — over the cycle. Only after the next election will we discover if he needs higher taxes to achieve it.

Will he raise taxes this year?

No, for the reasons outlined above and the small matter of a probable 2005 general election. After the Treasury’s robust message in last month’s pre-budget report, that the fiscal rules will be met with plenty to spare, an early tax rise would look bizarre. But expect to hear plenty of squeals from Whitehall departments in the coming weeks about the clampdown occurring in the 2004 comprehensive spending review.

Will this be the year of reckoning for housing?

No. Housing-market gloomsters split into two camps, those who predicted disaster in 2003, and those who said it would be delayed until 2004. The 2003 camp got it wrong and the same fate awaits the 2004 group, despite a historically high ratio of house prices to earnings. A modest rise in interest rates will not derail the market and unemployment will stay low. Those who predict a new tax hit for the market, say from stamp-duty rises, are ignoring the fact that the chancellor will not want to hit middle-class voters before an election. The housing market will continue to cool but average prices will still rise by 8%-9%.

Will the economy rebalance?

To an extent. As the governor of the Bank of England is fond of reminding us, this is the longest period in which consumer spending has grown faster than the economy as a whole since the 1870s. Never write off the British consumer but there are clear signs of slower growth in spending, partly under the weight of debt. Retail sales growth has almost halved in the past 12 months. Exports and investment, meanwhile, will benefit from a stronger world economy. Euroland, after virtually no growth in 2003, should manage 1.5%-2%. That won’t immediately help the balance of payments, which looks on track for a current account deficit of about 27 billion.

Will the exodus of jobs to China and India continue?

Certainly, but in the context of a generally strong jobs market here. Stronger growth — my 2.75% prediction is only slightly below the Treasury’s 3%-3.5% — should see the claimant count drop to 850,000, levels last seen in the spring of 1975.

What will happen to inflation?

Not much. Apart from the little excitement of the Bank of England’s new target, there is little reason to expect any action on the inflation front. The existing measure, retail prices excluding mortgage interest payments, should end the year at 2.5%, the new harmonised consumer price index at 1.75%. America, despite a falling dollar, low interest rates and a ballooning budget deficit, will not pay for it with higher inflation. Not yet at least.

So there we are. Britain’s economy looks to be sailing on serenely for a record 13th consecutive year of growth, despite one or two potential icebergs. Interest rates will nudge up, but not by much and inflation will stay low. Unemployment will fall. It sounds too good to be true. But why wish for trouble?

PS: The Economic Outlook Christmas quiz proved a great success, with replies coming in until late on New Year’s Eve. I may have to make it a regular feature.

The answers were as follows:
Q1. When base rates rose in November, it ended the longest period without an increase since when? A. 1951. Q2. When was the last time Britain had a quarter of negative growth — falling gross domestic product? A. 1992. Q3. Place these chancellors in order of length of time in the job, longest first. A. David Lloyd George, Gordon Brown, Nigel Lawson.

As for the tie-break — a new name for Brown to replace his “iron chancellor” sobriquet — a lot of people opted for the “ironic” chancellor, presumably because they see his declarations of prudence as meant ironically. The “plastic” chancellor, flexible and good for lots of borrowing, was popular, as was the rubber chancellor. We also had the trillion pound man, and a couple of culinary suggestions — the chocolate chancellor, melting under the heat, and “hash” Brown, which speaks for itself. None of it was meant in a mean-spirited way, I’m sure.

The three winners of signed copies of Free Lunch, from a large field, are Owain Bennallack, Alpa Shah and Anneka Treon (joint entry) and Tony Walter. Congratulations.

From The Sunday Times, January 4 2004