Future prospects

Our main scenario sees UK GDP falling by around 4.75% in 2009, but with quarter-on-quarter growth edging back into positive territory in the fourth quarter of the year due in large part to the stock cycle effects mentioned above. But there could be a renewed slowdown in quarterly growth in early 2010 after VAT rises back to 17.5% on 1 January next year. Thereafter we would expect a gradual recovery to resume as the effects of past fiscal and monetary loosening feed through, but growth in 2010 is still likely to remain modest at an average of only around 0.75% for the year as a whole.

As shown in Table 1.1 , our main scenario is broadly similar to the latest average independent forecast, but somewhat less optimistic than the Treasury’s Budget forecast. However, both our main scenario and the projections of other forecasters are subject to significant margins of uncertainty, as indicated by the alternative GDP growth scenarios shown in Figure 1.2

Risks to our main scenario for growth are much more balanced than earlier in 2009, but may still be weighted somewhat to the downside. We would therefore recommend that businesses should stress test their plans against the ‘prolonged recession’ scenario shown in Figure 1.2, which envisages a further 1.5% fall in GDP in 2010. This kind of ‘double dip recession’ is not the most likely scenario, but it certainly cannot be entirely ruled out. At the same time, the possibility of a stronger recovery can also not now be ignored given recent relatively more positive data.

Consumer spending is projected to fall by around 3.25% in 2009 and by a further 0.25% in real terms in 2010 in our main scenario. This reflects the squeeze on household spending power from continued credit constraints and the expectation in our main scenario that unemployment will continue to rise to a peak of around 3 million in the second half of 2010. As indicated by the alternative scenarios in Figure 1.3 and discussed in more detail in Box 2.2 within the full report, however, the path taken by unemployment is subject to considerable uncertainty with possible outcomes at the end of 2010 ranging from 2.8 to 3.5 million (on the Labour Force survey measure).

Business investment[1]  is also likely to remain weak in 2010, reflecting both subdued final demand growth and the continued influence of relatively tight credit conditions, even if these continue to ease over time. Housebuilding is also expected to remain relatively subdued in 2010, even if the worst of the decline in activity in this sector may now have passed.

Net exports are projected to make a positive contribution to GDP growth in 2009 and 2010 in our main scenario. The boost to exports from the fall in the pound since 2007 should help here together with the gradual recovery expected in the US and Euroland economies over the next year. Stronger growth in China and other emerging economies will have less direct benefit to the UK, however, as only a small share of UK exports currently go to these fast-growing markets.

Our main scenario for UK GDP growth would be consistent with inflation (CPI) remaining below target at the end of 2010, although the path of inflation is likely to be volatile in the short run due to the impact of energy price fluctuations and the rise in VAT from 1 January 2010.

In our main scenario, it should be possible for official short-term interest rates to be held at current low levels until mid-2010 with only a gradual rise thereafter. In the medium term, there is a risk that inflation could pick up again as and when the economy recovers, which could eventually cause interest rates to rise quite sharply (perhaps in 2011 or 2012) to pre-empt this risk. But this is not likely to be an issue in the short term.