Future prospects

Our main scenario sees UK economic growth slowing from around 3% in 2007 to around 1.75% in 2008 and 1.25% in 2009 as the effects of falling house prices, reduced credit availability, slower global growth and higher inflation come through, particularly by dampening consumer spending growth later this year and into 2009. As shown in Table 1.1, our main scenario is similar to the latest average independent forecast but below the Treasury’s Budget forecast, particularly for 2009.

Table 1.1 – Summary of UK economic prospects

Source: HM Treasury, Survey of Independent Forecasts (average values), PwC scenarios rounded to the nearest quarter of a percent. Investment refers to total fixed investment.

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. At present, risks to our main scenario for growth appear to be weighted to the downside and we would recommend that businesses should stress their plans against the downturn scenario shown in Figure 1.2, which envisages a mild technical recession later this year. This is not the most likely scenario, but its probability has been rising over the past few months and is now around 30% in our judgement.

Figure 1.2 Alternative UK GDP growth scenarios

Consumer spending growth is expected to moderate sharply from around 3% in 2007 to around 1.75% in 2008 and then only around 0.5% in 2009 in our main scenario. This reflects the squeeze on household spending power discussed further below.

Business investment[1] growth is also likely to slow markedly in 2008-9 in our main scenario, reflecting both slower expected future demand growth and the influence of tighter credit conditions. Housebuilding is also expected to fall in response to declining house prices. In contrast to the 2001-3 period, when the effects of a global economic slowdown on the UK were offset by increased government spending, slower private sector demand growth in 2008-9 will be reinforced by decelerating public spending growth given the weak state of the public finances at present.

Net exports are projected to make a positive but modest contribution to GDP growth in 2008-9 in our main scenario, with the boost from the recent fall in the pound being offset by slower growth in the UK’s key export markets in Euroland and the US. Although China and India will continue to grow rapidly, their share of UK exports remains modest for now. Import growth should, however, be dampened both by weaker domestic demand growth and by the relative weakness of sterling.

Our main scenario for UK GDP growth would be consistent with inflation (CPI) rising to around 4% in the short term, but then falling back towards its 2% target rate during the course of 2009. In this case, official short-term interest rates should be able to be held at around 5% over the next six months and might then be cut back somewhat in early 2009 to offset slower growth. If inflation accelerates much further, however, then the MPC may be forced to raise rates later this year, particularly if this is feeding through into inflationary expectations and wage claims.

[1] Business investment is the largest component of total fixed investment, which also includes housebuilding and government investment.