It’s official – the Bank of England’s latest inflation report confirms that UK economic growth is likely to be very weak at best for the near term. The Bank of England forecasts no growth until next summer. It has also downgraded its 2012 forecast from 2.2% in August to 0.9%. Inflation is expected to drop rapidly from 5% to well below its 2% target by the end of 2012.
The main problem is the slowing down in global demand, which is the culmination of several factors. Concerns have increased about sovereign risk, especially the solvency of some eurozone governments. These have increased the pressures on banking and some sovereign funding markets. Falling business and household confidence (at home and abroad) have added to the problems. Fiscal consolidation and the continued squeeze on the real incomes of households are also significant.
The view at present is that these factors have all conspired to produce significant downward pressures in the UK near-term economic recovery. The biggest single problem, though, is the lack of a strong, effective and sustainable response to the eurozone crisis.
The European economy appears to be slipping closer to recession in the wake of the continuing eurozone crisis. With key economic data (like unemployment and the purchasing managers’ index for the manufacturing sector) apparently weakening, a strong and sustainable response to the eurozone crisis is badly needed. The OECD has now cut its eurozone 2012 growth forecast to 0.3% (from 2.0%).
The IMF warns about the world economy ‘hurtling’ into a lost decade of economic growth. They argue for concerted action by the leading countries to mitigate prolonged high employment and low growth. Again, the urgency of resolving the eurozone crisis is emphasised as an important part of the key to global economic recovery.
The UK’s strong links to the eurozone mean that it is heavily affected by the eurozone crisis. Around two-fifths of UK exports are to the eurozone. UK banks are also exposed with their considerable loans to the peripheral countries, the so-called PIGS countries plus Italy. The prospects of big bank losses may operate to make the banks (even?) less willing to lend at home.
The Bank has signalled that it is likely now to pump billions more into the UK economy under its Quantitative Easing (QE) programme. UK Government ministers have also drawn up an ambitious plan for a £50bn emergency cash injection into the economy with the aim of boosting economic growth. These proposals will be announced in the growth review (on November 29), when private investors will be asked to pay £50billion into infrastructure investment funds. Investors will receive later dividend payments from these investments.
George Osborne, the UK Chancellor, is also finalising plans for a programme of ‘credit easing’. These plans will provide Government cash directly to struggling small firms. This move has been prompted partly by the failure of the UK’s five biggest banks to meet their agreed lending target (around £1bn) under the much vaunted (and increasingly disappointing) ‘Project Merlin’. Some financial commentators are also arguing for tax reform in the UK as part of the overall efforts to boost economic growth.
What the UK and global economy badly need is a big demand boost, but sorting out the eurozone crisis has to be the first necessary condition to achieve this.
Professor Ted Gardener