By Daniel Hunter

The UK economy is muddling through on the Government’s Plan A, with sluggish growth predicted for the next two years unless the Treasury and the Bank of England adopt a more innovative approach to fiscal and monetary policy, according to the latest Ernst & Young ITEM Club report.

The Ernst & Young ITEM Club’s Winter Forecast expects UK GDP growth of just 0.9% this year before staging a slow revival to 1.9% in 2014 and 2.5% in 2015. The report calls for a fresh approach to macroeconomic policy, in order to help stimulate investment and growth.

UK’s monetary and fiscal policy lacks firepower, says ITEM Club
Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club comments: “The UK has crawled out of recession but the Government’s mid-term report card should read ‘could do better’.

“Innovative policies from the Federal Reserve have helped to put the US economy in a stronger position to withstand tax increases and spending cuts. A fresh approach to monetary and fiscal policy in the UK could help open the door to long-term sustainable growth.”

The Ernst & Young ITEM Club says the package of infrastructure spending announced in the UK Autumn Statement had the potential to be a real game changer, but the £5bn investment didn’t go far enough and was a missed opportunity.

“There is scope for borrowing to help fund infrastructure investment,” says Spencer, “and the government could certainly do more to encourage housing investment, which is subtracting from GDP when it should be adding to it.
“On monetary policy, the inflation target has now become a risk to the credibility of the MPC and is long past its sell-by date. We are hopeful that the Treasury will see the arrival of a new Governor of the Bank of England as an opportunity to review the remit that it gives the MPC.”

According to the report, the UK’s short-term growth will be driven by improving prospects for the consumer, with falling inflation and rising employment levels boosting disposable incomes and helping to revive the high street. Consumer spending is forecast to increase by 1.1% in 2013 and 2.0% in 2014, but the Ernst & Young ITEM Club warns that this won’t provide the balanced, long-term sustainable growth the UK Treasury was hoping for.

Spencer explains: “The consumer revival is well under way and is one of the few bright spots in our forecast. By the end of the year earnings are expected to be outpacing inflation for the first time since 2007, while nearly a quarter of a million people are likely to be added to the UK pay roll. But this is by no means a long-term solution to UK growth.

“Companies have been holding onto staff in the hope of an uptick in demand and there’s a real risk that the growth in employment could go into reverse if GDP continues to disappoint. Balanced growth is ultimately dependent on a revival of exports and business investment, but this will remain elusive until confidence is restored to the financial markets.”

Net trade is expected to make a negligible contribution to growth this year, but should increase to 0.5% of GDP by 2015, as world markets pick up. The forecast says that business investment levels are unlikely to return to their former peaks until at least 2016. Although prospects in the world economy remain fragile, the report says the risks have lessened since this time last year but a lack of confidence is creating a climate of inertia amongst UK corporates.

Providing the Eurozone remains intact and corporate confidence continues to improve, the report expects companies to loosen their purse strings gradually with business investment forecast to increase by 3.1% this year and 8.1% in 2014.

Mark Gregory, Ernst & Young’s chief economist, says: “Businesses have been shell-shocked by the experience of the financial crisis and it’s taking time to recover. Companies have the finance available to invest and expand into new markets but a pervasive nervousness is causing many to sit on their hands until they see signs of a sustained recovery. Yet the one thing they can be certain of is low growth.

“The worry is that this strategy could see UK companies losing out to competitors from countries such as Germany and the US, particularly given the upturn in business investment in these markets.”

The Ernst & Young ITEM Club is calling on the Government to help stimulate investment by supporting the housing market. The report says that improving prospects for the consumer, low interest rates and the increasing availability of mortgages, have already laid the foundations for Government policy to build upon.

“History tells us that the housing market has the potential to provide a significant boost to the UK economy. In the 1930s, low interest rates stimulated a boom in house building, which created jobs and boosted related sectors such as construction and retail. With the right support, history could repeat itself. This is a prime example of how a more imaginative approach to fiscal policy could make a tangible difference to the UK’s growth prospects,” Spencer adds.

The Ernst & Young ITEM Club expects housing transactions to increase to over one million next year, with house prices set to follow, rising 2.1% in 2014 and 5% in 2015.

Concluding Spencer says: “The clouds of uncertainty are slowly beginning to clear, but only to reveal a low-growth landscape inhabited by consumers and corporates that lack confidence and policy makers that lack initiative. Plan A is still working but, for a real step change in the UK’s growth prospects, we will need to see a more imaginative approach to monetary and fiscal policy this year.”

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