Finance: Outlook - Small growth leads to small change

2005 could prove to be a reassuringly dull year for economists, says John Hildebrand.

Economists are worriers. In 2002 they were worried by lack of growth to the point that they wanted lower interest rates and higher government spending. Now they are worried that people are spending too much and not saving enough.

Most forecasters expect the UK economy to grow by approximately 2.5 per cent in 2005. This is almost exactly in line with what the authorities think the trend rate of growth ought to be. This, of course, is the biggest worry of all. If growth matches expectations, it leaves the authorities not knowing if they should be raising interest rates or lowering them.

Divided opinion

Forecasters, such as Roger Bootle of Capital Economics, claim that a downturn in the UK housing market, coupled with a post-election cut in government spending will lead to a sharp fall in growth. He therefore advocates cutting interest rates and predicts that they will fall to 3.5 per cent by 2007.

Others feel real interest rates, or the rate after inflation is taken off, are still low by historical standards, and note that average earnings are still rising by 4.5 per cent per annum.

In these circumstances, they feel rates need to go up.

The futures market is pricing in rates of close to 4.5 per cent by June, although we still feel there is a chance of them hitting 5 per cent.

Stateside growth

Rates overseas also look to be on an upwards trend. In the US, economic growth has been much stronger and the problems, such as the sizeable trade and fiscal deficits, are much larger.

We think rates will have to go up to 3 per cent by June. This will help curb domestic consumption and encourage savings. But if consumers and government spend less, growth will only be reasonable if exports grow and corporate spending picks up. Fortunately, the dollar has been weak and corporate balance sheets are generally strong and, judging by the amount of takeover activity, corporations appear ready to spend.

European rates low

Elsewhere, in Europe growth has been relatively weak and the danger is that, if they tighten too much, then economies will go back into recession.

Higher rates could also put upward pressure on the Euro, which would act as a further drag on growth. Consequently, while European rates may still rise they are likely to remain low.

Overall, the outlook for global economies looks reasonable in 2005, with inflation remaining under control. While there is plenty for the authorities to worry about, 2005 may prove reassuringly dull.

John Hildebrand is head of charities at Investec Asset Management

KEY POINTS

- Forecasters expect the UK economy to grow by 2.5 per cent in 2005

- Average UK earnings continue to rise at 4.5 per cent per annum

- The futures market is pricing in rates matching this 4.5 percent by June

- Rates in the US should rise to 3 per cent by June.

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