Growth 'set to fall' in OECD

Downward cast: The OECD is pessimistic about the Chancellor's Budget forecasts

PAUL WALLACE

Economics Editor

The British economy will grow in 1996 by considerably less than Kenneth Clarke forecast at the time of his Budget, says the prestigious Organisation for Economic Co-operation and Development. In its half-yearly presentation of economic prospects, the OECD cut its overall growth forecast for its 25 member countries. It warned that the pace of economic expansion could fall still further if budget deficits are not curtailed and consumer confidence remains weak.

The OECD projects that the British economy will expand at only 2.4 per cent next year, compared with the 3 per cent forecast by the Chancellor. The principal reason for the disagreement is that the OECD is less optimistic about the outlook for consumer spending next year, saying that it will grow by 2.3 per cent, little more than this year. The Treasury is predicting a 3.5 per cent increase.

This "relatively cautious view" is mainly because the OECD does not think consumers will dip into their savings to finance expenditure. The Treasury thinks the household savings ratio will fall by about 1 per cent in 1996. The Treasury's forecast also includes the effect of tax cuts, estimated to add 0.6 per cent to the growth of real personal disposable income next year. Neither forecast assumed changes in interest rates, which were cut last week by a quarter per cent.

The Paris-based think-tank is also more pessimistic about the outlook for the current account balance, which it projects at pounds 11bn in 1996, double the forecast in the Budget. It thinks that imports will grow faster than exports whereas the Treasury thinks the opposite will occur.

However, the OECD is more optimistic about the medium-term outlook. By mid-1996, it says, "the economy could be achieving 'a soft landing' with sustained output growth, the unemployment rate falling slowly towards its natural rate, and the PSBR on track towards a sustainable medium-term position. Such a configuration would prepare the ground for sustained output growth with low inflation in 1997 and beyond."

The OECD thinks that the UK will narrowly meet the criterion for budget deficits for eligibility to enter European monetary union. It predicts a deficit/GDP ratio of 2.8 per cent in 1997, just under the threshold of 3 per cent or less set by the Maastricht Treaty.

The OECD now thinks output will expand by 2.6 per cent in 1996 for all 25 member countries compared with the 2.9 per cent it was projecting a year ago. There has been a sharp downward revision to its outlook for growth in OECD Europe from 3.2 to 2.6 per cent.

German growth in 1996 has been pushed down from the 3.5 per cent projected in December 1994 to 2.4 per cent. The French economy is seen as growing at 2.2 per cent in 1996, compared with the forecast 3.2 per cent.

Even these forecasts will be regarded as optimistic by many market economists. UBS is predicting growth of just 1.5 per cent in Germany in 1996 and HSBC Markets is forecasting a similarly modest rate of expansion for France.

Despite this, the OECD said there was only limited scope for cuts in German interest rates to regalvanise growth in Europe. While low inflation and sluggish money supply growth pointed to a reduction in rates, high wage settlements in 1995, planned tax cuts and higher capacity utilisation pointed towards a more cautious stance. The implication is that the Bundesbank's cut in rates last week may be the last.

The OECD points to three principal downside risks to its general outlook for the OECD area. A failure to push through budget consolidation, particularly in the US, Italy and some other European countries, "would put current levels of long-term interest rates at risk and threaten the positive effect they are projected to have on private investment".

A second risk would come from a renewed weakening in the dollar against the yen and the mark. This would adversely affect prospects in Japanand Germany. Thirdly, consumer confidence could remain shaky, leading to higher saving and undermining the pick-up in consumer expenditure in Japan and Europe.

The OECD says that EMUwill highlight the problem of malfunctioning labour markets. "Since monetary policy will be set on the basis of Europe-wide conditions, the relative inflexibility of Europe's labour markets will present problems for the various regions and, in turn, for the credibility of policies."