UK Growth Slump Will Hurt Housing Market

Despite soaring oil prices, the IMF latest world economic outlook projects that world GDP will expand by 4.3% in both 2005 and 2006, well above its long term trend. However, it has also downgraded its forecast for UK GDP growth from 2.6% to 1.9% for 2005. Gordon Brown has therefore reluctantly acknowledged that his forecast for UK GDP growth of 3.0%-3.5% for 2005 will not be met. The always right' Chancellor has had to admit that he was wrong, but he has taken two steps to minimise the embarrassment. He has prepared the markets to expect lower growth and sought to pin the blame for the shortfall on the rise in the oil price.

Clearly, higher oil prices have been a factor behind lower consumer spending, but other influences relate to the delayed effect of previous interest rate increases, a slowing housing market and a rising tax rate. Whilst a high oil price has affected all economies, the UK slowdown has been particularly sharp. The US economy, by way of contrast, was growing strongly prior to the onset of Hurricane Katrina.

Government current spending was supposed to increase by 5.7% in 2005, but in Q2 rose by 6.8%, although it was distorted by inflation. Whilst consumer price inflation has risen, the inflation rate attributable to the public sector has been rising faster for the past 6 years at about 5%. The reason for this disparity is the rampant growth of public sector spending without adequate means of ensuring increased output. As a result, a given increase in public spending results in a smaller increase in real terms.

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Although the tax take has been rising, it has not closed the gap between government spending and tax receipts. When this occurs, the support for the economy from high public spending is counterproductive. The economic slowdown will increase the government borrowing requirement and it poses the problem of either accepting an embarrassingly high deficit or raising taxes in an economic downturn. Whilst many are taking comfort from the idea that the housing market has stabilised, personal tax increases have yet to be introduced. In consequence, the current position will deteriorate. The Chancellor's luck has finally run out.

By Edward Menashy, economist at Charles Stanley Equity Researc