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Monday March 19, 2007 - 11:18:30 GMT
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Economics Weekly: A happy tenth anniversary for Chancellor Brown? Weekly economic data preview: US & Japan interest rate decisions and the UK budget feature this week

Economics Weekly:

A happy tenth anniversary for Chancellor Brown?

Happy anniversary?
The Labour party won office in 1997 and Gordon Brown was made Chancellor by Prime Minister Tony Blair. This week will be his 11th, and likely last, Budget. Mr Blair is widely expected to step down this summer and Gordon Brown is expected to succeed him. So what has been his economic and public sector financial legacy, and what can we expect from this week’s Budget?

Expect few surprises in this week’s presentation of the 2007 Budget
There are a number of reasons why this week’s Budget does not seem to offer much scope for surprises from a Chancellor known for producing them. The first reason is that the budget deficit is 3% of gdp and cannot sensibly be increased any further. The second is that public spending has already risen strongly in the last five years, by twice the rate of real economic growth, and so cannot be increased. Indeed, it is planned to grow by just 2.6% in nominal terms, i.e. including inflation, in the next three years. The third is that all of the big announcements have already probably been made and he may want to leave any really interesting ideas for when he becomes Prime Minister. The fourth reason is that on all the major metrics of public finances, the UK’s position is deteriorating; tax is rising as a share of gdp, so is public spending, and borrowing remains at 3%, even though the economy is currently growing above its 10 year average rate of 2.8%. The fifth reason is that the broad macroeconomic picture this year is roughly as the Treasury projected, leaving little room for surprises. We agree with the central projection of 3% economic growth this year, though think that growth will be at the bottom of the 2.5% to 3% rate for 2008. For inflation, we think that consumer price inflation will exceed the Treasury’s forecast for this year and next, but only by about 0.25%.

For these reasons, we look for the Budget to say that healthy economic growth means that net borrowing will be at, or below, the revised 2006 Budget projection of £36.8bn for 2006/7 and that next year's borrowing will be held at £31.3bn. Net tax is set to stay below 40% of gdp and the fiscal rules, of only borrowing to invest over the economic cycle and to keep net government debt below 40% of gdp, will be met. Possibly, there could be announcements about securitising the UK government’s student loan book, raising potentially well in excess of £10bn, and economic data revisions are anticipated that will raise the level of UK gdp. This would at a stroke make all the public sector spending ratios we have just looked at appear substantially better. But the Chancellor is unlikely to embark on a renewed borrowing spree as a result. We look for confirmation of a tightening bias to government spending in the years ahead, with the 1.9% pay award for public sector workers a sign that the government is planning to keep departmental spending in line with the plans in the Comprehensive Spending Review. But that does not mean there will be no room for announcements about green issues, Olympics financing, large investment projects like cross rail, corporation tax, which has fallen below that in Europe, tax credits and a host of other issues. However, none will lead to big changes in tax or spending and the fiscal stance is expected to be on the same path as laid out in the 2006 Pre Budget Report.

The last ten years have seen a deterioration in the public finances, but strong growth
The last ten years have been good ones for Chancellor Brown. Not only will he be one of the UK’s longest-ever serving Chancellors but he leaves without having seen a recession under his watch or serious damage to his reputation. Chart a shows that UK economic growth this year will be close to the 3% he inherited in 1997, and, although there has been volatility, there has not been one quarter of falling output. How has this occurred? Chart b shows that although manufacturing has been recession twice, the services sector has continued to grow, with the flip side of this being seen in robust consumer spending and continued investment by services firms, alongside strong increases in public spending. As a result of continued growth over this period, chart c shows that employment has reached a record high of 29 million, up from 26.5 million ten years ago, and unemployment has fallen sharply from 5.5% to 2.9% on the claimant count basis. Inflation has been managed well overall, helped by central bank independence granted by Brown as one of his first acts as Chancellor in 1997. Average earnings growth is almost the same, at 4.2% annual currently, but price inflation has been rising recently and is now higher than when Brown took office in 1997, as chart d highlights. But he no longer has responsibility for keeping inflation under control. Chart e shows, though, why perhaps inflation is above target; interest rates are below where they were in 1997, at 5.25% in 2007 compared with 6% in 1997. However, one consequence of continued fast growth has been that the current account deficit has moved away from surplus in 1997 to a pronounced deficit in 2007, see chart f.

What about the public finances?
In his first five years, the Chancellor was frugal, keeping receipts ahead of government spending, But this reversed in the last five years, so that, see chart g, spending has been ahead of receipts since 2002. The consequences of this are shown in the following charts, h, i and j. Government expenditure has risen as a share of gdp, so has taxation. And they both now stand higher than when Brown took office in 1997. Net borrowing on an annual basis, chart i, is the same at 3%, but was in surplus of 4% in 2001. Outstanding debt is now rising as a share of gdp but stands below the 1997 rate of 44%. The Chancellor’s record is therefore mixed: good on the economy, not so good on the public finances after a strong start. Whether he will be seen as one of the UK’s greatest ever Chancellor’s may well depend on how the public finances perform in future, even though he may by then be Prime Minister.
Trevor Williams, Chief Economist

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Weekly economic data preview

US & Japan interest rate decisions and the UK budget feature this week

• The US Federal Reserve is not expected to cut interest rates on Wednesday, despite slower GDP growth, as last week's data showed core CPI well above the 1-2% comfort zone. But financial markets will focus on changes in the language and tone of the subsequent policy statement release, looking for signs of whether interest rates are now considered neutral for current economic activity.

• The Bank of Japan is expected to hold rates at 0.5% for a prolonged period, as there is a growing risk that deflation will resurface in the summer months and consumer spending remains weak.

• On Wednesday morning, the Bank of England minutes of its 7-8 March policy meeting will give an indication of the level of support, if any, for another interest rate hike. At 12:30 Chancellor Brown delivers his 2007 Budget Report, see main article in Economics Weekly for more details.

• There are numerous economic data releases this week that will have an effect on views of the balance of economic growth and inflation in the major economies. Tuesday is particularly busy for UK statistical publications, including CPI inflation, money supply and public finances. Key US housing market statistics will focus attention on whether or not the slowdown has bottomed out.

Last week's UK economic data such as core producer output prices, net external trade, private sector wage growth and housing market statistics indicated that UK economic growth remains strong and that there remains an upside risk to consumer price inflation and a possible need for higher interest rates. On Tuesday, we are expecting a strong monthly rise of 0.4% in headline UK CPI inflation for February, reflecting a rebound from the 0.8% decline in January, partly due to new retail stocks in the month. The old inflation measure, RPI, the benchmark for wage negotiations, may have accelerated even faster due to higher mortgage interest rate payments, by 0.5%. RPIX, which excludes mortgage interest payments, could have increased by 0.4%, the same as CPI, leaving the 12-month rate at 3.5%. In addition, we will be looking to see whether or not core consumer prices, which exclude energy, food, drink and tobacco accelerated again after falling to 1.6% in January from 1.8% annual growth in December. For the moment, although core inflation has risen in recent months it remains well below the 2.7% headline CPI rate, unlike in the US and Europe, where core inflation is accelerating more rapidly, but headline CPI is lower than in the UK, 2.4% and 1.8%, respectively. February's public finance statistics could show that the UK government is on track to meet its net borrowing target of £36.8bn for the current fiscal year, as the cumulative total to January was just £29.4bn, although this is only achievable due to a £5bn upward revision in the borrowing requirement last year.

On Wednesday, the publication of the minutes of the Bank of England's 7-8 March interest rate setting meeting will show whether or not Tim Besley and Andrew Sentance continued to be the only dissenters from the decision to keep rates on hold. Later in the day, the 2007 budget is unlikely to contain any radical measures, see accompanying Economics Weekly topic for commentary. The CBI industrial trends survey is also published on Wednesday – little change is expected in March from the 12-year high recorded in February, although manufacturing output has been flat this year so far. Thursday's retail sales number could rebound sharply, growing 2% on the month and 5.2% on the year, in line with positive survey evidence.

Although US inflation data was strong last week, the dollar weakened as financial markets became increasingly concerned over slower economic growth, compounded by ex-Fed Chairman Greenspan's comments about recession risk and global stock market volatility. We believe that this negative sentiment is largely overdone and that strong employment and earnings growth should support US GDP growth of 2.8% this year, down from 3.4% in 2006, and likely to rise to 3.2% in 2008. US housing starts, building permits and existing home sales published this week, will be closely watched for trends in the weak housing market.

The outlook for the euro zone economy continues to be positive, benefiting the euro. Also, headline inflation is remaining close to target (March CPI is due 27-29 March), so the ECB is clearly doing its job well. The strong German ZEW survey last week confirmed this positive outlook for 2007. Therefore, we expect another 25bp increase in interest rates to 4% by June to bring the repo rate closer to 'neutral levels', but after that further rises are less certain as the ECB will likely be guided more by incoming data.
Lloyds TSB Bank,
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