Abstract
This 2004 Article IV Consultation highlights that United Kingdom’s real GDP growth is estimated at about 3 percent in 2004 and is expected to stay stable at about 2½ percent in 2005–06, in line with potential growth. Domestic demand remains the key driver of growth, underpinned by continued strong earnings growth and robust corporate profitability. Inflation expectations remain well anchored. Rising import prices are expected to push inflation toward the 2 percent target over the coming 2–3 years.
1. This note reports on recent developments since the staff report was issued. These developments do not alter the thrust of the staff appraisal.
2. Economic growth increased somewhat in the fourth quarter of 2004, as envisaged in the staff report. Data on expenditure components indicate that, relative to projections, household consumption growth was slightly weaker than expected, while government expenditure growth was a little stronger than expected. Coincident and leading indicators continue to suggest that growth will settle at about 2½ percent in 2005–06, in line with potential growth:
Recent housing market indicators have been at least as strong as expected at the time of the staff report, though a sharp decline in house prices remains the key near-term risk to the outlook. House prices rose a little in January, raising the three-month on three-month rate of change to about 3 percent. BOE data on mortgage approvals increased a little in December after six months of declines.
Real retail sales growth rebounded in January, following the significant easing in the fourth quarter of 2004. However, this series is volatile and on average monthly growth has slowed substantially since mid-2004.
The composite output PMI remained close to its ten-year average in January, suggesting continued trend growth in the near term. A fall in the manufacturing PMI was offset by a rise in the services PMI.
3. CPI inflation remained at 1.6 percent in January. Core CPI inflation (excluding food, beverages, tobacco, and energy) stayed subdued at around 1¼ percent. Growth in private sector earnings excluding bonuses continued to be stable at about 4½ percent.
4. The Bank of England left its policy interest rate unchanged at 4¾ percent in early February. The MPC lifted a little its forecasts for CPI inflation in the February Inflation Report (compared to the November report), reflecting the somewhat higher level of current CPI inflation and slightly higher-than-expected producer and import price inflation. Under the MPC’s central projection, inflation will rise gradually to about 2 percent over the next two years. However, risks to the central projection continue to be skewed somewhat to the downside.
5. Fiscal data for January were in line with the Pre-Budget Report and staff’s projections for FY2004/05. Over the first ten months of the fiscal year, the growth rate of central government current receipts (including corporation and personal income tax receipts) was in line with PBR and staff projections for the year as a whole. On the expenditure side, central government current spending was a little higher than expected while net investment spending was slightly lower than projected. The Budget for FY2005/06 is scheduled to be released on March 16.
6. The government announced in early February a strategy to boost labor participation of older workers, people with temporary disabilities, and single parents. To encourage working past the state pension age of 59/64, a more generous and flexible option for deferring state pension will become available in April 2005. For people with disabilities, a new benefit system will be in place for new claimants by 2008. In the new system, benefits will depend on whether a person is assessed to have a manageable or severe condition, and there will be financial incentives for those with manageable conditions to attend work-focused interviews. For single parents, a new pilot program will be introduced to provide additional support and financial incentives to move back into work. These initiatives are consistent with the staff’s recommendations.
7. The Bank of England issued its first Payment Systems Oversight Report, as anticipated in the staff report. The report clarifies the rationale and objectives of the BOE’s oversight, gives an account of the BOE’s activities during 2004, and identifies priorities for 2005. While the U.K. payment systems exhibits a high level of robustness by international standards, the BOE continued to address systemic risks linked to tiering and worked toward improving liquidity funding and collateralization agreements. Progress was also made on implementing FSAP recommendations. A priority for 2005 is to strengthen arrangements for cooperative oversight of cross-border infrastructures. The Report appears to extend international best practice with respect to transparency about payment systems oversight and assessment.