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Prospects for the UK economy

• The economy will grow by 2.5 per cent in 2015, and 2.4 per cent in 2016.

• Unemployment will stabilise at about 5¼ per cent.

• CPI inflation rate remains close to zero for most of the year; we do not expect interest rates to rise until the beginning of 2016.

Although growth in the first quarter of 2015 was considerably weaker than expected, this is likely to be a temporary deceleration. We expect growth to rebound through the remainder of this year. This will be driven largely by consumer spending, supported by the positive terms of trade effect from the sharp fall in oil prices.

We continue to expect growth of around 2½ per cent per annum, which should gradually absorb the economy’s spare capacity. Inflation has already fallen to zero and we expect the level of prices to fall slightly for much of the year as the lagged effects of commodity and exchange rate developments pass through to consumer prices.

Future productivity growth remains the largest single uncertainty facing the UK economy, and hence the largest single domestic risk, both to the upside and the downside. Faster than expected productivity growth would boost output, raise living standards and ease fiscal pressures; even slower than forecast productivity performance would make matters considerably worse. Employment growth continues to be strong; we expect unemployment to fall to about 5¼ per cent at the end of the year.

Despite weak price growth this year, we expect monetary policy to begin tightening in the first quarter of 2016 as temporary oil price and exchange rate effects dissipate.

After this, Bank Rate will continue to increase by roughly 50 basis points a year. If the path of monetary policy evolves as we predict, by 2020 it will have reached just 3 per cent per annum. There exist risks around this central expectation. On the downside, inflation expectations decoupling from the target, or a disorderly exit of Greece from the Euro Area would require a more relaxed stance of monetary policy than we assume.

The divergence of monetary policy cycles has led to a continued appreciation of the sterling effective exchange rate. Despite this, we expect export performance to overcome continued short-term weakness and for net trade to contribute positively to GDP growth in the medium term.

Our projections assume the government sticks to the fiscal plans set out in Budget 2015.However, in practice, any future government is likely to pursue a somewhat looser fiscal policy. As our earlier work shows, this would lead to slightly higher growth and employment for the next few years, combined with slightly higher short-term interest rates and a slower rate of reduction in the deficit and debt to GDP ratio – relatively modest effects compared to other uncertainties highlighted above.

Notes:

The forecast for the UK economy is published in the National Institute Economic Review no. 232 May 2015.

For a full copy of the UK economic forecast or to arrange interviews, please contact the NIESR Press Office: Brooke Hollingshead on +44 (0) 20 7654 1923/ B.Hollingshead@niesr.ac.uk. The forecast will also be available online on the NIESR website from Wednesday 6 May 2015.

To discuss the forecast or for interviews, please contact:

Jonathan Portes on +44 (0) 7766 441148 / j.portes@niesr.ac.uk, or
Simon Kirby on +44 (0) 20 7654 1916/ s.kirby@niesr.ac.uk

Details of NIESR’s previous UK economic forecast can be found here.

The National Institute Economic Review is the quarterly journal of the National Institute of Economic and Social Research (NIESR). Published in February, May, August and November, it is available from Sage Publications Ltd (http://ner.sagepub.com./) atsubscription@sagepub.co.uk.

Further details of NIESR’s activities can be seen on http://www.niesr.ac.uk, by contactingenquires@niesr.ac.uk or the Switchboard on +44 (0) 20 7222 7665.