Chancellor is looking down a barrel as growth hopes take a knock
Influential economic forecaster warns high oil price could cause slowdown to 2 per cent - well below the Treasury's expectations
Sunday, 18 September 2005
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A leading economic forecaster has been forced to shave its predictions for UK growth as high oil prices start to hit home.
Ernst & Young's Item Club, which uses the Treasury's economic forecasting models, said GDP growth would slow to 2 per cent this year if oil prices remained around their current level of $65 a barrel. That is well below the forecast of the Chancellor, Gordon Brown, who is looking for growth of 3 per cent, and also marks a 0.1 per cent reduction in the Item Club's most recent prediction.
Professor Peter Spencer, the chief economic adviser to the Item Club, also warned that while a higher oil price would boost North Sea taxes, the Treasury would receive less revenue from other sources as profits are hit. "It adds to input costs and will lead to lower corporation tax," he said.
Oil prices have jumped recently, partly because of Hurricane Katrina and a lack of refining capacity, but also because of strong demand from the US and Asia.
"China has been growing so rapidly and it is essentially this that is going to keep prices at around $50 to $60 a barrel for the next two or three years," Professor Spencer said.
According to the Item Club's forecasts, the public finances would also suffer a £1.5bn hit over the next three years with oil at $65 a barrel. The overall budget deficit would be £39.1bn over that period, it warned. Professor Spencer said this could lead to higher taxes or cuts in public spending, or a combination of both.
This would put further pressure on Mr Brown's "golden rule" - the promise to balance the budget on day-to-day spending when averaged out over the economic cycle.
While growth and the public finances are set to take a hit, the UK economy would be better able to cope with higher oil prices were it not for the poor performance of its export sector, Professor Spencer said. "World trade grew by 10 per cent in 2004. Yet our exports grew by 2 per cent. That implies a huge loss of market share.
"Essentially, because the exchange rate has been so high for so long, we have offshored a lot of our industry," he said. "We are not in a position to meet demand when it turns up."
While the Item Club's forecasts are gloomy, some commodity analysts have warned that the oil price could go even higher than $65 a barrel. Goldman Sachs said earlier this year that it could top $100 a barrel as part of a "super spike".
If oil were to reach and stay at this level, the picture for the UK economy would be dire, the Item Club warned, with GDP growth slowing to just 1.5 per cent in 2006 and inflation leaping to 4 per cent. Export growth, investment and consumer spending would also suffer.
This, said Professor Spencer, would put the Bank of England's Monetary Policy Committee in a tough position. "The problem with rising oil prices is that they put up prices and inflation at the same time as depressing demand." The MPC, therefore, would not be able to act as it did at the start of this decade, when it cut interest rates aggressively to boost demand.
If the MPC reduced rates with oil prices at $100 a barrel, said Professor Spencer, it could cause an inflation balloon. "The Bank would not have that kind of luxury [to cut]," he said. "That means it would simply, in our view, do nothing."
