Interest rates should remain on hold, says Item Club
The Bank of England will meet next week (pic: Terry Murden)
Interest rates should remain on hold as Britain looks poised for an uplift in activity, says a key forecasting group.
The EY Item Club says the decisive general election result and the prospect of tax cuts will provide a short-term boost to the economy.
It expects an increase in business investment and projects that had been delayed during 2019. Consumers may also be more prepared to step up their discretionary spending.
However, it warns that issues around an EU trade deal remain and urges the Chancellor to invest in infrastructure.
In its Winter Forecast the Club urges caution on monetary policy and believes that interest rates should remain at 0.75% this month – and likely beyond – “given that the economy looks well-positioned to pick up early on this year, fiscal stimulus is on the way and the labour market also looks strong.”
The EY ITEM Club believes that the Bank of England can justifiably remain in “wait and see” mode, despite recent indications from some MPC members that they may act quickly on interest rates.
It has increased its projection for GDP growth to 1.2% in 2020 and 1.7% in 2021, compared to the 1% and 1.5% predicted in its last quarterly forecast.
The predicted growth for 2020 is slightly less than the estimated outturn of 1.3% in 2019. However, EY ITEM Club expects UK GDP expansion to improve from 0.8% in the fourth quarter of 2019 to 1.6% in the fourth quarter of 2020.
The forecast assumes that interest rates will remain on hold this year until around mid-2021, although it acknowledges that the Monetary Policy Committee’s decision on 30 January looks to be on a knife edge and is very hard to call.
According to the forecast, the UK economy is likely to show signs of improvement in the early months of 2020 but may struggle to ‘kick on’ as the year progresses due to uncertainty around the EU and UK’s longer-term relationship.
The EY ITEM Club expects the UK economy to see stronger growth in 2021 as a result of reduced uncertainties, fiscal stimulus, a healthier labour market and a brighter global economic environment.
However, this is based on the assumption that the UK and EU reach some form of Free Trade arrangement by the end of 2020, or end up extending the transition agreement.
Mark Gregory, EY’s UK chief economist, says: “There may be some improvements in the economy, but it’s not time to pop the champagne yet. While we have some clarity, there are still significant unknowns – about the trade deal around Brexit, and the wider policy agenda of Government.
“The Government has indicated that it will be aiming to use the Budget to boost investment in infrastructure and help “level up” economic performance in struggling towns.
“It should also aim to encourage businesses to invest and consumers to responsibly increase their spending to provide growth to support the plans for economic rebalancing.”
Business investment likely to pick up
According to the EY ITEM Club, business investment is expected to increase by 1.4% in 2020 due to the reduced near-term uncertainties.
Consumers hedging their bets
The forecast is also predicting only small improvements in consumer spending. Growth is expected to improve from 1.2% in 2019 to 1.4% in 2020.
House price confidence
The improving outlook for consumers should also see better prospects for the UK housing market. The EY ITEM Club has increased its house price forecast from its last report in the autumn. House prices are seen rising by around 2.8% over 2020, up from the 2.0% predicted three months ago. It expects house prices to rise at a modestly increased rate of around 3.5% in 2021.