Britain's economy rolls into 1995 on the crest of its best performance in decades. Growth, at better than 4%, is the strongest in six years, unemployment is down from a peak of 10.6% two years ago to 8.8%, and both the fiscal and current-account deficits are improving, while retail inflation is a low 2.2%.
Can these happy days continue in 1995? It looks that way. Despite a likely subdued showing by consumers, reflecting a second year of higher taxes for the year ending in April, exports and capital spending are set to lead growth. A stronger-than-expected world recovery and gains in competitiveness from sterling's decline two years ago will buoy foreign shipments. Solid demand, rising utilization rates, and fatter profits will lift plant-and-equipment outlays. Many analysts are betting that growth will outpace the 3.2% consensus expectation.
Of course, inflation has always played the spoiler in Britain's economy--but this time looks different. The Organization for Economic Cooperation & Development has estimated that there is enough spare output capacity to allow growth at the current 4% pace for two more years before hitting inflationary limits.
Moreover, government policy is anti-inflationary. The Nov. 29 budget for fiscal 1995-96 retained both the previously announced tax hikes and the trend of spending restraint, while offering a plan to cut long-term structural unemployment. Although Parliament's Dec. 6 rejection of a planned increase in home-fuel taxes lopped off about 25% of this year's tightening, the Treasury offered offsetting hikes. The government expects the deficit to shrink to 3% of gross domestic product in 1995-96 (chart).
Out of concern that strong growth will fuel inflation, the monetary authorities have already raised interest rates twice, and more hikes seem likely in the first half. Even if the government cuts taxes prior to a likely 1996 general election, it's a good bet that tighter monetary policy will take up the slack, helping to maintain growth with low inflation.