Britain: The Stimulus Is Paying Off

The British economy heads into 2002 in much the same way it traveled through 2001: on two separate tracks. Consumer spending and housing are strong, while manufacturing is in a recession.

The result is a mix of weakness and resilience that could make Britain the fastest-growing economy of the Group of Seven nations for the second year in a row. Economists expect growth of just over 2% in 2002, about the same as in 2001.

To be sure, the economy will not escape the global slowdown's impact on exports and manufacturing. Optimism among manufacturers dropped to a three-year low in December, and output expectations hit a 13-year low, reflecting excessive inventories.

The economy is slowing sharply in late 2001 and early 2002, but it should avoid outright recession. Consumer spending has slowed from a gallop, but its underlying strength was evident in surging November retail sales. And while unemployment ticked up in October and November, it remains near a record low.

Britain's resilience mainly reflects stimulative policy from both the Bank of England and government spending. The BOE cut interest rates by two percentage points in 2001, to a 37-year low of 4%. With core retail inflation in November at just 1.8%, which is below the BOE's 2.5% target, economists are not ruling out another cut by February. The effects of those cuts on retail sales, house prices, and borrowing will spill over well into 2002.

Fiscal policy, which turned stimulative last spring, will offer further support in 2002. The government has recently announced new measures on pensions and health care, and various tax credits, in addition to already-announced increases in outlays for transportation, hospitals, and schools. The stimulus will total more than one percentage point of gross domestic product.

One implication of Britain's buoyancy: As manufacturers and consumers begin to head in the same direction later in 2002, the BOE may well be the first central bank to tighten monetary policy.

By James C. Cooper & Kathleen Madigan

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