The outlook for 2011

It seems a shame to start off my new blog on a gloomy note. But it makes sense to open with the outlook for 2011. And there’s no way round it, I’m afraid. This year is not going to be much fun for most of us.

The problem that we face is an unpleasant combination of high price inflation and low growth. The current headline inflation rate (measured by the Consumer Prices Index, or CPI) was 3.7% in December. National income (measured by the Gross Domestic Product, GDP) fell by 0.5% in the last three months of 2010. It’s not as bad as the mid-1970s, where inflation hit 24% and GDP fell two years running. But that’s hardly a great comfort.

The surge in prices is mainly the result of 3 factors. There is strong demand elsewhere in the world, especially China roaring along at 10% growth, for rubber, cotton and fuel (and food, a bit). Bad weather in advanced countries has reduced the supply of cereals. With demand up and supply down, the simplest of economic models predicts higher prices, which is exactly what we’re seeing. It’s a reminder that the UK is small economy in a global market for commodities. In the UK, this is compounded by rises in taxes (VAT went up to 20% in January) which will add to the prices paid by consumers. By the latest forecasts, the average household in the UK is likely to pay around £950 more in 2011 for the things that it bought in 2010.

This wouldn’t be so bad if everything, including wages, went up at this rate of inflation. But wage inflation is muted: the average wage went up just 1.1% in the last 3 months of 2010. At that rate, the average household income will go up in 2011 by about £350, leaving quite a gap between income and expenditure rises. Worse still, lots of households face benefits cuts. Those reliant on the public sector for their jobs may face unemployment as the reductions in government spending really start to
bite. All in all, real wages (that is, wages after inflation is taken into account) are likely to be no higher in 2011 than they were in 2005.

How will policy-makers respond to all this? The Bank of England can hardly cut interest rates further; and will probably not raise interest rates soon, despite strong inflation. What would be the point? The causes of inflation lie mostly outside the UK. This is good news if you hold debt, like a mortgage; bad news if you’re a net saver. The Government has nailed its colours to the mast of reducing spending and increasing taxes, in order to reduce the deficit that ballooned to save the banks. (That’ll be the subject of a future post, by the way.) In short, not much to cheer anyone up much.

So, if you’ve yet to feel the effects of everything that has hit the UK over the last 2 years, 2011 may come as a shock.

I hope to be a bit less gloomy in my next posts. But with the banking situation to cover, I’m giving no guarantees.

2 comments to The outlook for 2011

  • Darren

    The constant changes in the VAT rate over the past few years will have done nothing to help the consumer or in fact any end user that is unable to recover the VAT they pay on the goods they buy. Even with the temporary reduction in VAT to 15% a lot of retailers would have not passed on the full effect to the consumer meaning in reality the 20% increase would have been higher than the 2.5% increase from the original 17.5% VAt rate in force in the past.

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