United Kingdom - Developments in Individual OECD Countries

OECD Economic Outlook, June, 1993

Nominal pay increases have continued to fall to below levels that would have been thought of as floors in the 1980s. Underlying average earnings growth was down to 4 per cent in March compared with 7 1/2 per cent a year earlier. Private-sector wage settlements have narrowed to the 2 to 3 per cent range, with moderation spreading from the manufacturing to the service sector. A policy of limiting public-sector pay increases to 1.5 per cent is in place for this fiscal year.

Net exports, a significant drag on real GDP growth since early 1991, provided a slight boost to output growth in the last quarter of 1992. Growth of manufactured export volumes has picked up in response to an improvement in cost competitiveness of some 12 to 15 per cent. Import volume growth, which was surprisingly strong during the second half of 1991 and most of 1992, stabilised in the last quarter of 1992. Despite a recovery in export orders in response to sterling's lower rate, the slowdown in Europe is restraining the rise in new orders. Reflecting the "J-curve" effects of depreciation, the current-account deficit widened in the fourth TABULAR DATA OMITTED quarter, resulting in a deficit of |pounds~12 billion (2 per cent of GDP) for 1992 as a whole. Notwithstanding the positive revaluation effects on foreign-currency-denominated investment income, the traditional invisibles surplus has eroded rapidly, owing to the sharp run-down of net foreign assets. Little is known at present about trade developments in 1993: total trade data for the first quarter of 1993 will not be published until the middle of the year due to the introduction of EC single-market customs regulations.

Policies and other forces acting

Monetary conditions have eased substantially since sterling left the ERM. By early 1993, the effective exchange rate had dropped by some 15 per cent as base lending rates were brought down quickly from 10 to 6 per cent. Sterling has since strengthened modestly with the trend to lower interest rates in Continental Europe. The growth of M0 has picked up to above its monitoring range since the turn of the year, while that of M4 has moved up to within its monitoring range. All in all, the course of monetary policy and the scope for further interest-rate reductions will depend on near-term price prospects and their implications for meeting the Government's inflation objectives: underlying inflation in the range of 1 to 4 per cent for the remainder of the current Parliament, and in the lower part of the range by the end of Parliament. Inflation expectations remain above the government's target range, as indicated by long-term bond yields above 8 per cent, despite the lowest "headline" rate of inflation in almost three decades.

The March 1993 budget signalled the government's intention to make significant reductions in the structural deficit when the economic recovery is more firmly based. Tax increases, including the non-indexation of income tax allowances, raising some |pounds~1/2 billion in FY 1993/94 were announced in the budget. Deferred tax increases of |pounds~6.7 billion (1 per cent of GDP) were also announced for FY 1994/95, rising to |pounds~10.3 billion (1.5 per cent of GDP) in FY 1995/96. Specific tax measures announced included a 1 percentage point increase in employees' National Insurance contribution rates from April 1994; the phased imposition of VAT on domestic fuel and power consumption in 1994 and 1995; the limiting of tax relief on mortgage interest to the lowest income tax rate of 20 per cent; and lower tax credits for dividend income. The expenditure control totals announced in the Autumn Statement were unchanged.