Headstart: US economy - Why the fate of the US matters to us.

In the pre-election fever which seems already to be gripping the UK, attention is focusing on the performance of the economy. The UK is enjoying probably the best combination of sustained growth, low inflation and falling unemployment since the sixties and, despite the slowdown across the Atlantic, there are signs that growth over here is continuing. Yes, the economy slowed in the fourth quarter of 2000 due to a decline in oil and gas output, but manufacturing held up well in the quarter and over the year as a whole grew by 1.6%, the best performance since 1994. Consumer confidence remains high and retail sales went up by 0.7% in January.

So have we managed to disengage ourselves from the US cycle and are we able to forge ahead unencumbered by the global economic slowdown? US growth has decelerated sharply from a near 6% annualised rate in the first half of last year to near stagnation. Such a rapid slowdown is quickly transferable: with Japan not growing either, South-East Asia is seeing its two main export markets grind to a halt simultaneously and this in turn affects earnings, growth, investment and employment. It also intensifies competition as oversupply is diverted to third markets, competing with rival producers in the industrialised world such as the UK, the US and Europe. As long as the US slowdown is not reversed, the effect will inevitably spread.

Thus we are not immune. Not only are there interconnections on the international scale, but the UK’s direct links with the US are substantial. The UK exports some 15% of its total sales of goods and services overseas to the US, equivalent to some 5% of GDP. But in addition, of course, the UK has been a net exporter of capital to the US and a considerable chunk of company profits originate from US operations. With US stock markets weak, it is now becoming fashionable in the UK to be as concerned about the impact here of such financial effects on sentiment and activity as about the direct implications of a straight US industrial output decline.

This explains why the main focus of UK monetary policy currently is its effect on confidence and expectations. The quarter point interest rate reduction this month does not appear to be justified by domestic conditions, and yet it will probably be followed by further cuts to forestall a substantial drop in confidence. That is one scenario no chancellor can contemplate in the run up to an election. By happy coincidence, the Bank of England cannot afford to let the deflationary impacts of lower world growth be reflected for too long in an inflation figure which stays below target.

So rates will come down and a recession will be avoided, helped by the increased spending already budgeted for and the tax cuts being contemplated.

Unless something goes very wrong, growth of around 2.5 % in the UK this year seems to be almost assured. ?: