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WEEKLY ECONOMIC REVIEW

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UK economic growth remained strong in the first quarter, rising by 1.0% led by buoyant consumer spending. Retailers...
UK economic growth remained strong in the first quarter, rising by 1.0% led by buoyant consumer spending. Retailers have clearly benefited but their success has yet to filter downstream. Whilst experiencing only a modest rise in demand at home, manufacturers' have also been hit by sterling's strength (the trade weighted index has risen by more than 18% since its previous 'trough' last August) on the export front

On the whole, recent inflation data have been encouraging with producer price inflation currently at its lowest level for 30 years (0.5% in March excluding food, drink and tobacco) and the RPI falling back to 2.6% in March. This has however, served to distract from growing inflationary pressures in the economy. The strength of consumer spending has been boosted by a gradual rise in average earnings since mid-1995 culminating in a 5% rise in February and there are clear signs of a tightening in the labour market, particularly in the service sector. Although distorted by the introduction of the Jobseeker's Allowance last October (which toughens up the rules for benefit claims), unemployment fell by a substantial 58,700 per month on average in the first quarter.

House prices have been on a rising trend since mid-1995 and there are now signs of an accelerating trend in the South East rekindling not-so-fond memories of the late 1980's bubble. This, along with the above factors all suggest some action to moderate the growth in demand should be taken soon. If ignored then it seems all the factors are in place for a mini-repeat of the late 80's. Should Labour win the election (which seems likely), Gordon Brown will come under immediate pressure for a rise in interest rates from the Governor of the Bank of England - possibly for 50 basis points - which he may yield to (otherwise opting for 25).

Labour will probably present an immediate Budget (as the Tories did in 1979). It could be argued that a tighter fiscal would be preferable to a tighter monetary stance - which would also benefit the poor state (for this stage in the economic cycle) of public finances. However, this is largely academic as it is unlikely that Labour will raise taxes/cut spending so soon after an election.

So a 0.25% to 0.5% point rise in interest rates seems inevitable following Gordon Brown's first meeting with the Governor of the Bank of England. This will have the effect of underpinning sterling. The exact extent of this impact on trade, is one area of uncertainty about the likely strength of economic growth over the short term. Although February's official data is the first sign of any effect on exports (a fall of 4.0% m-on-m), any deterioration could seriously downgrade growth forecasts as the year progresses.
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