Economic View: Some reasons to be cheerful

What will happen this year? Now is the time when economists make asses of themselves by getting their predictions wrong. So in the spirit of seasonal goodwill, here goes.

What will happen this year? Now is the time when economists make asses of themselves by getting their predictions wrong. So in the spirit of seasonal goodwill, here goes.

Let's start with growth. As a benchmark, I have shown in the bar chart above a typical financial market forecast for growth this year (this one is from Deutsche Bank), together with the expected outcome for 2003. Last year the main engines of growth were Asia (in particular, China) and the United States, and this pattern is expected to continue in 2004, though with the US falling back a little. Japan is forecast to continue growing, and Britain to have another decent year, though not as good as the 3-3.5 per cent growth our Chancellor expects. And the three continental laggards, Germany, France and Italy, are expected to show some growth after virtually none in 2003. Europe as a whole will be helped by a good performance in the accession countries, and in Russia.

That set of forecasts feels pretty sensible. There is such huge momentum behind the Asian boom that it is hard to see it coming off quickly. India is increasingly joining China as an important source of world demand. The US will be sustained by the cheap dollar and the tax cuts, while the UK will for the time being be sustained by high public spending. There does seem to be reasonable momentum in Japan, and the very latest figures for business confidence in Germany are relatively encouraging. That should help its neighbours in the eurozone, which have been pulled down by Germany's poor performance.

The problem with this relatively sanguine outlook is that there are risks on the downside. Were the dollar to fall sharply, that would choke off European growth; were there to be some kind of financial collapse in China, that entire region would be troubled; were our own housing boom to collapse, the UK would miss its growth forecast. The US has a presidential election coming up, so there will be great pressure to keep things going until November, and I reckon the first half of the year will be safe enough. But it may be a year of two halves, when the second half disappoints.

It is certainly going to be a year when interest rates rise, at least in this country. They will go up in Britain first, followed by the US and eventually by Europe. Bet for the Bank of England rate at the end of 2004? Let's say 4.75 per cent. That would be enough to steady the housing boom but not too much to kill it entirely - and if the second half of the year goes really wrong, rates by then could even be on the way down again.

That leads on to the financial markets. On the exchanges some further dollar weakness is certainly possible. If it were to get out of hand, I would expect some kind of central bank intervention. This would take the form of co-ordinated support for the dollar, coupled with pressure on the east Asian nations that link to the dollar (especially China) to allow a currency revaluation against it.

Equity markets? Well, we have had one year when shares have ended higher after three in a row when they went down. That applies both to the UK market and to world equities as a whole. I know all the arguments about US shares now being overvalued and markets in general having anticipated too much good news.

The fact remains that it is extremely unusual for shares to fall for more than two years on the trot: in the past century it has only happened four times in the UK and only twice on global share markets. And in every instance bar one, shares have subsequently risen for at least two years. So expect shares to end 2004 higher than they have in 2003. It is 2005 I am more worried about.

Fixed-interest securities, on the other hand, may have a poor year, as short-term interest rates rise - though, conversely, they may recover in 2005.

Of the rest - well, I am worried that the world economy is unusually vulnerable to shocks. Things come along you cannot hope to predict: Sars, a serious terrorist attack, war in one of the world's trouble spots. A healthy, balanced world economy can rise over these and carry on delivering growth. But the world economy is not balanced at the moment, relying too much on the US consumer to keep demand moving and too much on US borrowing to cover its twin deficits on fiscal and balance of payment accounts. We managed to scramble out last year, with east Asia recovering remarkable swiftly from Sars, far more swiftly than many of us expected. That, with hindsight, has been largely the work of the US consumer, supported by tax cuts.

And there is the rub. The world economy has been flying on one engine, the US, which in turn depends on consumption. I know it looks like two engines because China has also been contributing strongly. But China depends on the US taking its exports, which takes us back again to the US consumer.

Still, there is a lot more momentum than there was even three months ago, and that will carry us all along for a while yet. As noted above, I am concerned about the second half of 2004 but on balance the year should be all right and, indeed, turn out better than 2003.

A final world about a further concern. This is the failure of some parts of the not-yet-developed world to make real economic progress. This column has been mostly about the developed nations, which, with China and India, account for more than 80 per cent of world output. Will there be better news for Africa and the less developed parts of the Middle East? Fingers crossed that there will be.