The economy and growth by NIESR on 10-Feb-2014

Good news - the National Institute of Economic and Social Research's latest data show that the UK's economic recovery has become entrenched. Above-trend growth returned in 2013, while the remarkable performance of the labour market persists. Consumer price inflation returned to the Bank of England's target rate in December, raising the prospect of a resumption of real consumer wage growth.

Highlights of our figures show:

• The economy will grow by 2.5% in 2014 and 2.1% in 2015.
• Unemployment will drop through the Bank of England's 7% threshold early this year.
• CPI inflation will be marginally above target this year, dropping below target in 2015.
• On current plans, the public sector finances will be in surplus in 2018-19.

Recent GDP growth has been driven by domestic demand growth, especially consumer spending, which contributed 1.6 percentage points to growth in 2013. This has come despite further falls in real consumer wages. We expect consumer spending to remain the key driver of recovery in 2014 and 2015, supported by continued buoyancy i n the housing market. House prices have seen a dramatic rise throughout the year, concentrated in London and the South East. There is considerable uncertainty over the magnitude of the impact of the second Help to Buy Scheme: stronger house price inflation would lead to even stronger consumer spending growth in 2014.

Domestic demand growth will not be solely dependent on the consumer; a supportive funding environment, coupled with further reductions in uncertainty about future demand growth, is also expected to support robust growth in business investment. Net trade will remain weak however, with weakness in the Euro Area, the UK's single most important export market, continuing to weigh on demand for UK exports.

The performance of the labour market continues to be a welcome surprise. Employment rose in 2011 and 2012, even as the economy stagnated, and employment growth accelerated into 2013. The corollary of this is stagnant productivity and we expect this to persist in 2014. In the short term, increased employment is welcome, but over the medium-term the absence of productivity growth would limit real consumer wage growth. Our forecast remains one of a gradual improvement in productivity, but continued stagnation poses a downside risk to the UK's medium-term prospects.

The surprisingly-rapid fall in unemployment raises questions over the credibility of the Bank of England's forward guidance; it remains unclear how this will be resolved. We have brought forward the point at which we expect interest rates to rise in the second quarter of 2015, although this is still more than a year after a breach of the unemployment threshold is expected.

The Chancellor has announced a review of the current fiscal framework and has suggested that the government will now target a budget surplus. In fact, we expect the overall budget, including investment spending, to have just moved into surplus in 2018-19. However, this reflects both a very sharp squeeze on government consumption and continued low levels of public sector investment.

For more information, please visit: www.niesr.ac.uk

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