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UK economy to hit full capacity in 2-3 years

by International Commercial Investment on March 20, 2014

Source: Reuters

Britain’s economy is likely to run out of spare capacity faster than most Bank of England officials expect, a member of its rate-setting committee said on Thursday.

Martin Weale – whose concern about inflation risks prompted him to vote against the central bank’s launch of forward guidance on interest rates in August – said he estimated there was less slack in Britain’s economy than the Bank estimated last month.

Once an economy hits full capacity, growth that is faster than its long-term trend is likely to generate inflation.

“While I expect interest rates to remain low over the next two to three years, it is not possible to guarantee this,” Weale said.

The central bank has said it does not expect to raise interest rates from their record-low 0.5 percent soon, but intends to do so before all the spare capacity in Britain’s economy is used up.

Weale, an external member of the central bank’s Monetary Policy Committee, said that point could come sooner rather than later, given the BoE’s recent robust growth forecast of 3.4 percent this year and 2.7 percent next year.

“I think the forecast is broadly consistent with slack being used up over the next two to three years while the collective judgement of the committee was that slack would remain at the end of that period,” he said.

Weale’s remarks were addressed to local businesses in Windsor, just west of London.

The central bank estimated last month that there was 1.0-1.5 percent spare capacity in Britain’s economy. Output is still lower than before the financial crisis after a far slower recovery than in almost all other major advanced economies.

Weale said his personal estimate was that there was just 0.9 percent spare capacity. Other Bank officials, such as Governor Mark Carney and external MPC member David Miles, have said there was probably more than 1.5 percent spare capacity.

Sustainable growth is limited by factors such as population expansion and long-run technological progress, which in Britain has historically led to an annual rate of growth of slightly over 2 percent.

Weale said his lower estimate of spare capacity was based on factors such as the risk that people would become less willing to work longer hours as the economy improved, or that people who wanted to work longer hours might be less productive than those who did not.

He also said that it was hard to compare the estimate of spare capacity produced by the Bank and the one from government’s budget watchdog, which is somewhat higher.

The Office for Budget Responsibility’s measure was geared around estimating how far tax revenues are below potential, Weale said, and so was designed differently to the BoE’s measure, which aimed to predict inflation pressures.

International Commercial InvestmentUK economy to hit full capacity in 2-3 years