January 24, 2011 / 11:07 PM / 9 years ago

Slowing economy to flag "stagflation-lite" fears

LONDON (Reuters) - After last week’s shock rise in inflation, GDP data on Tuesday will show the economy slowed in the final quarter of this year, highlighting the dilemma facing the Bank of England.

Pedestrians walks along a street, in central London January 18, 2011. REUTERS/Stefan Wermuth

Bank Governor Mervyn King will have a chance to answer his critics in a speech at 7.40 p.m. , but the problem of weakening growth and rising inflation is an acute one that leaves the Bank unable to deal with one problem without potentially exacerbating the other.

At 3.7 percent, inflation in Britain is almost double the Bank’s target and likely to rise further in the coming months. Although a return to recession is unlikely and inflation remains far from the double-digit rates seen in the 1980s, some economists are already dubbing it “stagflation-lite.”

The central bank’s credibility has increasingly come under attack given inflation has been at least a percentage point above its 2 percent target throughout 2010, with markets increasingly pricing in an interest rate rise by the summer despite the subdued outlook for growth.

The median forecast in a Reuters poll is for UK growth figures, due out at 9.30 a.m., to have slowed to 0.5 percent in the last three months of the year, down from 0.7 percent in the third quarter and 1.1 percent in the second.

The range of forecasts is wide, spanning 0.1-0.6 percent and reflecting uncertainty over the impact of unusually heavy snowfall in what was Britain’s coldest December in a century.

GLOOMY HEADLINES

The construction sector — which contributed almost 40 percent of the GDP growth in the second quarter and almost 30 percent in the third — is likely to have taken a particularly severe hit.

“Construction activity will be seriously affected and the risks to the GDP numbers are almost certainly to the downside,” said Brian Hilliard, UK economist at Societe Generale. “It’s bound to generate gloomy headlines.”

What is even more certain is that growth will slow yet further in 2011 following a new year rise in value-added tax and with sharp government spending cuts to rein in a record budget deficit set to bite deep.

A first estimate of fourth-quarter GDP — the first from any of the G7 nations — will be released alongside December public finance figures.

The latter figures will be closely scrutinised by bond investors who want reassurance that the government’s deficit-busting austerity programme remains on track.

Government borrowing unexpectedly surged to a record high in November and unless December’s figures show some reversal investors will start to worry that the government’s full-year borrowing target of 148.5 billion pounds will not be achieved.

“Prior to last month the government’s short-term budget plans looked consistent with the data, but if December borrowing is high again gilts will be vulnerable,” said Sam Hill, fixed income strategist at RBC.

“Market participants will understandably show concern if a material gap opens up between what the government is planning and what it is achieving at such an early stage in the fiscal consolidation project.”

The median forecast in a Reuters poll suggests public sector net borrowing (PSNB) will come in at 18.1 billion pounds in December, around 3 billion pounds lower than the same month the previous year.

Editing by Mike Peacock

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