What lies ahead for 2014?

Stephen Boyle, head of Economics at Royal Bank of Scotland, looks at the year ahead.

Economic forecasts for the New Year are like Christmas jumpers from relatives who visit only at Yuletide. You know they’re coming. They are almost certainly far too big or far too small. All in all, you wish they hadn’t bothered.

The spurt of growth that began in late spring will carry on in 2014. Just as this year has been better than last, so next year will be better than this. National income will increase by around 2.5%, its average pace over the last 60 years.

One result is that more people will be in work. They will be better off. But the fastest growth since 2007 will still leave many families feeling hard-pressed. In part, that is because prices will be rising faster than wages for most of the year. Our spending power will keep falling.

Yet the squeeze on most people’s living standards has had only a little to do with a weak economy. It will not fully lift as growth strengthens. The squeeze is the result, first, of a pincer movement by globalisation and innovation on middle and low paid jobs. Globalisation means some workers face more competition. New technologies tend to replace people in skilled trades and mid-level office jobs. Globalisation and innovation are here to stay.

Second, we have made Britain an expensive place to live. Our houses are among the most expensive in Europe and the way we control where retailers locate makes shopping pricier than it needs to be.

Living standards will rise only if the economy grows. But spreading the benefits means making sure people have the skills to resist the march of globalisation and robots, and that we push living costs down, not up.

Growth at the rate I expect should mean inflation stays under control. There is still a great deal of spare capacity in the economy. Unemployment is high. Most parts of the country have empty shops, offices and factories. Some businesses that cut shifts during the recession are still not working full-time.

That means the Bank of England can keep interest rates just where they are throughout 2014. It will be 2015 or later before they rise. Even then, it will be years before they return to what we thought were normal levels before 2009.

The surprise of 2013 was a dog that barely barked. Cyprus aside, the euro zone’s problems were dormant. That brought stability to financial markets that had been plagued by the single currency’s woes for three years. Where might 2014’s surprises or shocks lie?

For the first time in years, US politicians are edging towards a solution for the country’s public finances. The problem is simple: Americans want US levels of public services but will pay only US levels of taxes to get them. That is not too much of a challenge today.

It becomes a huge one towards the end of the decade. That is when many more people start to collect public pensions and rely on taxpayer-funded healthcare. The recent deal on spending and revenue raising gives hope that the continuous loop of midnight hour deals and shutdowns has been severed. If so, and if Americans believe it, confidence there should grow and the recovery should strengthen. Since they account for more than $1 in every $5 the world produces, what happens there matters to all of us.

Two factors could dent prospects here at home. Bank of England Governor Mark Carney is concerned that the housing market starts moving at ‘warp speed’. House prices are rising by more than 5%. If inflation gets close to 10%, the Bank of England will make mortgages more expensive. Much of the boost to the economy in the last few months has come from housing and if the Bank has to let air out of that balloon next year it could temper wider growth.

Second, I could be wrong about inflation. Perhaps the skills of many people who are out of work have decayed. Maybe they do not live close to where jobs are being created. Likewise, vacant properties could be the wrong types or in the wrong places. The economy might have little space to expand before wages, rents and other prices start rising too quickly. That would mean Bank Rate rising sooner than expected, putting a brake on growth. A burst of inflation is unlikely but if it is going to happen we will see wages rising sharply by summer.

And finally. Dormant they might have been but the euro zone’s problems have not gone away. It will take good judgement and good luck for 2014 to be as quiet as 2013. In autumn, regulators will assess the strength of euro zone banks. Let’s hope that, or other events do not tip the single currency zone back into crisis.

Happy New Year.

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