Dated: 16 November 2010

Today the Institute of Directors (IoD) publishes its economic forecast for 2011 in the November edition of IoD Pulse.

Key points:

• The IoD forecasts GDP growth of just 1.2 per cent in 2011 – the forces for economic deceleration reining back those for acceleration.

• The recovery cycle appears to be taking the shape of a square root sign, with a temporary spurt in growth in 2010 set to level off in 2011.

• There is too much doom and gloom surrounding the Spending Review but there also needs to be greater realism about weakness elsewhere in the economy.

• If the IoD’s GDP forecasts prove correct, the Chancellor may need to find more spending cuts (or tax rises) to meet his budget deficit targets.

• The presence of an output gap does not automatically lead to its closure. The experience of Japan in the 1990s shows that below trend growth can persist for so long it becomes the trend.

Commenting on the forecast, Graeme Leach, Chief Economist at the IoD, said:

“After an extraordinary financial crisis, fiscal explosion and the introduction of unconventional monetary policy the level of economic uncertainty remains at a very high level.

“The effectiveness of traditional forecasting models – always questionable – is open to very serious doubt when they have little or no capacity to incorporate the effects of quantitative easing, and when the size and sign of fiscal multipliers is open to question in the wake of the financial crisis and exploding public debt and deficits. In such circumstances economic forecasting becomes what it always has been, an issue of feel and judgement.”

So how does the IoD think the economy will perform in 2011?

• Over the past year we have consistently argued that economic recovery would take the shape of an ‘L’ – although not a literal L with zero quarter-on-quarter GDP growth. By L-shaped we meant a relatively gentle upward slope. However, we have also argued that there might be a few quarters of stronger growth where the economy grows in line with a normal cyclical bounce back but the recovery then levels off. We called this the square root shape recovery.

• The evidence thus far in 2010 suggests the square root shaped cycle might be unfolding. GDP growth in Q2 and Q3 this year was on a par with a normal cyclical upturn. The depth of the recession and the size of the output gap has supported the ‘up tick’ part of the square root cycle, with the level-off then attributable to factors such as the legacy of the financial crisis, an impaired monetary policy transmission mechanism, weak money supply growth, a fiscal squeeze and de-leveraging across the household sector.

• The crucial point underpinning both the L and square root shaped cycles is that there are significant forces accelerating the economy forward, but they are competing with a very powerful set of decelerating influences.

• We do not think the decelerating forces will lead to a double-dip recession – but the risk is there especially if business and consumer confidence begins to slide.

In looking forward into 2011 we divide the huge range of economic influences into two camps – headwinds and tailwinds. To see the IoD’s views on these influences in detail, go to the full forecast in the November edition of IoD Pulse: http://www.iod.com/Home/Policy-/IoD-Pulse/