The Confederation of British Industry (CBI) has downgraded its 2008 outlook for UK growth and stated that it forecasts even slower growth in 2009 due to continued troubles in the credit markets, rising commodity prices and weak domestic and global demand.

As the economy continues to loom large on the political horizon, this week’s Knowledgeshop looks at the economy’s impact on elections this year and beyond.

Economic Forecasting

The CBI recently lowered its figure for this year’s rate of GDP growth down 0.2% to 1.8%. The forecast for next year has also been downgraded and the CBI’s figure of 1.7% GDP growth for 2009 contrasts with the Budget’s more optimistic forecast of between 2.25% to 2.75%.

On the 19th March, Chancellor of the Exchequer Alistair Darling gave evidence to the Treasury Select Committee on his 2008 Budget of the previous week. The opening question by Committee Chairman John McFall focused on the Chancellor’s Budget forecasts and, in particular, the opinion that its growth forecasts were “out of kilter” with the view shared by most economists.

Mr Darling stuck to his guns and maintained that the growth forecasts were realistic. He noted that: “if you have 30-odd economists commenting on something it is unlikely they are all going to agree and come to exactly the same conclusion.”

The Chancellor reiterated his belief that the UK economy is “resilient” and in a strong position to deal with the current global economic uncertainties.

The sustainable investment rule was also on the agenda when one Committee member asked if it was “fit for purpose”. Commentators have voiced the concern that, in the face of a prolonged credit crunch, if the Treasury’s 2009 forecasts prove to indeed optimistic then the Chancellor would have to choose one of three options:

·         Admit that the forecast was unrealistic

·         Re-work the “Golden Rule”

·         Raise taxes

The fear among business leaders would be that, in a possible general election year, the Prime Minister would be reluctant to raise taxes that would directly affect consumers and the electorate and instead focus more on business and industry.

In the meantime, the Government continues to underline the fact that the country still enjoys relatively low interest rates, low inflation and low levels of unemployment.

In the latest Prime Ministers’ questions, Gordon Brown fended off criticism from David Cameron over the handling of the current downturn, adding that: “the right hon. Gentleman simply does not understand basic arithmetic.”

However, the leader of the opposition also pointed out how “the real cost of living under Labour” has increased, as the cost of rising commodity prices are passed on to the consumer.

Commodity Prices

Rising commodity prices have been an ongoing feature over the past year, with oil prices breaking the $100 mark and gold peaking to the all-time high off $1,030 per ounce just this month.

The rise in the price of oil and metals has now been followed by an increase in food prices, with corn, wheat and rice particularly affected.

The International Monetary Fund (IMF) has identified a number of factors which have contributed to the current trend of rising prices, including:

Commodities as alternative financial assets

The credit crunch has seen a growing media interest in private equity funds, sovereign wealth funds and hedge funds, following multi-billion dollar investments in the financial sector.

As the US dollar has weakened, commodities have become increasingly attractive to investors. Strong demand, a sluggish response to high prices and, in some cases, non-renewable resources have lead to record prices.

Last week, there were reports that hedge funds were cutting their exposure in the commodities markets, prompting some commentators to suggest that many of the recent transactions are speculative. However, the IMF also warned against any expectation of a large decline in commodities prices and that markets remained tight.

Increased demand in commodities may also reflect a growing desire to hedge one’s bets in the current global financial turmoil.

Increased demand from emerging economies

·         In the oil market, demand from China, India and the Middle East was responsible for more than 56 percent of the growth in oil consumption between 2001 and 2007;

·         China alone accounted for a 90 percent increase in the global consumption of copper between 2000 and 2006;

·         China now accounts for 40 percent of the world’s soybean imports.

Biofuels have boosted demand for food crops

·         Rising oil prices, driven partly by increasing vehicle ownership, and partly by policy support from the EU and US, have led to an increase in the use of biofuels as a supplement for transport fuel;

·         In major producing countries, up to 50 percent of feedstocks, such as corn and rapeseed, are being used in the production of biofuels.

Oil prices now have a significant influence on food prices – both directly and indirectly. Not only is it used in the manufacture of fertilisers as well as in fuel for agricultural machinery, it is also driving price – and demand – for biofuels and feedstocks.

There is a great deal of debate on the merit of biofuels. Can they really reduce carbon emissions or do they simply lead to deforestation? Campaigners are holding out more hope for “second generation” biofuels which, it is claimed, are more sustainable than the first.

The 2007 Energy Bill in the US, which increases its biofuel target 400 percent by 2022, and the EU target that biofuels be used in 10% of transport fuel by 2020, mean there will be continued policy support for biofuels for some time to come.

Finding a sustainable method of biofuel production would have a profound impact on a range of commodities and there is a great deal of research in this area. Companies such as BP and Volkswagen have claimed they are already making progress on research into alternative, non-feedstock, sources.

At Home

In one extreme case, in 2007 the ‘”tortilla riots” in Mexico were prompted by a 400 per cent increase in the price of corn after US supplies were diverted to the biofuel industry.

Despite the popularity of Tex-Mex food over here, these scenes are unlikely to be repeated in the UK but, as David Cameron highlighted in PMQs on Wednesday, these international factors are now being felt by ordinary households (and voters) across the country.

Only a few hours after PMQs, Mervyn King, Governor of the Bank of England, told the Treasury Committee: “Following increases in gas and electricity bills, consumer price inflation has risen. The central projection in our February Inflation Report is for it to rise further, to around 3%. That pronounced pickup stems from sharp rises in commodity prices around the world. Food prices on world markets are more than 50% higher, and oil prices two-thirds higher, than they were a year ago.”

Economic uncertainty is never good news for a Government in power. The Conservatives have accused the Government of compounding the pressure on families by increasing taxes in the Budget.

David Cameron said in PMQs: “Labour now seem so out of touch with the lives of working people that they keep on making things worse, with an extra £110 of taxes a year in the Budget for the average family…Why are Labour kicking families when they’re down? Why won’t they understand that life is getting really tough for people?”

Although the Treasury may, justifiably, argue that economic stability is the most important goal, rising food prices are an easy target for the opposition ahead of the upcoming GLA, mayoral and local elections.

The latest YouGov poll showed a 14 point Tory lead and Prof Colin Rallings of the LGC elections centre at the University of Plymouth recently suggested that a resurgent Conservative Party could make gains deep in traditionally Labour council seats.

The Conservative line that the Government is “out of touch” with the electorate is echoed in Boris Johnson’s mayoral campaign that it is time for a change. With the resignation of one of Mr Livingstone’s adviser’s earlier this month, he faces a strong challenge from Boris, with recent polls showing them neck and neck.

Ken may say that the mayoral election is not Celebrity Big Brother but, as the New Statesman suggests: “If it isn’t Celebrity Big Brother, then on the evidence to date it is about him, Ken, about his management style and about people wanting someone different now.”

The current economic climate is merely providing a backdrop for what is, inevitably, a London-centric mayoral election campaign focusing on transport, the environment, crime and affordable housing. But it is providing ammunition for the opposition parties in Parliament which will filter down, to some degree, to the general malaise among the electorate.

The three main candidates in the Mayoral election, Johnson, Livingston and Paddick, have all portrayed themselves as slightly rebellious characters, and have downplayed their party-political affiliations. However, Ken will be unable to disassociate himself entirely from the Government and the former Chancellor of the Exchequer, and the economic downturn can only hurt his chances.

Come 2009, if the Treasury’s economic forecasts do indeed prove to be optimistic, we could see a similar effect in a general election year.