Optimism on UK economy doesn't stretch to the euro

LONDON BRIEFING / Chris Johns: As with most small open economies, the UK looks forward to a New Year almost entirely in thrall to events outside its control.

The simple fact is that the most important drivers of the British economy are to be found beyond the borders of the UK.

If you want to know what will happen to the UK economy next year, you have to know what will happen to the world economy. That this is true of many other OECD economies will be of small comfort to a government - and particularly a Chancellor - that will in all likelihood be reaching the half-way point of the current term of office. Thoughts of the next general election will be looming; euro decision time will be imminent.

All things considered, the economy had quite a good 2002. Actually, with the exception of the euro area, that is true of much of the rest of the world. Even Japan managed to register a half-decent growth rate and the US economy, despite all impressions to the contrary, managed to record one of the fastest rates of growth in the world.

If we had said at the beginning of the year that stock markets would fall another 20 per cent - 30 per cent , oil prices end the year above $30 a barrel, Europe flirt with recession and war tensions build through the year we would almost certainly have talked about slumping economies and rising unemployment.

That things turned out to be much better than we might have expected is testament to the flexibility and resilience of many economies, including the UK but particularly the US.

As well as revealing inherent underlying economic strength, last year also confirmed the ongoing importance of sound policy making.

Strong and sensible central banking in the UK and US played a large part in the relatively positive economic outcome. Unsound and idiotic central banking in the euro area played a large part in that region's economic underperformance.

The UK economy did well, but in an unbalanced way. Manufacturing slipped into recession but the service sector grew reasonably strongly.

Luckily, manufacturing is now relatively unimportant, comprising less than 20 per cent of the economy, so its weakness did not have too large an impact. Linked to industrial sluggishness and the strength of the consumer, the external trade deficit widened.

Going forward, these imbalances will have to be rectified. The most painless way for this to happen would be a rise in the demand for UK exports and a gentle slowdown in consumer spending.

Linked to a necessary slowing in consumer demand will be a softening in the housing market. Whether "softening" becomes a crash is the single most important issue that divides forecasters. My guess is that the outcome will be a benign one.

One reason for optimism going forward is the sheer resilience of the economy in the face of so many uncertainties and risks witnessed throughout last year.

Another is that a key export market for the UK may actually surprise us and grow in 2003. That market is Europe. Domestic European economic weakness in 2002 occurred in part because many people perceived the introduction of the euro as inflationary; many shoppers reckoned that the change over resulted in rip-off pricing.

While this was true in some cases, most people completely over-estimated the extent to which overall inflation rose. As all of these effects drop out next year, consumers may surprise us with a little more spending than expected.

But the single biggest reason for becoming a touch more optimistic about Europe is the signal from the European Central Bank that it is preparing to drop its rather silly monetary policies and become slightly more active in promoting growth. This is good news for all concerned, not least UK exporters.

In all sorts of ways, Europe will continue to dominate the UK domestic political and economic agenda. 2003 will be the year when Tony Blair finally reveals whether or not we are to have a referendum, this side of the next general election, on joining the euro.

The Treasury is due to pass judgment on the economic wisdom of joining and its decision will almost certainly decide sterling's fate, at least for the next five years.

My guess? I would have an easier time convincing the British electorate about the existence of Santa Claus than about the merits of the euro.

For this reason alone, we may find that the Treasury arrives at a rather negative assessment of the economic consequences of joining the euro.

Chris Johns is Chief Strategist at ABN Amro Securities, London. All opinions expressed are entirely personal.