37/03 25 March 2003
WAR – THE ECONOMIC CONSEQUENCES FOR THE UK
By Trevor Williams, Head of Group Economic Research, Lloyds TSB
The war against Iraq has finally started, but what does it mean for the UK economy asks Trevor Williams, head of group economic research, Lloyds TSB. The prospect of war has already taken its toll on the global economy, causing much of the recent rise in oil prices and gyration in equity markets. But what happens from now depends on how the war unfolds.
A recent meeting of the Centre for Strategic and International Studies (CSIS) discussed how the war could develop. Three key economic scenarios were produced based on the expert views of strategists, military experts, oil experts and political analysts: a benign scenario, an intermediate scenario and a worse case scenario.
The benign scenario assumes that the war lasts no more than eight weeks, with no political upheavals in the region or a major terrorist attack globally, and oil facilities in Iraq, and oil exports generally, not unduly affected. Recent falls in oil prices and rise in equity markets suggest that this is the view financial markets are adopting.
The CSIS give this scenario a 40 to 60% probability. In this outlook, oil prices start to fall back and equity markets bounce back, with consumer and business confidence returning quickly to pre-crisis levels. The impact on the UK is negligible this year and there could even be a beneficial effect on UK growth in 2004 of 0.25%, if oil prices fall back as Iraq produces more oil and oil prices fall.
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The intermediate scenario assumes damage to oil facilities and oil markets. The war spreads to other countries in the region, lasts longer and leads to political instability, civil unrest and terrorist attacks. In this scenario (given a 30 to 40% rating), oil prices rise more rapidly, US and UK government deficits are bigger, equity markets fall more sharply and confidence suffers.
The UK could see growth up to 1% lower in 2003 - around 1% pa rather than the 2% pa in the benign scenario. Government borrowing could be up to £11bn higher, or some 1% of gdp, not just as a result of higher military spending, but due to slower economic growth pushing down tax revenues while spending rises due to higher unemployment. However, economic growth should bounce back more strongly in 2004, by some 0.5% more than in the benign view, as interest rates are cut sharply and the government lets the ‘fiscal stabilisers’ work and the public sector deficit expand.
The worse case scenario (5 to 10% chance) is a UK recession, as gdp growth reduces by 2.5%. A major war develops – lasting much longer with significant damage to infrastructure and oil supplies, as well as higher costs than in the benign case. There are also major terrorist attacks. Consequently, oil prices approach $70-$80 dollars a barrel and deep cuts in interest rates and a wider budget deficit are not enough to prevent negative economic growth this year. However, US-led forces are still expected to prevail and UK growth should bounce back to 2.5% to 3% in 2004, as oil prices fall sharply and the effects of loose monetary and fiscal policy spark economic recovery.
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For more information:
Jo Ganly
Lloyds TSB Press Office