During the last 12 months production has made a modest recovery from the recession of 1975. But the economy is still working well below its productive capacity, industrial investment is rising but is still too low, and there is still a substantial current account deficit on the balance of payments to be eliminated.
If we were to make no change whatever in present policies, I would see the prospects as follows. Production would grow only slightly in the next 12 months. The main increases in demand are likely to be in net exports and manufacturing investment—the sectors which we want to lead the recovery of the economy. From other sectors, however, little or no stimulus is to be expected. Public expenditure on goods and services will be rather lower than last year. And on present policies, I would expect no increase in private consumption. Indeed, there might be some decline.
Taken together, these trends could be expected to mean that demand and production would continue to grow slowly. But with so modest a recovery in output I would not expect any fall in the level of unemployment. Indeed, I fear that some further rise would be more likely. The rate of increase in unemployment has, however, been falling markedly. In 1975 the increase was 40,000 a month; in 1976 it was 13,000 a month; and this year there has been a welcome fall in the level of unemployment. But two months is too short a period on which to form a judgment. The plain fact is that the present level is unacceptably high; and action is clearly needed to improve the future prospect.
The rate of price increases is also a cause for acute concern. I have said many times that we need to get our inflation rate down to the level of our main competitors'. Last year's experience with the exchange rate shows what is bound to happen until we achieve that. Our inflation rate was falling rapidly in the first half of 1976, thanks to the £6 pay policy, but our rate was still much higher than those of our main competitors. The disparity caught up with us and caused a fall in the exchange rate. There were other factors, such as the drought and the world increase in commodity prices, but the fall in the exchange rate was the main factor which checked the decline in our rate of inflation last summer and prevented us from reaching single figures by the end of 1976.
The response of the trade union movement, first to the £6 pay limit and then to its successor, gives us a very good chance of resuming the fall in inflation in the second half of this year when the effects of last year's depreciation have finished feeding through into prices. Indeed, there is a real prospect of getting inflation into single figures by the second quarter of next year, provided that we can avoid substantial depreciation.
This will be possible only if we maintain confidence at home and abroad in our determination to reduce our inflation rate; and that, in turn, means that we must get a satisfactory agreement on pay to operate when the present pay agreement expires at the end of July.
There is no chance of getting a new agreement unless we make sure that the benefits of pay policy and a more stable exchange rate feed through into prices in the shops. So we intend to prevent any unreasonable profit mark-up, by keeping the price control on profit margins, and by taking a new power to freeze a particular price for up to a year when an independent investigation shows this to be justified. At the same time we have to be careful that price controls do not damage the rate of return on investment. This has been driven down by inflation and recession to exceptionally low levels. We must make sure that the return on capital is allowed to recover sufficiently to reinforce the upturn in investment and to ensure that the new jobs we need are created.
The balance of payments prospect is now a good deal better. During the next 12 months we can confidently expect a large increase in the flow of North Sea oil, and an increase in visible and invisible exports, all of which will substantially improve the balance of payments. Our current account deficit, which has been running at an annual rate of a little over £1½ billion in the last six months, should be progressively eliminated and we have good prospects of a healthy surplus in 1978.
The foreign exchange markets have been much more stable everywhere this year. The stability of sterling has been partly due to the December measures and the IMF agreement and also to the reassurance offered by the recent new agreement on the sterling balances, for which we are grateful to our central bank partners. Sterling has also been helped by the repayment of the sterling loans made to finance trade between third countries, which I took measures to stop late last year. I am now proposing to strengthen our exchange control powers over the raising of sterling finance by companies resident in the United Kingdom but controlled by non-residents.
The reserves are now at a much more satisfactory level. Provided that we secure and maintain a balance of payments surplus, we can begin to repay overseas debt. Until this repayment is safely under way, our domestic economic policies will be subject to constraints. I made it clear in the context of the agreement on the sterling balances that I do not intend to rely on sterling inflows on private account as a means of financing the remaining deficits. So I have continued to borrow on a secure medium-term basis, in order to improve the overall pattern and level of reserve assets in relation to the debt structure. But I do not expect this type of borrowing to be necessary much longer. It is a most welcome change to be speaking to the House about the prospect of repaying debt rather than reviewing the prospect for getting more overseas financing.
The outlook for the monetary aggregates has shown a significant improvement. Domestic credit has expanded very little in the last six months, and in the year to mid-April 1977 its expansion is now expected to be only about half that allowed for by the ceiling of £9 billion in the Letter of Intent. In my December statement I said that I expected the associated growth of sterling M3 to be between 9 and 13 per cent. With the much lower expansion of domestic credit, the growth of sterling M3 will now be at or below the bottom end of the range.
Finally, the public sector borrowing requirement has fallen. The total for the financial year now ending is currently estimated at £8·8 billion, but it will be some months before we know it for certain. We know very little yet about public borrowing in the last three months of the year apart from that of central Government itself. The reasons for this downward revision from the forecast in the Letter of Intent to the IMF are discussed in the Financial Statement and Budget Report. Some of the effects carry through to the forecast for 1977–78.
The estimates now suggest that if present policies were continued, the PSBR for the next financial year would be about £7½ billion, about £1¼ billion lower than the figure of £8·7 billion agreed as a ceiling with the IMF. This improvement is mainly due to better prospects for employment, interest rates and the exchange rate since the December measures.
The forecast for 1977–78 takes account of the intention, which I announced in December, to sell an amount of British Petroleum stock which will leave the total of the Government's and the Bank's holdings at 51 per cent.—more than we held before the Bank acquired the ex-Burmah shares. This sale will go ahead in 1977–78, and in framing my Budget proposals I have made full use of the room for manoeuvre which it will give me. Since there is still the impediment of Burmah's claim against the Bank of England, the Government will sell part of its own holding, in the expectation, based on strong legal advice about the merits of the Burmah claim, that we shall in due course be able to consolidate the 51 per cent. holding by securing the transfer to the Treasury of the stock now held by the Bank.