How things change. Back in the 1970s, the UK, struggling to cope with double-digit inflation, rising unemployment, spiralling government spending and appalling industrial relations, was the sick man of Europe. Now, in 2001, with the US slowing, Japan in economic quarantine and Germany sliding towards recession, the UK has some claim to being at or near the top of the world’s economic Premiership.

The domestic turnaround has been a long time coming. After several false starts, the authorities came to the view that what the private sector wanted most from government was stability, an end to the boom-bust cycles that had undermined the confidence of management. Controlling inflation was the chosen route. The prevailing view is that with low and stable inflation leading to low and stable interest rates and a stable and competitive pound, the conditions for stability would be created.

This stance was first adopted following the UK’s humiliating exit from the exchange rate mechanism in 1992 and has been pursued by governments of both parties ever since. Gordon Brown, the present chancellor, went further than his predecessors by taking decisions on interest rates out of politics and giving responsibility for managing inflation to the Bank of England’s monetary policy committee (MPC). No longer, therefore, will politicians be able to attempt to link the economic cycle with the political.

The results of this minimalist policy have been impressive. Inflation in the UK today, using the European Union’s harmonised measure, is around 1 per cent, the lowest rate in the whole continent. For nine years, moreover, inflation in Britain has been 3 per cent or less, an environment unknown in this country for half a century. As a result, base rates have been under 7 per cent for most of the past seven years, employment of over 28 million people is the highest in history, unemployment of under one million the lowest since 1975, and government finances are in their most robust condition for a generation. No wonder the government believed its economic record was its strongest card at the recent general election. The electorate seemed to agree with them.

What is happening, in effect, is that as far as company planning is concerned, the economy is now a neutral factor. If the ranges of inflation, growth and interest rates are a lot narrower in the future than we have known in the past, businesses need not worry as much about where the economy is going in 12, 24 or 36 months’ time. With such stability comes the confidence for companies to focus on the only issue that will ensure they continue to deliver profitable returns, which is to be smarter than the competition.

Welcome as this stability is, beneath the surface is some extreme turbulence that makes a low-inflation, stable environment more fiercely competitive than the old double-digit inflation, boom and bust economy. Evidence for this comes from the fact that some of the best-known names on the high street - Marks and Spencer and C&A, to name but two - faced severe pressure in the second half of the 1990s, pressure that threatened their independence and, in the latter’s case, drove it off the high street. Yet, this was, after all, the most stable environment the UK has known for a generation.

The simple message is that for every company, in every industry, in every region of the country, low inflation is rewriting the rules of business. Today, there are no quick wins or easy fixes in terms of rising inflation rescuing businesses loaded with debt or artificially boosting assets. With consumers more price sensitive, moreover, the scope to widen margins or pass on cost increases is greatly reduced. The need to manage costs, to focus on efficiency, is paramount as firms try to be smarter than the competition.

Although the UK appears to be well placed at the moment, there are concerns that international developments, particularly in the US, may derail our economy. Something similar happened with oil prices in the mid-1970s, and it took years to get that out of our system. Such fears seem totally misplaced because, unlike the mid-1970s, the fundamentals of our economy today are in much better shape.

The days of Edward Heath and Harold Wilson saw inflation take off, government spending soar and unemployment on the rise. Now, however, the authorities have more flexibility in their policy responses. If, for example, consumer spending weakens and growth slows, the MPC could lower interest rates to less than 5 per cent without taking any risks with inflation. In contrast, because inflation was rising a quarter of a century ago, the government was in no position to cut rates even though recession was approaching.

And this is not all. The prime minister and the chancellor are committed to improving public services and, for once, they have the money available to honour their pledges. The difficulty is that private-sector spending is so buoyant that if the government starts to increase spending now, it could spark inflationary pressures. Brown needs the private sector to slow down to create room for outlay on the public sector. Compare this with the Heath-Wilson era, when government spending outstripped tax receipts and forced a sharp rise in public-sector borrowing.

As the authorities have room to ease both monetary and fiscal policies, growth should stay on course this year, at around the trend of 2-2.5 per cent, despite gathering stormclouds in the US, Japan and Europe. For once, we should be able to insulate ourselves from overseas developments.

Home-grown threats

This is not, however, a risk-free environment, and there are some home-grown threats to interest rates and growth. The most obvious is that not all parts of the economy are doing well, with manufacturing and agriculture the obvious laggards. A boom in consumer spending has boosted services and helped to create imbalances, in both industrial and regional terms. This two-speed economy owes much to the pressure exerted on exports by a pound that has been relatively strong, particularly against the euro. With the EU accounting for around 55 per cent of exports, British companies have found it difficult to sell into a slow growing market while sterling eats into margins or pushes up prices.

As a result, the MPC is in a genuine dilemma. Manufacturing leaders are demanding lower interest rates but the strength of the consumer and housing markets suggests that the next move in rates should be upwards. The tightening labour market and the emergence of skill shortages, moreover, is starting to feed a faster growth in wage costs, another factor that might push interest rates higher.

But overall, the adjustments to policy will amount to modest fine tuning, not shifts in direction. Although companies struggling to compete in this new environment might find it hard to believe, we are in good economic health. For once, we have a chancellor who can go abroad and offer advice to his foreign counterparts on economic policy and expect to be taken seriously.

We’ve come a long way since Denis Healey needed the support of the International Monetrary Fund to get the UK out of trouble, a journey that has taken us from the second division to the top tier of the Premiership. The indications are that we should be able to stay there for a while yet.

Mark Berrisford-Smith is a senior economist at HSBC. He will be speaking at the CIPS annual conference, “A call for change”, which is taking place in London from 3-4 October. For more information, call Jill Hepburn on 01780 756777 or visit www.bookit.cips.org