UK: Economy On Brink Of Snapping

An Economy On The Brink Of Snapping

By Tom Stevenson | 18 November 2007

Talk of 'soft landings' or a 'happy handover' of growth from America typifies end-of-bull-market wishful thinking.

It has been said that the road to every recession is signposted "soft landing". The end of this economic cycle looks like being no exception, even if the terminology is slightly different. This year's wishful thinking is dressed up as Goldman Sachs's "happy handover" or the ubiquitous "decoupling". They are new tags, but the principle is the same. America's economy may be going to hell in a handcart— manufacturing slipped into recession again, new data showed on Friday— but the rest of the world will muddle through.

Global growth is slowing, but five years into the expansion it still looks robust— Tony Dolphin, a strategist at Henderson Global Investors, predicts 4.5 per cent next year for the world as a whole. That's down from last year's 5.6 per cent and 5.2 per cent in 2007 but still safely higher than the long-run trend.

The high-octane growth of China and India, however, disguises a gloomier outlook elsewhere. Henderson expects the US, Japan and Britain all to record growth rates of less than 2 per cent in 2008. In Europe too, the stranglehold of an overpriced currency will peg output growth to just 2 per cent.

Even these predictions may be too relaxed. Morgan Stanley said last week that there was a 40 per cent chance of recession in America. "The real risk is that the current credit crunch and financial turmoil will lead to a US recession, which in turn drags down the rest of the world; and that the weak dollar and high oil price are too much for the European cycle," said Teun Draaisma, a strategist at the bank. He is in good company. Alan Greenspan, the former Fed chairman, recently put the chance of economic contraction in the US at "30" per cent, while Bill Emmott, a former editor of the Economist, told a gathering of investors at Nomura last week that there was a "60" per cent chance of recession.

After a week of relentlessly depressing economic news, the doom-mongers' hand-wringing is understandable. An older adage is reappearing: it says that when America sneezes the rest of the world catches a cold.

The sub-prime debris is already washing up on Britain's shores. Last week Barclays tried to draw a line under its exposure to the toxic waste of US mortgage derivatives. Putting a figure of £1.3bn on the damage scotched the wilder rumours, which suggested that the bank might be sitting on £10bn of losses. But question marks remain over how much more there might be to come or whether Barclays' assumptions were conservative enough.

A spike in Libor, the rate at which [international] banks are prepared to lend to each other, showed that wholesale money markets remain almost as gummed up as they were at the height of the summer's credit crunch. Philip Shaw, the chief economist at Investec, warned that "things are likely to get tighter still in the run-up to Christmas".

At the heart of the now inevitable slowdown in Britain is the housing market, which has faced a barrage of bad news. On Friday Nationwide warned that house prices will stagnate next year. "As we move into 2008, economic tailwinds are increasingly being replaced by headwinds," says Fionnuala Earley, Nationwide's chief economist. "A slowing economy, tighter credit conditions, stretched affordability for first-time buyers and lower house price expectations appear likely to reduce the level of activity." Earlier, the Royal Institution of Chartered Surveyors' housing survey showed sharp falls in price expectations and the numbers of new buyers and completed sales. Kelvin Davidson, Capital Economics' property economist, says the figures "clearly point to a housing market that is feeling the strain from past interest rate rises". He adds: "Our central expectation is that annual house price growth will turn negative next year."

Michael Saunders, an economist at Citigroup, points to a strong historical link between slowing housing demand and retail sales. He believes that the recent 0.1 per cent drop in retail sales volumes, the first since last November, is the start of a trend.

"We expect a further marked slowdown in the trend of retail sales growth in the coming months," he says. "Retail sales volumes fell month on month in six of the 12 months ended August 2005, after the last housing slowdown."

The government retail sales figures chimed with data from the British Retail Consortium, which showed a sharp fall in the annual growth rate of like-for-like sales values from 3 per cent to 1 per cent in October. Unexpectedly strong consumer spending over the summer has hit the buffers spectacularly.

Other recent data show that the slowdown is not restricted to housing and the high street. There was a 0.6 per cent fall in manufacturing output in September, while a 0.4 per cent slide in industrial production meant there was no growth at all in the third quarter. Meanwhile, Britain's trade deficit hit a record in September as imports rose by 2.4 per cent but exports fell by 1 per cent.

Against such a gloomy backdrop it is little wonder that the Bank of England's quarterly Inflation Report last Wednesday should have struck such a downbeat tone. The Bank forecast that economic growth would slow from 2.6 per cent to 2.4 per cent, but even that weak performance assumed interest rates coming down by 0.75 percentage points by the beginning of 2009.

At the time of the last Inflation Report, the Bank was more worried about inflation than growth and the market concluded that interest rates would rise to 6 per cent from the current 5.75 per cent. Now, rates of 5 per cent seem baked into the Bank's forecasts, a huge swing in sentiment in just three months.

Yet despite the change of emphasis, the fear of rising prices refuses to lie down. With oil flirting with the psychologically important level of $100 a barrel and food prices rising steadily higher, the spectre of stagflation has returned to haunt the British economy 30 years after it last stalked the country.

Producer output prices rose by 3.8 per cent in October, a 12-year high, pushed up by sharply higher energy and food costs. There was an 8.5 per cent year-on-year rise in input costs, putting pressure on manufacturers to pass on higher prices to consumers.

It all adds up to a headache for policymakers and a dilemma for investors, who have seen share prices shake off the credit market turmoil with unexpected panache. Morgan Stanley's Draaisma thinks there is "a growing risk that this decade's bull market is ending", although he doubts that it will end like the 1990s bubble with a blow-up and subsequent bear market.

"The end of this cycle may well be more like the one before. There are many similarities between the end of the 1980s and now, including a junk bond crisis and overvalued real estate" he concludes.

Between 1989 and 1993 stock markets in Europe simply moved sideways. A whimper rather than a bang— or is that just another piece of wishful thinking?


Is An Economic Slowdown Coming?

By James Hall | 18 November 2007

We'll soon start to feel the pinch as economic woes come home to roost.

For months the phrases "sub-prime" and "credit crunch" have been abstract concepts for British consumers, detached from the economic realities of their everyday lives. However there are growing signs that the effects of the credit crisis are trickling down to the average British household. Last week, the Office of National Statistics said that retail sales unexpectedly fell for the first time in nine months in October as shoppers bought less food and clothing, a sign that higher borrowing costs are squeezing consumer spending. The figures add weight to Bank of England Governor Mervyn King's concerns that the economy may slow "sharply" in the next year.

Andy Bond, the chief executive of Asda, the UK's second biggest supermarket, says that there is concrete evidence that shoppers have less money to spend than they did earlier in the year. New research for the supermarket by the Centre for Economics and Business Research, the consultancy, shows that households who shop at Asda have an average disposable income of just £120 a week once essential bills— such as utilities, mortgage payments and basic food— are paid. Given that Asda has 16m shoppers every week, this figure is a reasonable proxy for the UK as a whole.

"It is worth understanding just how little money people have right now," says Bond, who points out that commodity price rises of up to 50 per cent have put the cost up of a weekly shop. A litre of unleaded petrol at an Asda forecourt cost 79p last year [[$6.12 per gallon: normxxx]]. Today it costs 97p [[$7.52 per gallon: normxxx]].

The rising prices plus falling disposable incomes means tough times are ahead. Retailers such as WH Smith and French Connection last week said they are "cautious" about the consumer environment. The upcoming Christmas trading period is likely to be very nasty for some retail chains.

However Bond warns that the UK is in danger of "talking itself" into a recession if it overplays these dangers. "I fully recognise that it is a tough time for consumers but you equally make yourself a hostage to fortune by talking the country into a recession," he says.

Life is about to get yet more expensive for up to one million families. Low-cost fixed-rate mortgages taken out at the end of 2005 and the start of 2006 expire around now and are being replaced by today's more expensive deals, adding hundreds of pounds to mortgage bills.

At the same time the UK housing market is slowing. Chris Wood, a director at PDQ, a Cornwall-based estate agency, says we could be heading for a "mini-recession". The sub-prime crisis and the introduction of controversial Home Improvement Packs (Hips) have led to a 20 per cent drop in the number of houses on the market in England and Wales compared to last year, he says.

"Sub-prime has psychologically made a big dent in the market," says Wood, who is also senior vice president of the National Association of Estate Agents.

Wood's medium-term outlook is bleak. "We are going to see asking prices drop a bit, but there will be some sellers and letting agents who panic and drop their prices more than they need to. There will be an initial dip of 4-5 per cent in prices over a four-month period, then a levelling off," he says. So, not a major crash but a market correction. However Wood agrees with Asda's Bond that consumers are in danger of scaring themselves into a recession. "Once it gets to a certain level it becomes self-fulfilling," he says.

Economists say that the "real" economy is definitely being hit after slowdowns in the retail, manufacturing and services sectors in recent weeks. "There are growing signs the real economy is being hit. The data released over the last few weeks has been consistently softer," says Howard Archer, chief UK and European economist at Global Insight.

Archer expects the UK economy to grow by 1.9 per cent next year, down from 3.1 per cent this year. This would represent the second weakest annual growth since 1992.

In a sure-fire signal that a slowdown is on its way, consumer goods companies are starting to get jittery.

According to the chief executive of an advertising agency, a sign in adland that times are getting tough is when the number of companies putting their marketing accounts out to tender increases. This is happening now.

"The same thing happens when you are going into a recession as when you are riding a boom: there is an outbreak of pitching as clients put their accounts up for tender. It happens in a boom because companies think that the economy's got momentum and they want to review their options, and it happens going into a recession because they want to get value for money," says the chief executive.

"The latter is happening now. This sounds counter-intuitive but the ad market feels like it's hotting up, which means that the economy could be slowing down," he says.

Normxxx    
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