Business confidence takes sharp dive

NORMAN LAMONT, the Chancellor, will defend his economic strategy before the all-party Treasury Select Committee of the Commons today as a new survey shows that the devaluation of the pound has prompted the sharpest slump in business confidence since the beginning of the recession.

A new forecast carried out using the Treasury's own computer model of the economy also suggests that Mr Lamont has little scope to lift the gloom by cutting interest rates if he is serious about achieving the inflation target he announced last week.

Further interest rate cuts are seen as 'vital to improving . . . confidence for a recovery', according to the latest quarterly survey of managing directors by Dun & Bradstreet. The survey showed greater pessimism about sales, profits and new orders in the fortnight after 'Black Wednesday' than for over a year.

'The outlook for economic growth is now extremely weak. Confidence in an export-led recovery is not as strong as might be expected after sterling's devaluation', Philip Mellor, D&B's marketing director, commented.

Some 41 per cent of directors expect sales to rise in the next three months, just 2 percentage points more than expect a fall. This compares with a 30-point balance expecting a rise in sales three months earlier - the steepest decline in optimism since early 1990.

Despite the weaker pound helping the competitiveness of British companies selling their goods overseas, confidence in export growth has slipped back to its lowest level in nine months. Companies are worried that their greater competitiveness may be offset by weaker demand as many of Britain's overseas markets see their economies slow.

But the weakness of the pound is none the less expected to help lift Britain out of recession early next year, according to the latest forecast of the independent Item Club, which uses the same computer model of the economy as the Treasury. As well as helping exporters, the lower pound makes British goods more attractive relative to foreign imports. But higher import prices boost inflation, which the Chancellor has pledged to keep under control.

Mr Lamont's scope to cut rates will be severely limited if he seriously intends to keep to his 1 to 4 per cent target for underlying inflation between now and the next election, Item argues. The Government defines underlying inflation by excluding mortgage interest payments from the retail price index.

If the Chancellor were to cut base rates to 8 per cent by the end of this year - and hold them for most of 1993 - underlying inflation would be at the top of the target range for much of next year. It would then average between 3.5 and 4 per cent until 1997 if the pound re- entered the ERM at the end of next year.

Under this scenario, gross domestic product in 1993 - the total amount of goods and services produced in the economy - would be 0.9 per cent higher than in 1992, against 0.8 per cent growth if we had stayed in the ERM.

But Item argues that the Chancellor is more likely to 'go for growth' at the cost of missing his inflation target. Cutting base rates to 6.5 per cent by the middle of next year would boost growth in 1993 to 1.8 per cent, but accelerating inflation would still force interest rates up again from the end of next year. Even with base rates rising back to 8 per cent, the Chancellor would have to give up any hope of keeping underlying inflation below 4 per cent between now and 1997.

The extent of company failure and factory closures during the recession has also cast doubt on the ability of British industry to cope with a recovery. A survey by Remploy, the contract manufacturer, shows that the number of manufacturing sites in Britain is now 13 per cent lower than in 1991, double the rate of decline seen in the previous year.

A fall in business volume in financial services in the third quarter reversed the small improvement in the previous three months, according to the latest Confederation of British Industry survey.