Hamish McRae: It'll be a tricky week, but Goldman's optimism offers renewed cheer

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The Independent Online

This week will be one of information overload, and information, I fear, of a pretty depressing nature. We get the pre-Budget report, which will purport to set the framework for the Budget next spring. I say purport because of the forthcoming election. Even in the unlikely event of Labour managing to stay in office, its post-election plans would be very different to those set out now.

So what we will get on Wednesday will be largely a political document rather than an economic one, setting out plans designed to make it as difficult as possible for the other side. However, there will be some things to look for, including the new Treasury economic forecast and the estimate for the fiscal deficit this year. While we should not take too seriously the Government's plans to correct the deficit, any information about the scale of the catastrophe will be helpful.

But before we get too deeply into either the dismal politics or the sense of despair about our nation's finances, it is worth questioning whether the fundamental economic outlook is quite so dire as it has been painted. Put it this way: a few years of decent growth would make it possible to get the country's financial position under reasonable control, whereas several years of slow growth would compound the present disaster.

The prevailing view seems to be that next year will see a lacklustre recovery, with the possibility of a second downward leg to the recession: the dreaded double-dip. Take two economic teams that I much respect. The new forecast from the National Institute, out today, expects growth at only 1.1 per cent in 2010 and 1.7 per cent in 2011, while the latest numbers from Gerard Lyons, the chief economist at Standard Chartered, have growth at 1.2 per cent and 1.9 per cent for those two years. This would be bad news for fiscal consolidation, and the National Institute reckons that the next government will have to tighten fiscal policy by a total of £90bn a year. That feels about right. My own back-of-an-envelope tally puts the needed tightening at £100bn, but what's £10bn between friends?

Credit Suisse leapt into the attack last week, writing in a note to clients that the UK was in a far worse state than other major economies, and that the Bank of England "may be in danger of losing its credibility".

There is, however, an alternative and much more optimistic outlook. It comes from Jim O'Neill and his team at Goldman Sachs and it needs to be taken seriously. In a nutshell, their view is that not only is there likely to be a solid global recovery next year, and picking up pace in 2011, but that the UK will benefit from that and become the fastest-growing large developed economy, with growth at 3.4 per cent in 2011. That is pretty close to the Bank of England's much-derided forecast of growth at 2 per cent next year and 4 per cent in 2011. If Goldman is right, we should be back to our peak output in early 2008 by the middle of 2011.

So there are two quite different views. Can they be reconciled? I think the best answer to that is: not yet. There is no dispute about the fiscal mess. The difference is over the pace of global growth in the future, and, more particularly, the ability of the UK to profit from it. The Goldman thesis is based on the proposition that the world economy's sustainable rate of growth is around 4 per cent. That is the rate it can achieve without running into inflationary problems.

In 2008, global growth was only 2.7 per cent and this year it will be about minus 0.8 per cent. So there is plenty of room for making up a bit of lost ground and Goldman thinks the world could grow at around 4.5 per cent in 2010 and 2011. Most of the growth will take place in the Brics (Brazil, Russia, India, China). But even within the developed world there will be reasonable growth and the UK will do especially well, helped in part by the cheap pound.

We will just have to wait for evidence as it comes through, but optimists should note that the poor numbers for the UK are being revised up and it may well be that I am right in suggesting that growth here did begin in the third quarter. It now seems that construction, far from shrinking, actually grew during that period. While that would not be enough to have pushed the economy into positive territory, we are getting there. Just why the statistics should be so poor needs to be examined – but that is a story for another day.

The issue we in the UK have to confront will be how to correct the deficit without damaging growth. My greatest worry is that there might be some sudden loss of confidence in British economic governance in the coming months. The fact that we have managed so far to avoid that does not mean that we will continue to do so. If it seemed likely that there might be a minority government next year, that might provoke a domino collapse and we might find that UK interest rates had to be increased sharply to support sterling. We have to assume that the UK will lose its AAA borrowing status, which of itself need not be a disaster but which would mean that long-term interest rates would rise.

Some work by Richard McGuire at RBC Capital Markets noted that Spain's loss of AAA status in January has increased its borrowing costs by around 0.5 percentage points, though much of the rise took place ahead of the actual downgrade and was in response to a warning that its status might be cut. He suggests that the UK's costs might rise by more, since we don't have the implicit protection of being within a larger currency zone. The bank is bearish about UK gilts, given the fact that overseas investors are the important marginal purchasers. We have doubled the stock of UK public debt held abroad during the past decade. If we don't have much faith in UK financial governance, why should they?

So I am less worried about our economy than I am about our national finances. One characteristic of confidence is that it can evaporate quite suddenly. We saw that with US sub-prime debt or indeed with Dubai's debt. Everything canters along fine even though the fundamentals are going haywire. Then there is a tipping point and money runs away.

Next week will be dangerous because our fiscal credibility is on the line. It would be a strange paradox indeed if the only thing between this government and a catastrophic loss of confidence were the widespread belief that it will be kicked out in a few months' time.


It is humiliating to get an unimportant job in Europe (and put a nonentity into it) and in the horse-trading lose the post that would be really important to our national interests.

President Nicolas Sarkozy expressed what many of us here suspected when he crowed about France getting the EU internal-market commissioner's job, saying: "The English are the big losers in this business."

But is it really such a disaster? That he should speak out displays a certain candour. We might privately be pleased to pull a fast one on the French but we would not go public about it. Actually, I think we were silly to cancel the president's visit here in retaliation – it makes us look petty – but there you are.

Whether it will damage London's financial-services business is another matter. We know the French authorities are concerned that so many young French want to live here. London is, so to speak, the fourth-largest city in France. Many work in finance and so, were it possible to get some of them to relocate to Paris, that would be a prize worth fighting for. But I don't think the real threat to London comes from Paris or Frankfurt but from New York and Hong Kong. In other words, the weight of the European time-zone in finance may diminish vis-à-vis the other two time zones. There is a natural advantage in being in the middle zone, because you can talk to the other two in working hours. But there is a disadvantage in being located in the slowest-growing of the three regions.

Assuming Europe applies its regulation moderately insensitively, the UK will be the biggest loser in existing areas of business because we have more to lose. But the greater concern is that London may miss the new areas of business as they develop. Banking is going to be under stress for a decade, probably longer, so the emphasis will be on the securities markets to fill the gap. On the face of it, that might favour London, because we have more of a securities-based financial system whereas Continental centres are more bank-based. But if the new securities market stuff goes to Geneva and Zurich then we have a problem. The English may indeed be the big losers, as the president claims, but the Swiss are likely to be the big gainers, not the French.