Jeremy Warner's Outlook: As the road surface turns from smooth to bumpy, what now for the UK economy?

First Technology attracts bidding war
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The Independent Online

It has not been a good week for the British economy, as judged by the official figures at least. Retail sales last year showed their lowest annual growth since the Second World War, unemployment is rising again, UK productivity is slipping further behind our major competitors, and the public finances seem to be sinking further into the mire.

With earnings and price inflation apparently slowing fast, there could scarcely be a more potent cocktail of negatives for those that believe the Bank of England should be taking urgent action to cut short-term interest rates. Even the notoriously hawkish Mervyn King, Governor of the Bank of England seemed to acknowledge the point in a speech to business leaders in Kent when he said that the level of official interest rates thought necessary to meet the 2 per cent inflation target might be lower than it has been in the past.

Just to avoid any confusion, this was not intended as a signal that he is about to cut rates, but rather formed part of a wide ranging analysis of the low interest rate environment more generally. In fact, he thought, things could just as easily go the other way, with a sudden surge in price inflation requiring higher interest rates.

Yet no one looking at the state of the economy as it stands today would think this latter outcome very likely. For retail sales growth to be lower than it was even during the recessions of the mid-1970s, the early 1980s and the early 1990s, is a really quite astonishing statistic. But for late Christmas surge, the position would have looked even worse.

Are things as bad as the figures suggest? Well perhaps not quite. As a segment of the UK economy, retail is becoming the new manufacturing, which has been in decline for decades.

The problem is not so much lack of demand as lack of pricing power. Most retailers would have experienced a considerable degree of price deflation last year.

The headline retail sales figures are based on value, not volume. If prices are falling, the volume needs to rise by a compensating amount for the value to show any rise at all, and that's plainly what's been happening in this instance.

Past recessions have been characterised by declining demand. That's not yet the case with UK consumption. Strong service sectors and fast increasing Government spending have in any case kept the economy as a whole growing.

The danger of price deflation is what happened in Japan, when consumers took the view that there was no point in buying something this month if it was going to be cheaper next. So they started saving rather than spending, which made the situation even worse. There's little evidence of that happening in the UK. To the contrary, despite record levels of debt, our appetite for spending seems to know no bounds.

Even so, the situation is plainly a worrying one. There's little the Chancellor can do to revive demand should it decide suddenly to head south. He's already spending more than he can afford, and there's no scope whatsoever for tax cuts without compensating cuts in spending.

The Governor has got more ammunition than the Chancellor, but he doesn't want to encourage the debt mountain any further than he's done so already with ever lower interest rates. To do so only risks a much worse demand shock further down the line when interest rates do have to rise.

In his Kent speech, Mr King warned of a bumpy road ahead. The change in road surface doesn't necessarily mean the wheels are about to come off the economy, but he may need to engage in a lot more swerving if we are to avoid a nasty road crash. The domestic economy is one thing. The challenges faced by the global economy are more daunting still, and perhaps unfortunately, there's little the Governor can do to address them.

First Technology attracts bidding war

Not many people know this, but First Technology Plc, the British safety device engineering company, is a world leader in crash test dummies. Don't laugh. This is a vital piece of test equipment which has saved countless lives, and though hardly of mass market appeal, it is something the company can justifiably be proud.

After years of struggling to get noticed, First Technology suddenly finds itself the object of a bidding war. Few of us may have noticed this little jewel of a company before, but the Americans certainly have, and now two of the giants of US engineering, Honeywell International and Danaher Corporation, are slugging it out for control.

It is always faintly embarrassing for directors when they recommend an offer which is later substantially trumped by someone else, and this is precisely what's happened here. Last month, the company recommended a £207m bid from Honeywell. That was then and this is now, and yesterday there was an even more wholehearted recommendation for a £251m bid from Danaher, which apparently offers a superior scientific fit to that of Honeywell. Over to you, Honeywell.

Exactly the same thing happened with P&O, which recommended a bid from Dubai ports only to find there was an even better offer forthcoming from the port authority of Singapore. Embarrassing, yes, and not entirely beyond reproach, for when a bid is recommended as a fair offer, it can encourage some shareholders to sell in the market in the belief that this is the best they are likely to get. Yet scandalous? Not really. Recommendation is frequently the quid pro quo demanded by overseas acquirers for making a bid at all. To get the auction going, there has to be a recommendation.

Most of First Technology's assets are in the US, so its takeover can hardly be seen as part of the trend which has seen whole swathes of Britain's industrial heritage swallowed by overseas bidders. None the less, there are some wider points to be made here.

The first is that British valuations are still relatively cheap compared with some overseas markets, which makes UK plc a target for foreign acquirers. One of the reasons for this is that our big occupational pension schemes, which have traditionally been the main support for UK equities, have become big sellers, disproportionately depressing their price. Their loss is the foreign bidders gain. The other big new buyers of UK equities are private equity and hedge funds. Again, they have become big beneficiaries of the insanity which causes British pension funds to swap equities for bonds.

The second point is that it remains relatively easy to buy British publicly quoted companies. This is perhaps not the case for many overseas markets, which remain substantially closed to foreign acquirers.

Yet the opportunities are fast running out. One of the most striking things about the London stock market is how unrepresentative of the UK economy it has become over the past 20 years.

Where once it was a proxy for the hinterland of British industry and commerce, today it has come to be dominated by big global corporations, some of which have no UK assets of significance whatsoever but find London a convenient place to domicile and do business. More than half the FTSE 100's earnings now come from overseas. As far as the British economy is concerned, it becoming progressively impossible to buy directly into its key sectors, many of which are now largely owned either by overseas concerns or by private equity.

The LSE needs to work harder to address this problem. The Alternative Investment Market, which provides a low cost way for smaller companies in new industries to float, is only part of the solution.

I've nothing beyond anecdotal evidence for this claim, but the impression is that as many of the older names of British corporate life disappear into the anonymity of overseas ownership, they are not being replaced to anything like the same degree by the up and coming success stories of British entrepreurialism.

j.warner@independent.co.uk

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