But the data that is coming though suggests that ahead of the bombings the economy was slowing sharply. You may recall there was a downward revision in the official figures of recent growth. As a result, some forecasters (including Deutsche Bank and Global Insight) have cut their estimated growth for this year to 1.8 per cent. If that were to happen it would be the weakest performance since 1992. Things may turn out a bit better than that but clearly the Chancellor's pre-election Budget forecast of 3-3.5 per cent looks absurd. Now, with the bombings, it is just possible - though not yet probable - that we will have a quarter of negative growth.
The latest unemployment data is discouraging. Unemployment on the claimant count is up by 8,800 to 2.9 per cent. That in itself is small but this is the fifth month on the trot when the figure has risen, again the longest run since 1992. Private sector employment is also falling. The first chart, from Deutsche Bank, suggests this weakness in the labour market is likely to pull down the rate of growth in earnings. So fewer worries about the medium-term trend in inflation, despite the upward nudge of the latest data.
Obviously the housing market will be the key to future demand. It seems to have stabilised, with the number of mortgage approvals turning up at last. In the past that has given some guide to changes in the market (next graph). On the other hand, there is almost certainly still some overvaluation relative to earnings, and Deutsche Bank reckons prices could fall by 10-15 per cent.
Given the extent to which the slowing market has already cut back the levels of equity take-out (final graph), retail sales are unlikely to get much support from that quarter if that sort of decline in house prices does indeed taken place.
At any rate, the mounting evidence of the slowdown will lead to interest rate cuts. It may well be that the first cut could come next month, although that depends on what happens in the next few days. Obviously the timing of the first cut is important for psychological reasons but the more substantial issue is not one of timing but of how far down rates will go.
That leads to a further issue. How long and how strongly can rate cuts puff up demand, both here and elsewhere in the world? Cheaper money is the weapon the world's central banks will use because that is the only weapon they have. How well will it work?
Look forward. Let's assume we get a run of cuts here through the autumn and winter. Let's assume that the Fed stops its "measured" increases in the autumn and makes its first cut early next year. Let's assume that the European Central Bank capitulates and cuts rates in, say, November. What then?
In the case of the UK and the US the key thing will be whether cheaper money averts a sharp fall in the housing markets. If it does and prices steady, then growth will resume for a while.
In the case of the eurozone the picture is more complicated because some parts, such as Spain, need higher interest rates to curb inflation, while others - Germany in particular - need even lower rates (maybe zero rates) to restart domestic demand. So do not expect too much in the eurozone: a bit more inflation in Spain and continued near-recession in Germany. (Interesting to see, by the way, that the excellent economic team at HSBC reckons there is serious danger of prolonged stagnation in some eurozone countries and that eventually the zone may well break-up.)
As far as the UK is concerned there will be a tussle next spring between the addition to demand created by lower interest rates and the reduction in demand that will come from the corrections the Chancellor will have to make to his Budget plans. Slower economic growth will mean slower growth in revenues, so there will be either tax increases, or a reduction in spending plans, or higher-than-projected borrowing. There will probably be a combination of all three.
But it will not be easy. Increasing taxation in the face of a stagnant economy is exactly the sin that the Chancellor accuses his European counterparts of committing. Europe knows how to create economic stagnation as well as double-digit unemployment. Mercifully the UK will not be starting from the same base. But we would be naïve to assume that there will be no contagion from Continental stagnation or that UK growth can be sustained by restarting the housing boom.
My guess is that as far as the UK and US are concerned, the forthcoming interest rate cuts will work for a while. If this year growth turns out, in the UK at least, to be a disappointment, next year will see a recovery of sorts. But it will not be sustained for long. The problems will be pushed forward but not resolved. The trouble is that apart from the decade after the Second World War, a very unusual time, we have no experience of the long-term consequences of very low interest rates.
Meanwhile the thing to watch will be the high street. There was one particularly glum report yesterday in the shape of the fall in demand at Marks & Spencer, though fortunately that has as much to do with the company as the conditions of the market. I would expect sales to be very soft until the end of the holiday season. If they do not recover sharply by October it will take aggressive cuts in interest rates to get things going again. The risks are surely more of slipping into deflation than reawakening inflation.
This leads to a contentious matter. For many months now the Bank of England has undershot its target of 2 per cent inflation on the new consumer prices measure. Just yesterday inflation came up to the mid-point of the range. The Bank is required, under legislation, to regard the 2 per cent figure as the centre-point of the range. In that regard it is unlike the ECB where the 2 per cent number is supposed to be a ceiling. Having undershot for so long it would be normal and natural for the Bank to have a period of overshooting, provided inflation were kept well below 3 per cent.
It is too early to be able to make any judgement on this, for we don't yet have any real information about the impact on the economy of the bombings.
In any case what is happening in central London gives little guidance to what is happening elsewhere. But things do feel as though they are coming to a halt and if the figures confirm that, then cheap money will be in store.Reuse content