Outlook: Chancellor's taxing problem creates interest rates dilemma

Housing downer; Royal & Sun

National Insurance up, council taxes up, and next month's Budget still to come. All over the place, taxes are rising, and still it's impossible to get the children into your school of choice.

The Government says we'll soon be getting better services for all our extra taxes, but if you live in London, where council taxes are rising fastest, it's hard to agree that ploughing the money into traffic abatement humps, parks, green spaces and bigger housing association grants really amounts to notably better service.

Be patient, says the Government, and eventually you'll see the improvement, but voters are not on the whole a patient lot. More money for taxes means less money in people's pockets for spending. Instead the Government spends the money for you and although even public spending supports growth, the more the public sector grows at the expense of the private, the smaller the proportion of the economy that pays the taxes.

With the economy grinding to a halt, it all amounts to a giant headache for Gordon Brown as he pores over the arithmetic for the forthcoming Budget, and increasingly for the Bank of England's Monetary Policy Committee too. The Bank held interest rates yesterday, but barring an incredibly swift and satisfactory outcome to war against Saddam Hussein, it's a racing certainty they will have to fall again soon.

The only thing that stopped them doing so at yesterday's meeting is the slide in sterling. The recent data has been terrible, with two of the three Chartered Institute for Purchasing and Supply (Cips) surveys – manufacturing and services – pointing to stagnation, and the third – construction – indicative of growing weakness.

A survey combination of this sort would normally be the trigger for more rate cuts. The anecdotal evidence too is distinctly gloomy. The admittedly unscientific measure of chief executives I've recently lunched with continues to point to exceptionally fragile business confidence. Few yet think recession inevitable, but many business leaders believe their industries to be in the midst of profound structural change, virtually none of which is good for jobs. There's a will to start investing again, but no one wants to commit so much as a sou until they can see clear evidence of economic recovery.

Looking further out, the news may not be much better. Cheaper oil prices following a successful resolution to the Iraqi problem will be a boon, and a quick war would certainly be a confidence booster. But there are all kinds of other economic problems building, not least the deteriorating state of the public finances across the developing world. In time this will prove inflationary, and interest rates will need to rise again. Disposable income will be damaged accordingly.

The news from the Continent hardly gives cause for encouragement either. German unemployment has hit a five-year high and France scarcely looks much better. As ever, the European Central Bank squandered the opportunity for doing something decisive yesterday. It did cut interest rates, but only by a disappointing 0.25 percentage points. That's of no use to anyone, with minimal likely impact on sentiment.

Back in Britain, there's only one bit of the economy in vibrant health right now, and that's the public sector. Unfortunately for the Chancellor, the public sector doesn't generate any tax. The bit of the economy that does, the private sector, is meanwhile being thrashed into the ground.

Housing downer

To buy a house, or not to buy a house. That's still the question obsessing middle England, and for more and more people the answer is in the negative. Countrywide Assurance Group had a great year last year, as you would expect for a chain of estate agents slap bang in the middle of a near record year for house price inflation. But it admits that things have looked grim since.

Like-for-like sales volume has dropped by a jaw dropping 33 per cent in the first two months of this year. Harry Hill, Countrywide's managing director, says that volumes are still healthy in Scotland, but that the situation gets progressively worse with every degree of latitude south, culminating in London's Kensington High Street, where volume is down a sickening 65 per cent. Not everyone agrees with these numbers. Halifax, which owns one of Britain's biggest mass market estate agents, says volumes are still rising, though it admits that things are a good deal better up North than down South.

Estate agency is a commission-driven business, and because prices are so much higher than a year ago, any collapse in volumes is not yet reflected in revenues. The big question is whether it soon will be, as prices begin to follow volumes down.

Common sense tells you there cannot be a collapse in volume sales without an eventual effect on prices. Estate agents say it's all down to the effect of the war on confidence, but actually what's happening is the beginnings of a buyers' strike. Rightly or wrongly, buyers sense the market has peaked and, if they wait, there may soon be bargains to be had. Housing is an extraordinarily illiquid commodity, but in the end it isn't so very different from other markets. The primary driver is the balance of opinion on whether you will be paying more or less if you wait.

London experience tells you that prices are already falling. Where transactions are taking place, they will typically be 5 to 10 per cent below asking prices. Undoubtedly they've got further to go. The two really big historical dampeners for the housing market, rising unemployment and rising interest rates, are for the time being absent, but buyers are none the less becoming notably more cautious. There are some astonishing cheap mortgage deals on offer, making housing more affordable now than it has ever been, but nobody believes it will last, disposable incomes are being squeezed, and for those who take any interest in their personal finances at all, there's the ever shrinking pension and endowment policy to worry about too.

On the other hand we are highly unlikely to see a housing meltdown of the catastrophic variety that engulfed the market in the early 1990s. For that to happen, unemployment would have to rise to German type levels. It's not impossible, but nor is it at all probable.

Royal & Sun

By the time Andy Haste arrives next month to take up his post as chief executive of the troubled insurance group, Royal & SunAlliance, the stables will already have been largely cleared. The real muck was cleared out yesterday, with another thumping great operating loss and and a 62.5 per cent cut in the dividend. Mr Haste has already had his strategy for the future largely mapped out for him as well. After failing to persuade the City to back a rescue rights issue, the company announced radical plans to shrink itself by approximately a third, withdrawing from unprofitable lines so that the capital could be concentrated on more profitable, higher growth areas of the insurance market.

Even so, there's plenty left for Mr Haste to do, both in executing the strategy and rebuilding the group. The idea of shrinking down to grow again looks fine on paper, but Royal & Sun is still perilously short of capital, and by the time it gets itself into a position where it can begin to write significant quantities of new business again, the present upswing in premium rates may be over. The life and pensions arm has been closed to new business, but it will remain much more of a liability than an asset for years to come. All chance of selling it disappeared two years ago.

Again, concentrating on particular lines of general insurance looks fine on paper, but you have to wonder what the long-term future is for standalone insurers without the captive distribution channels of a bank or alternative customer base. The cleanout is complete, but the real job has only just begun.

jeremy.warner@independent.co.uk