Consumer caution could be a real drag

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The Independent Online
Until a few weeks ago, the idea that economic growth in the UK would slow sharply next year had hardly been articulated. People were still revising their forecasts up rather than down. This view is still unfashionable, but within the City the economics team at Kleinwort has gone nap on the slowdown, and much of the current information on the economy would be consistent with this view.

Thus yesterday's little crop - the slowing of growth in consumer credit, the M0 figures and the slightly muted August car sales - suggest that the early spurt of recovery is now past. If one is interested in forward indicators, rather than temperature-taking, the most important thing to look for will be any fall-off in house prices for, if these stagnate, consumer confidence is likely to do so too.

One can add in other possible elements, in particular some slowing of growth in Germany, which is still our largest single export market. But in a way one does not need to, for the argument stands without it - consumer spending is such a large part of final demand that if it slows the economy will slow too. That will happen notwithstanding a pick-up in investment - which seems now to be happening - and a solid export performance in non- European markets.

If this line of argument proves right, the prospect for financial markets to the first half of next year will be very different from the mainline expectations of the present.

First, British interest rates will rise much more slowly than the markets currently forecast. One can calculate the implied future base rate by looking at futures contracts - in other words, what the markets really think, rather than what their forecasters think. These have base rates at 6.6 per cent this December and 8.7 per cent in December 1995.

This must be wrong, even if the economy were to carry on growing at around 3 per cent next year, but it would be doubly wrong were growth to be close to 2 per cent. Under that sort of profile, base rates could even be back to the 5 to 5.5 per cent zone by the end of next year after perhaps rising to 6 per cent by this December.

Next, profits of companies relying largely on UK demand will tend to grow more slowly than they might otherwise expect. The impact on the largest firms will be very small for, with the exception of the former public utilities and the supermarkets, British revenues are a small proportion of the revenues of the top 20 or 30 companies. Indeed, only about half the profits of FT-SE 100 stocks are accounted for by the UK - the rest comes either from exports or from overseas subsidiaries. But the effect on second and third division UK firms could be substantial.

This need not necessarily mean that shares of smaller companies will perform worse than those of larger ones. They are such a varied group that any such generalisations are pretty meaningless, and in any case the performance of the various groups of companies, ranked either by size or by sector, has more to do with investor fashion than relative performance. Besides, even slower growth in overall UK consumption would not necessarily affect all sectors. In recent months demand for food products has held up very well, while sales of clothing have been disappointing.

But one should acknowledge that slower growth in consumption would carry risks for companies which had called the cycle for their particular industry wrong. Most investors, company directors and indeed housebuyers are aware that inflation will no longer bail them out if they make bad investment decisions. Maybe companies will need to accept that the economic cycle will not necessarily bail them out either. Simply getting that right in macro-economic terms will not be enough.

Finally, slower-than-expected growth will have some political impact. This week a lot of attention will be paid to the monthly meeting between the Chancellor and the Governor of the Bank of England, particularly since the minutes of the meeting will subsequently be revealed. Whatever the Bank does or does not do in the markets will be reinterpreted in the light of their discussion.

But worrying about policy on short-term interest rates on a month-by-month basis is a dispiriting business, for these are quite limited executive decisions. They are much less important than the great swings of investor psychology, such as the move out of bonds in the first quarter of this year, or of economic fundamentals such as the rapid recovery which the UK has until now been sustaining.

The obvious political assumption would be that slower growth would be bad for the Government. But, since two years of rapidly rising consumption does not seem to have helped it, even that assumption may prove wrong.