Credit contagion spreads to manufacturing confidence

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More strong signals have emerged that the credit crisis is making its presence felt outside the City and financial services, and is helping to slow down the "real economy".

The recent strength in the pound, combined with a slowing in the US and the eurozone, is also weighing on British manufacturing, according to the latest CIPS manufacturing PMI survey. Its index of confidence fell in September. In due course, a tightening in lending criteria and strengthening of corporate covenants may also weigh on the costs of the sector, which over the past year has shown remarkable resilience. Similar indicators in the US and France published yesterday told much the same story.

Bank of England intelligence on interest rates for households and companies "show early signs of the pass-through from the financial market crisis to the real economy", said Michael Saunders of Citi European Economics.

Consistent with the Bank's recent Credit Conditions Survey, the average interest rates on new fixed-rate bank loans to non-financial companies are markedly higher, up 1 percentage point in the past two months.

This suggests that the markets are, if anything, doing the MPC's work for them in bearing down on domestic inflationary pressures. Mr Saunders added: "We suspect that the September readings will show even greater widening of credit spreads. The key point is that these data give an early confirmation that the ongoing crisis in money markets is feeding through to the real economy. All this will exacerbate the slowdown in the economy, especially housing".

Meanwhile, the latest research from the Bank of England confirms the picture of a property market gradually slowing down. The Bank's figures for mortgage approvals fell from 115,000 in July to 109,000 in August, the lowest level since April.

Matthew Sharratt, economist at Bank of America, said: "Signs that the housing market and the economy are beginning to moderate suggests that the BoE will soon begin to lower rates. Although we currently expect the Bank to cut rates by 25 basis points in February, we see a growing risk that the easing will start in the last quarter of 2007."

Most economists expect no change in rates from the MPC announcement on Thursday. The possibility of a quarter-point cut in November, to coincide with the inflation report, remains very much live.

Longer-term prospects for the economy look no better in the latest official measures of productivity by the Office for National Statistics. These show that last year the UK's labour productivity performance, on a GDP-per-worker basis, remained lower than that of the US and France, similar to that of Canada, Germany and Italy, and above that of Japan. However, on a per-hour basis, taking into account different working patterns across nations, productivity is relatively poorer, with the UK behind the US, France and Germany.