Why Britain may well escape the worst of the economic downswing

The UK will be a 'safe haven in a risky world' during any downswing
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The Independent Online

It has been pretty unfestive this week: serious worries on the financial markets worldwide; a growing apprehension about the dangers of a hard landing for the US economy; more evidence of a slow-down in Japan; mixed news from continental Europe. But what about Britain?

It has been pretty unfestive this week: serious worries on the financial markets worldwide; a growing apprehension about the dangers of a hard landing for the US economy; more evidence of a slow-down in Japan; mixed news from continental Europe. But what about Britain?

Let's try and lift the gloom with a positive prediction. It is: That the UK will come through what is bound to be a difficult year in better shape than the US, continental Europe and certainly Japan. The spur for making such a bold prediction comes from the editors at the Bank Crédit Analyst, in Montreal, the research group that specialises in analysing very long financial trends. The latest issue of its international edition reckons that Britain will be "a safe haven in a risky world".

Its argument runs like this: The world is heading into the downswing phase of the economic cycle so the issue is how well or how badly different countries manage the transition.

It argues that Britain is well set to manage an ultra-soft landing. We start from a good position, with the economy picking up speed during the third quarter in contrast to most other countries where growth has eased.

The economy now looks relatively resilient, with the leading growth indicator turning up, the prospect of a fiscal boost in the budget next year, relatively loose financial conditions, and financial markets less caught up in the hi-tech bubble that has engulfed the US.

The solid growth in domestic demand for the last eight years is shown in the left-hand graph - and note the little kick up at the end.

Looking head, the BCA team does see a slowdown. Exports will be hit by lower demand in both the US and continental Europe; some jobs will be moved offshore by multinational companies; City bonuses will be lower; and there will be some fallout from the hi-tech boom here, through not as large as in the US. But it argues that the Bank of England will be ready to cut interest rates if demand falls and that it has considerable room to do so given Britain's low inflation rate. Not only is underlying inflation below the Bank's target of 2.5 per cent; on the harmonised basis used by the European Union, it has virtually the lowest inflation rate in Europe.

For financial markets, the main message is that the UK market is attractive. Shares are fairly valued by comparison with most other countries and they are expected to do well as short-term interest rates come down in the second half of the year. Bond yields will decline in the next few months, though they may rise later in the year. The main counter-force against this positive outlook is that lower UK rates will tend to weaken the pound against the euro. But the BCA team does not predict any collapse of sterling, merely a modest weakening, which will in any case help export demand.

Since this report was written a couple of things have happened that lend further support to its argument. One was the vote at the Bank of England's most recent monetary committee, where two members voted in favour of a cut in rates. Expect the Bank to be ready to move quickly if it looks necessary to do so. The other was the data on the economy published yesterday. Growth in the third quarter was revised up slightly from 2.9 per cent annual rate to 3.0 per cent and the current account deficit was revised down from £3.4bn to £3.2bn.

All this looks pretty persuasive. Of course there are risks in all down-phases, but I for one would buy the BCA thesis as the most likely outcome for the new year. It would also fit with the common sense view of the UK economy that it behaves rather like the US one, but that it frequently tends to underperform during the up-phase of the cycle and overperform during the down.

There is, however, a cloud on the horizon: the dependence on British consumers to keep spending. Savings have been run down very sharply over the last five years. As you can see on the right-hand graph, they are as low as they were at the peak of the late 1980s boom. At least they are not negative, unlike the US, but when you see a graph like that with such a pronounced cyclical pattern, it is hard not to feel that the line will climb back over the next few years. Maybe not next year, but sooner or later people will want to rebuild their savings. When they do, money being saved is money not being spent, so demand will inevitably suffer.

But how quickly will savings recover? The usual trigger for people in the UK to save less is a rise in asset prices, which in practice means a rise the price of their homes.

The usual trigger for people to save more is fear: particularly fear of unemployment. So the key questions next year will be what happens to house prices and whether unemployment rises as the economy cools.

The property market seems fine. It has cooled in the last few months but the absolute price level is still rising and the relative level is still well within the sustainable post-war range of three-to-four times earnings. So no nasties there.

A final reason for thinking positively is that force called momentum. When an economy has been growing quickly it takes quite a long time for it to slow down. If that is right, then the first half of next year, maybe the whole year, should be fine. The problems, if any, come later.

I have just one slight niggling doubt about that. Maybe, just maybe, the structural changes that have taken place in the economy will lead it to make a swifter response to signals of a downturn than in previous cycles.

That seems a reasonable expectation for the US, where companies are forced by the financial markets to react instantly and savagely to any downturn. Things could come off very fast in the US in the next few months. If they do, then it would be unwise to assume we will not be caught in the backwash. Yes, we may well have a softer landing than most. We may be a safe haven; but it is still a risky world.

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