Outlook: Never mind the housing bubble, think about rising taxes

City job losses; Pension deficits Â

A few months ago, Mervyn King, the next Governor of the Bank of England, gave a speech in which he warned of the dangers of a potentially crippling demand shock to the economy if the housing boom was allowed to carry on unchecked. He didn't say it, but he implied that higher interest rates might be necessary to dampen down house price inflation.

It wasn't the house price bubble itself Mr King was so concerned about. Central bankers are generally of the belief that they cannot and should not attempt to prick asset price bubbles just for the sake of it, this because it's so hard to know precisely when a rise in prices becomes a bubble. Pricking a bubble is the financial equivalent of launching a pre-emptive war.

You need enormous self belief to think you know when the time is right for pre-emptive action. Just look at the difficulty Messrs Bush and Blair are having carrying public opinion with them on war against Iraq. The public aren't going to thank you if you clobber growth in pursuit of a bubble that turns out to be a mirage. Most bubble sightings turn out to have been false.

So much for the sanguine view of bubbles. What Mr King did was take the debate a stage further by saying that you should indeed be worrying about bubbles if you think they are going to lead to inflation or deflation down the road. Mr King's fear was that so much consumption had come to rely so much on ever-rising house prices that when they stopped rising the economic consequences might be calamitous. Consumption might go into a steep decline too.

Since that speech, the debate has moved on again. House prices as a whole have continued to climb, but in the capital, they have plainly started to fall and all the anecdotal evidence is that consumption is slowing fast. Crunch that together with the worst recession in manufacturing industry since the last one, and it's easy to see why the Monetary Policy Committee thought it necessary to cut interest rates this week. Even Mr King might have changed his view a bit, though we will have to await publication of the minutes to know.

In any case, this week's quarter point cut is of itself most unlikely to cause house prices to rise further. HBOS yesterday announced it was cutting its variable mortgage rate by only 0.1 percentage point, a saving which on the average mortgage would be barely enough to keep you in clean hankies. With interest rates already so low, house prices are being driven by much longer term considerations – earnings expectations and prospects for long term interest rate stability.

The second of these is pretty much assured. The same cannot be said of earnings, where job insecurity is already beginning to bite, despite exceptionally low unemployment. More worrying still, the Chancellor is planning to take a further £4bn a year out of consumers' pockets from next April in National Insurance contributions. An equal amount will be added to payroll costs through the same mechanism. This is precisely the wrong time in the economic cycle to be imposing these increases.

Mr Blair may or may not be right in slavishly supporting the US on Iraq, but he should be unifying his approach to taxation too. President Bush is cutting business taxation in an attempt to generate growth. The Chancellor needs to think seriously about doing the same, even if it does mean the budget deficit temporarily rises to a level which breaches his own rules. The MPC cannot be expected to do everything.

City job losses

Neil Blackley, Merrill Lynch's star media analyst, got a rough ride from the press this week when he announced his early retirement at the ripe old age of 47. Rival analysts gleefully seized on the news to insist he must have been forced out, selectively citing a number of recent instances where his judgement had been proved wrong. Well, nobody gets it right all the time, especially in a bear market, and in fact Mr Blackley's record stands very favourable comparison with his peers. He wouldn't have been paid so much over the years if it didn't. Mr Blackley is a decent and talented sort who deserves his success.

However, it is not Mr Blackley's record I want to discuss. Rather it is the whole idea of making so much money as a City wage slave that you can afford to retire by the age of 47. A former colleague of mine, Mathew Horsman, as it happens another media analyst, is in much the same position. After little more than six years in the City, he recently announced he was quitting his £1m-a-year job with Investec to set up his own consultancy, for which read get up late and go to cocktails early.

I'm not jealous, you understand, not jealous at all, this despite the fact that I once employed Mathew on a salary that would these days barely pay his taxi fares. I'm pleased these two media analysts have done so well for themselves, blast them and damn them. But good luck to them too. They'll soon get bored with the sun loungers. Within the year, Mr Blackley will have had his fill of doing "absolutely nothing" and he'll be desperate to get back. It's in his blood. That's the thought I'm comforting myself with anyway.

However, the point I'm trying to make is a rather different one. Nobody quite knows how many jobs have been lost in the City this past three years. Investment bankers are notoriously secretive about their hire and fire policies. I used to know the head of the internet team at one of the big five global investment banks. At the height of the boom he had 30 junior analysts working for him. A year later he was on his tod. In the City, employees quite literally disappear in the night and many of them are never heard of again. But on the assumption that about 300,000 people worked in the City's capital markets at the height of the boom, about 10 per cent of them have probably already gone.

We may or may not be at the bottom of the bear market in shares, but we are certainly not yet at the bottom of the bear market in City jobs. The problem is that the City was simply paying itself far too much, and now the fees are no longer there, the cost base looks far too high.

There are few industries as cyclical as investment banking. As the boom gathers pace, the investment banker thinks, "it's party time again". Then comes the hangover and the convalescence, but before you know it the temperature is rising again and the party begins anew. I'm afraid that this time around it's rather more serious than that. The technology bubble was the investment banking party to end all parties.

Some, like Mr Blackley, will have made enough money in the boom not to have to worry about working again. Others won't have been so fortunate, and as for the City as a whole, it will be an awfully long time before it again starts paying salaries and bonuses of the magnitude enjoyed during the boom. Many of these once highly paid jobs may have gone for good. Like Mr Blackley, many analysts are reconciling themselves to the idea of complete lifestyle and career change.

Pension deficits

New disclosure rules are forcing companies to quantify and publish one of their biggest long-term liabilities – their pension obligations. I'm all in favour of the maximum possible disclosure in all circumstances, but with falling stock markets, the revelation of ever-wider pension fund deficits is beginning to have some perverse effects.

Yesterday, the credit rating agency Standard & Poors said it would be downgrading 10 big European companies because of unfunded pension liabilities, including J Sainsbury, BAE Systems and Rolls Royce. Of itself, this may not be very surprising. We've known about their pension deficits for some time. However, S&P doesn't help matters. S&P is contributing to a downward spiral. The more stock prices fall, the wider the deficits get, the more it damages the share price and so on and so forth.

Interest rates across the world are at rock bottom, but for many companies credit conditions continue to deteriorate. It's all very worrying.

jeremy.warner@independent.co.uk