Sunday, September 05, 2004
Economy gets bogged down in a soft patch
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

Early September, when the tans are fading and most people are back at their desks, is a good time to take stock.

Those who managed to avoid August will have returned to a distinct change of mood. The nights are cooler and so is the economy.

A month ago consumers were still spending with abandon, the housing market appeared impervious to the Bank of England’s efforts to slow it, and industry was enjoying its best time for years on the back of the global economic upturn.

In early August the Bank’s monetary policy committee (MPC) was about to raise rates and seemed odds-on to do so again, at least a couple of times, before it was done.

Now, however, things have changed. For Britain’s high streets, the past month appears to have been truly grim. Uncomfortably humid weather followed by record downpours produced first torpor and then a reluctance to venture out and spend. Retailers, like farmers, always blame the weather. This time they are justified.

But the retailing slowdown appears to go beyond climatic conditions. The CBI’s distributive trades survey, in which a balance of only 2% of retailers reported sales up on a year ago (down from 24% in July and the weakest since March last year), appeared to reflect wider economic factors.

Digby Jones, the CBI’s director-general, cites the slowdown in spending on durable goods as a sign that the Bank’s five rate hikes since November are starting to have an impact on consumers.

That is also what seems to be happening in the housing market, with a paper-thin increase of just 0.1% in house prices reported by Nationwide building society for August, compared with 2.1% in July.

Even more dramatic was Halifax’s 0.6% fall in prices last month, after a 1.1% rise in July.

The figures reflect offers made and accepted two to four months earlier. The implication is that the long-awaited slowdown has been in train for some time.

That is also evident in the slump in mortgage approvals, from 125,000 in May to 97,000 in July. Whether it is interest rates alone or the “Mervyn King effect” — June was when the governor gave his warning about a possible house-price crash — some buyers have certainly been scared off.

The final piece in the slowdown jigsaw was provided by the purchasing managers’ index for manufacturing, which dropped last month from 56 to 53.1, while the index of export orders slumped from 53.2 to 47.6.

So what’s happening? The economy, plainly, has entered a “soft patch”, to use the phrase of Alan Greenspan, Federal Reserve chairman. Does that mean, as some are now saying, that the Bank is done with raising interest rates and 4.75% will be the peak? An abrupt change of gear for the economy can be a clear turning-point or, more usually, a distorted reading. Amid the gloom, the purchasing managers’ index for services actually rose.

The last time Britain went into recession, which astonishingly enough was as long ago as the summer of 1990, there was indeed an abrupt change of the kind we have seen in the past month. But there have been many occasions since when the readings have been false.

Three things have come together in the past month. One is the weather effect on retailing, the West Country tourist trade and, at the margin, the housing market. Freak weather is getting more frequent, but we should still regard its economic effects as temporary.

The second is that the Bank’s rate rises are indeed having an impact. It has been a drip-drip of increases since last autumn, and the vast majority of households are still comfortable with rates at present levels. But the MPC’s tactics, as it hoped, are starting to affect the psychology of homebuyers and consumers. The squeeze is gentle but is being felt. One argument is that, with household debt over £1,000 billion, consumers have become hypersensitive to even small changes in rates.

As an aside, the latest housing-market readings have not changed my view on the outlook. Does anybody remember the great cooling of 2000? Then prices fell for four successive months between April and August after the Bank raised rates. But this did not lead to annual falls in prices and neither should it now. I am still looking for a soggy rather than a crashing housing market.

The third factor, particularly relevant to exporters, is the global economy. An unintended slowdown in America and a planned one in China have taken the edge off global growth. High oil prices will reduce growth next year.

Brian Reading of Lombard Street Research has dusted off some of the theories about long economic cycles, so-called Kondratiev cycles, and sees a “synchronised sinking”, in which both America and China will pay for their booms with a period of very weak growth. Even without that, the global upturn seems to be past its best.

So, to answer my earlier question, are base rates at their peak? It is a tribute to the change of mood that a month ago this would have seemed a silly question. Further rate hikes, it appeared, were a certainty. Now that is not the case.

But they are still likely, for two reasons. While some on the MPC regard the idea of a “neutral” interest rate with distaste, it is still a useful way of thinking about where rates should settle. At 4.75% we look a bit below neutral, whereas at 5% or 5.25% that would not be so.

More significantly, it is worth remembering that, while the figures over the past month have been unusually weak, the Bank had been expecting a significant slowdown. Its latest inflation report, published less than a month ago, had growth slowing from 3.7% now to just over 2% during next year under the impact of “lower house price inflation, past increases in official interest rates
... and the reduced stimulus from fiscal policy”. But this forecast also implied that one or two more rate rises would be needed to keep inflation below the official 2% target.

The economy has hit a soft patch. But interest rates have probably not peaked.

PS: My unconventional approach two weeks ago to valuing houses — comparing prices to those of cars and finding that the ratio has soared — drew a huge response.

Some readers made the point that while new cars have got a lot better even as prices have come down, new houses haven’t obviously done so. Others said they spend so long sitting in traffic jams these days they have contemplated installing double-glazing and an en-suite bathroom in their vehicles.

The house/car price ratio may get another outing, although I could do with some better long-term figures on car prices. Meanwhile, there are other interesting figures on cars to contemplate. This month, with the new September 54 registration, 440,000 cars should be sold, according to the Society of Motor Manufacturers and Traders (SMMT). That’s less than the 470,000 in March, the start of the 04 registration, but still strong. The SMMT is looking for a full-year total close to last year’s record of 2.58m.

The car market is changing. Only 19% of cars sold in Britain so far this year were made here. For those just back from holiday in countries where imports are thin on the ground and national marques dominate, that’s quite a statistic.

It is not the full story, however. In the first seven months of the year, just over 1m cars were made in Britain and 70% were exported.

The industry has changed. But it still means Britain has a huge trade gap in cars. The deficit on manufactured goods is more than £40 billion a year. A quarter of that is due to our preference for foreign cars.

From The Sunday Times, September 5 2004