Sunday, July 06, 2008
Economy is running on nearly empty
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


One of the most remarkable things about Britain's economy in recent years has been its ability to keep growing. Through thick and thin, even at times when the battery threatened to give up entirely, the long expansion has continued.

Millions of children have never known anything other than rising national income. Today's 16-year-olds were emerging blinking into the sunlight last time real gross domestic product showed a single quarterly fall.

Now, however, after 63 consecutive quarters of growth, is the party over? There have been close calls along the way in the spring quarter of 2001 GDP rose a mere 0.1% in spite of a big public spending boost but avoiding at least a quarter of falling GDP looks like an enormous challenge.

How much of a challenge has only just become clear. It started with the downward revision of first-quarter growth to 0.3%, half its rate in the final quarter of 2007 and a third of its rate a year earlier.

The quarterly numbers suggested a sharper slowdown than had been thought. They were followed by a series of very weak survey numbers and some high-profile corporate woe. With half the year gone, the gloom threatens to become all-enveloping. Will we even get to the end of the year with the growth record intact?

The question is, where will the growth come from? In a clutch of nasty numbers last week, some of the nastiest were the purchasing managers' surveys.
The survey for manufacturing reported that, with continuing price pressures, the index recorded its largest monthly decline since January 2000 and was at its weakest since December 2001, with output, new orders and employment all declining.

You may say we have become used to gloom from Britain's factories over the years. This year, though, it was supposed to be different, with the economy "rebalancing" towards Britain's factories, helped by sterling's fall against the euro.

Instead, manufacturing appears to be suffering from the credit crunch and soaring commodity prices along with the rest of the economy. The Engineering Employers' Federation said the survey may have overstated the gloom. However, hopes that industry would keep the rest of the economy afloat are fading.

If manufacturing is disappointing, construction is looking like a demolition site. The purchasing managers' index (PMI) for construction dropped to 38.8 last month. Last summer it was running at 64.8. The housebuilders' intense pain is being reflected in the numbers.

Bad news comes in threes, and the third was the PMI for services, the biggest contributor to economic activity. We know financial services are in trouble you certainly would not want to be a mortgage broker these days and the sector's woes are serious enough to push overall service activity down; to 47.1 from 49.8.

The service sector, of course, includes retailing and last week we had a 21-gun warning from Sir Stuart Rose, chairman of Marks & Spencer. We heard much the same from him in early January, since when consumer spending has surprised on the upside, including that spectacular, though disputed, 3.5% jump in retail sales in May. If you believe the official numbers, sales volume in May was up 8% on a year earlier. Even if you take them with a large pinch of salt, Rose's retailing recession must have started after May.

There is no doubt, however, that times should be getting much tougher for consumers and retailers and will do so over the second half. The squeeze is on.

The way the PMIs work is that levels below 50 indicate a sector is contracting. With manufacturing, construction and services all below the 50 level in June, that suggests the recession started last month. In practice, the read-across is not quite so neat and the survey levels for manufacturing and services are probably consistent with snail's pace growth rather than recession, but the warning signs are there.

Each month the Treasury asks independent economic forecasters to submit their predictions for the economy. The latest average, compiled a couple of weeks ago, was 1.7% growth for this year, 1.4% next.

Only one forecaster, Peter Warburton of the consultancy Economic Perspectives (and the shadow monetary policy committee, see item at end), predicts outright recession. In his view, growth this year will slow to 0.7% and the economy will contract by 1.9% next year.

He is, as I say, on his own but more economists are starting to talk about "technical" recession two consecutive quarters of declining GDP. For most individuals, and people in business, all this is a decimal point too far. What matters is how weak it feels and the consensus among economists is that 2008 and 2009 will be the two weakest years since the last recession.

The question is whether "weak" captures it properly. If the credit crunch can bite so savagely in one area housing what will be its effect on the wider economy? If consumer confidence is plumbing new depths now, what will it be like if unemployment jumps and home repossessions soar?

The combination of the credit crunch and soaring oil prices is a horrible one, two big economic shocks in one. The crunch is biting harder, according to the latest credit-conditions survey from the Bank of England, while declining oil use in America is not enough to deter the oil bulls from pushing prices to new daily highs.

Last week the Basel-based Bank for International Settlements (BIS), the central bankers' bank, gave a pretty scary assessment of the outlook for all the advanced economies, including Britain. We could be on the brink of a "much greater and longer-lasting" downturn than people are assuming, it warned, so much so that the problem central banks could be facing in a few years could be deflation falling prices rather than inflation.

We know about deflation from Japan's experience over the past two decades and from the 1930s. The BIS says such an outcome is "unlikely" but "cannot be ruled out entirely". Let's hope it stays unlikely.

PS: What should the Bank of England do this week? The "shadow" monetary policy committee is clear; it should not raise rates. Eight members of the SMPC, which meets under the auspices of the Institute of Economic Affairs, think Bank rate should stay on hold. One, Patrick Minford, votes for a quarter-point cut.

Overwhelmingly, the shadow committee is more concerned about the downturn and the sharp deceleration in money-supply growth than inflation. Six of those who voted to hold this time have a "bias" to cut rates in coming months. They think the commodity price boom will come and go but the effects of the credit crunch are here to stay.

In contrast, two SMPC members have a bias to raise rates to anchor inflation expectations, which have been rising. The shadow committee's deliberations (available in full on my website, are always interesting. What makes them particularly so this time is that this is not a group of people who could ever be described as being soft on inflation.

Yet they are troubled by the danger signs. Roger Bootle said: "We could be facing an economic crisis and a financial collapse." Tim Congdon commented: "I've been surprised by how bad conditions have become and how quickly they've changed." And Peter Warburton said: "Events of the past year have fired Exocet missiles at received wisdom about the UK and its policy framework."

The SMPC's verdict is probably quite helpful for the Bank. Certainly it suggests this is no time to be thinking about higher interest rates.

From The Sunday Times, July 6 2008