Sunday, July 31, 2016
Confidence has crumbled - but it can be rebuilt
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

We are at an interesting moment, something which will be of intense interest to future economic historians. Business and consumer confidence have taken a battering since the Brexit vote on June 23. Is the slump in confidence an inevitable harbinger of very tough times ahead for the economy, a recession, or can it be turned around?

That confidence has fallen sharply is not in doubt. One of the longest running measures of business confidence, dating back to the 1950s, is the CBI’s industrial trends survey. Its latest reading, published a few days ago, was a bit of a shocker.

Optimism over the business situation fell at its fastest pace since January 2009, which was in the depths of the global financial crisis. The drop in confidence was similar to previous periods in the survey’s history when the economy has been in recession.

It is not just businesses which are feeling downbeat. In the immediate aftermath of the referendum GfK, which has been monitoring consumer confidence in Britain since the 1970s, released a “snap” survey showing a sharp fall.

Some suggested that this was a knee-jerk reaction which overstated the true picture, and that confidence would soon settle down. Well on Friday GfK released final figures for July, which showed that the drop was even more dramatic than it had first thought. Instead of falling by eight points, confidence this month was down by 11 points compared with the pre-referendum period.

This, to put it in perspective, was the biggest fall in confidence for 26 years – bigger even than during the financial crisis. Consumers are particularly gloomy about the general economic outlook though they are also worried about prospects for their personal finances.

This downbeat mood among consumers has not been without real consequences. As well as its industrial trends survey, the CBI released its distributive trades survey last week. It showed that retail sales have fallen this month at the fastest pace for more than four years.

We are, as I have noted before, still in the dark when it comes to hard data. In some of the sillier corners of Fleet Street, the second quarter gross domestic product figures, which showed a rise of 0.6%, were greeted as a post-Brexit triumph.

In fact the figures contained virtually no information collected since the referendum and were boosted by an unexpected and slightly odd looking leap in industrial production way back in April. Service sector growth slowed compared with the first quarter and the construction industry, in figures which are admittedly volatile, is officially in recession, shrinking for a second successive quarter.

It would be wrong to deny, however, that on the available evidence we have, the picture in recent weeks has been mixed. At the gloomy end of the spectrum, apart from the confidence readings, was that “flash” purchasing managers’ index, touched on last week. Its drop from 52.4 to 47.7 reflected not just a fall in business expectations, but also in output and new orders, particularly in the service sector.

It was enough to persuade Martin Weale, the outgoing “hawk” on the Bank of England’s monetary policy committee (MPC) to sound the alarm. The figures, which he described as “the best short-term indicator we have”, were “a lot worse than I had thought” he said.

Other evidence has been a little less scary. The CBI’s industrial trends survey, despite the plunge in confidence reported by participants, was relatively upbeat on output and new orders. Some companies too have chosen to emphasise their confidence in Britain since the referendum, such as GlaxoSmithKline’s pledge to invest £275m in its UK manufacturing and McDonald’s promise of 5,000 new jobs by the end of next year. Lloyds Bank announced job losses but its own business barometer survey was surprisingly upbeat.
My informal soundings suggest that for many firms it is indeed business as usual, with no discernible impact on activity in the past few weeks, while for others the uncertainty has hit home, and quite hard. Most of the gloomier ones will, however, take stock after the summer holidays rather than acting precipitately.

That suggests there is time to turn things around. The good news about consumer confidence is that, while it has fallen a lot, it has done so from very high levels, so much so that even after its drop this month it is well above where it was during the crisis, or even as recently as 2013. This is not surprising, given the recent experience of strong employment growth and rising real wages. Households are downbeat but they have not thrown in the towel.

As for business confidence, there have been times when its plunge has either been a harbinger of recession, or has occurred in a recession. Most, it should be said, have been when the global economy has also been in trouble. And, while the world economy is not in great shape now, the clouds hanging over it have lifted a little since the start of the year. America’s Federal Reserve hints at a rate rise in the autumn because the risks to US growth have diminished, notwithstanding Friday's weak second quarter GDP figures.

There have been a couple of occasions in the past quarter of a century when business confidence has fallen very sharply without signalling impending recession. One was in the autumn of 1998 when the simultaneous Asian financial crisis, Russian bond default and the failure of the Long Term Capital Management hedge fund spooked markets and central banks. The other was in the aftermath of the 9/11 attacks on New York and Washington.

In both cases the Bank responded with aggressive cuts in interest rates and the danger passed. There was no recession. The Bank will respond again this week. It does not have a huge amount of room to cut rates but it has other weapons in its armoury, including quantitative easing, which we did not even think about a decade and a half ago.

The Bank, of course, cannot do everything. What the politicians do also matters. At the moment, having found themselves in jobs they did not expect to be doing, including the new prime minister, they are mainly treading water. There will come a time, however, when bland words of reassurance will have to be followed by action. We face what could be one of the most interesting autumn statements for many years, yet without much clue about what the “reset” of fiscal policy hinted at by Philip Hammond might mean.

In the meantime, the small group of headbangers in the Tory party who talk of an early “hard Brexit” and distancing Britain from the single market as quickly as possible would do well to shut up. If anything is like to further undermine business confidence and turn the existing fall in optimism into something more concretely negative for the economy that is it.