Is Britain's economy heading for the perfect storm?

Is Britain's economy heading for the perfect storm?




* Record monthly fall for consumer confidence index
* Investment chiefs deny credit crunch recklessness
* FSA warns lenders to prepare for crisis
* David Prosser's Outlook: Why the R-words are unacceptable here
* Hamish McRae: I've changed my mind: the Bank must lower interest rates if we
are to avoid recession


The storm clouds are gathering over the jobs market; the climate on the high street is growing distinctly chilly; a typhoon of bad debt is buffeting the banks. Could a "perfect storm" be about to hit the British economy?

The signs couldn't be much bleaker. The switchback in sentiment since the credit crisis began in the summer has been violent. The Nationwide Consumer Confidence Index recorded its largest drop yesterday, and joins the GfK/NOP survey earlier this week in suggesting that a wave of pessimism not seen for years is washing over the economy.

House prices have begun to fall, albeit slightly; commercial property is seemingly on the brink of collapse on a par with that seen in the early 1990s. The buy-to-let market is vulnerable. The Bank of England has, unprecedentedly, voiced concerns about the grim prospects for real estate. And the Financial Services Authority has warned of the "very real prospect" of the global credit crunch getting much worse. It is that bad.

Shopkeepers are looking forward to a black Christmas. Sir Philip Green, the boss of Top Shop and BHS, said last night on Sky TV that "business is very, very tough". The British Retail Consortium says that sales grew only marginally in November, having slowed markedly in October. JD Sports, ScS furniture and Greene King are the latest household names warning of setbacks. About 4.4 million credit-card customers still haven't cleared debts they ran up last Christmas, according to MoneyExpert.com.

We're less ready to spend, particularly on "big ticket" items furniture, fridges, cars and so on. We're more pessimistic about our finances. We don't want to take on more debt and we want to rebuild our savings. The credit markets are seizing up again. That means banks are becoming much, much choosier about who they lend to, and are charging ever higher rates, despite the efforts of the authorities to keep money markets functioning normally. No lending; no spending.

That unwillingness to lend the credit crunch has started to affect businesses too, though firms remain generally more upbeat than consumers. Manufacturing firms, and in particular those in the car industry, are happy, a veritable ray of sunshine. However, manufacturing makes up only 15 per cent of the economy. In the financial sector, responsible for more than half of the recent growth in the UK's GDP, the mood is glum.

After months defying gravity, share prices have suffered some dramatic falls. City bonuses will be cut this year and next along with recruitment and investment. Barclays, HSBC and other banks have reported billions in losses, while the future of Northern Rock is uncertain.

Growth in the construction sector eased to a 14-month low in November, according to the Chartered Institute for Purchasing and Supply. The gentle rise in unemployment over the past 18 months may accelerate. The accountants KPMG say that "what we are seeing is that the credit crunch is tightening its grip over the economy... an underlying weakening, with both demand for permanent staff and vacancies down on the levels earlier this year."

Everyone from the Treasury to the IMF has trimmed their forecasts for UK growth; from close to 3 per cent for 2008, down to nearer 2 per cent. The IMF says that even this is now too optimistic. Is it time to start talking about the "R-word" recession, and the possibility that the economy might shrink?

The difficulty is that the credit crisis is a process that feeds on itself rather than an event that can be declared "over". It began with the collapse of the US sub-prime mortgage market and the housing crash there, problems which are intensifying. As more sub-prime customers default because of the credit crunch more banks record losses and stop lending, and more properties are dumped on to the depressed US housing market. That depresses confidence and spending, and the screw turns again.

On this side of the Atlantic we feel the chill because our banks are exposed to sub-prime and because the US economy is the world's biggest. If it slows, it drags us down with it. And the mood of economic gloom Northern Rock, headlines on house-price crashes, higher prices for fuel at forecourts and food at checkouts is reinforcing itself. Confidence is the magic ingredient in any economy; it is evaporating fast. There's no knowing how bad it could get.

The most pernicious aspect of this downturn is how it could turn not so much into a recession, but into "slowflation" slow growth plus inflation. A depressed economy can co-exist with high inflation, as the world found in the 1970s. Low demand and high input costs (such as oil at $100 [48] a barrel; wheat prices at record highs) squeeze profits and employment and cut the real value of wages. It also makes it tougher for the Bank of England to allow interest rates to drift lower.

But the really bad weather would arrive if the Chinese economy stumbled. Next year, more than half the world's growth will derive from China, India and other emerging economies. Were they to falter say because the Shanghai stock market bubble burst the world would almost certainly lurch into recession.

In all events, the worst of the slowdown will hit us towards the end of 2008, going into the spring and summer of 2009; the point when a general election is due. By then the public finances would be well out of control, though that may be the least of ministers' worries. Gordon Brown might not have sowed the seeds of the coming economic storm, but he may well reap the whirlwind.

Business as us

"There is an air of unease among stockbrokers at the moment. In recent weeks the market has been trying to factor in the credit crisis and what it means going forward. Obviously this has affected the bankers most, but it has trickled down to other areas. People in property have been severely hit, as have house building stocks. But further down, even the pub operators have faced trouble. There's certainly an air of caution that has descended on investors ever since Northern Rock there's no doubt about that and I'd say the mood is still cautious going into 2008. The stock market acts as a barometer of where things will be in the next six to twelve months, so investors must broadly expect conditions going forward to be difficult."

Ron Turnbull: Finance director of SCS Upholstery, Sunderland

"Clearly our sales have been worse this year than we forecast, and significantly down on the same period last year. We've been suffering for some time from the interest rate increases, and these are now filtering through to the customer.

"The effect of turmoil in the American sub-prime sector has had a big influence on the confidence of consumers over here. But it's not just that they're feeling more anxious because they see savers queuing up outside Northern Rock; they've actually got much less disposable income than they've had for a long time."

"Banks are less willing to lend to customers, even cutting down on lending to each other. Meanwhile essential spends like utility costs and council tax are rising way above the rate of inflation. All of this is coming together to make consumers much more cautious with their spending, and it is businesses like ours, which are vital to a healthy economy, that are suffering the consequences."

Barnaby Stutter: Store worker, Brixton Cycles Co-operative

"Like any other, our business is not 100 per cent recession- proof. But partly because we're a workers' co-operative, and partly because we've got a lot of fluidity, I think we'll survive any coming troubles. We can move from selling bikes to fixing them; pubs and restaurants, who really are suffering, don't have that sort of option.

"There's a snowball effect: the more people worry about it, the worse it becomes. Our culture seems to thrive on anxiety and people are ready to panic about what they're told to panic about. But retailers on the high street expecting a big Christmas bonanza are going to be disappointed.

"Realists always sleep well at night, and being realistic about the forthcoming festive season means lowering our expectations of it."

Carl Lester: Birmingham fashion boutique manager

"People do seem to be spending less at the minute. I've got two branches selling designer clothes in Birmingham, and overall the business is down.

"I think people who might once have shopped here once a month are coming more like once every two. Also, customers seem to be thinking more about what they already have before they spend.

"We've talked ourselves into a recession, and all of a sudden it seems like we're going to get one. I'm not too worried, as my business survived the same thing happening in the 90s."

Tony Brooks: Owner of the Cluny pub and restaurant, Newcastle

"I'm in no doubt that this is the start of the worst trading conditions in the 28 years I've worked in the industry. If you read the trade papers they're full of terrifying figures about the difficulty of the current climate. But in reality it's even worse than they make out.

"The pub trade in particular is coming under heavy attack from the Government on several fronts. Supermarkets selling ridiculously cheap alcohol make it impossible for us to compete, while the smoking ban has been a massive drain on our appeal. And new planning regulations are so tough it's proving harder than ever for us to make money. Some weeks, pubs are down 20 to 30 per cent on the same period last year.

"The broader economic conditions are making our life hell. Higher interest rates and unaffordable mortgages mean that disposable incomes are fast shrinking. Every consumer has priorities; our industry relies on there being some change in people's pockets after those priorities have been met. Today that spare change is disappearing.

"I'm not exaggerating in saying the next few weeks are going to be very painful, and 2008 will be the worst year ever for our industry, with more than 2,000 pubs almost certain to close."

Peter Clayton: Chief executive of the Association of Professional Recruitment Consultants

"As with any sector, there are noticeable trends in recruitment that are an indication of the health (or sickness) in our present condition. What we've seen over the past few months is a move to contract placements rather than permanent placements, which is a sure sign that employers are feeling shaky. Permanent placements have dropped by about 30 per cent in the last quarter a massive shift.

"These trends haven't been such a prominent factor in the recruitment sector for several years. Employers on the whole are feeling very anxious and less willing to increase their payrolls by expanding staff numbers. Businesses are starting to recruit themselves rather than through agencies which, again, is a sign of anxiety."

BHP Billiton's bid for Rio Tinto stirs fears of iron ore monopoly

Some of the largest steel makers in Asia are voicing opposition to BHP Billiton's proposed takeover of Rio Tinto Group, asserting that such a takeover would create a "monopoly" in the iron ore trade.

The concerns come as BHP's chief executive, Marius Kloppers, travels the region seeking support for the proposal.

Posco, the South Korean steel maker, said Tuesday that a BHP-Rio combination would increase concentration in raw material supplies.

"We are concerned about it and we think it's not desirable," said Kwon Young Tae, executive vice president in charge of Posco's raw materials department.

The China Iron & Steel Association has also voiced objections to the proposed deal, publishing a statement on its Web site that said the merger would create a monopoly.
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The world's three biggest iron ore producers - BHP, Rio Tinto and the Brazilian mining company CVRD, or Companhia Vale do Rio Doce - account for more than 75 percent of all global iron ore trade, the statement said.

"We do not want to see this merger create an even bigger monopoly," it said, adding that as the world's biggest steel producer, China had the most to lose, and that it relied on imports from Australia for 38 percent of its iron ore. "This is not a good thing."

BHP is pursuing the bid after an offer of three of its own shares for each one of Rio's stock was rejected.

Combining BHP, the world's biggest mining company, with Rio would create a group with 38 percent of the world's seaborne iron ore trade, according to Australia & New Zealand Banking Group. CVRD has a similar share.

Kloppers has said that the proposed combination of BHP and Rio would allow the new company to produce more iron ore at a lower cost.

The proposed union is "a powerful proposition for customers," he said.

Still, Hajime Bada, president of the steel division at Japan's JFE Holdings, said Monday that the would-be merger "will be harmful to the fair trade of iron ore and high-grade coking coal."

The International Iron & Steel Institute, whose members include 19 of the world's 20 biggest steel makers, said on its Web site that the competition authorities should block the planned takeover.

Iron ore prices have tripled in the past five years on increased Chinese demand. Next year, contract prices for the commodity may rise by 50 percent, Macquarie Group estimated last month.

Kloppers met Tuesday with Posco's chief executive, Lee Ku Taek.

"We think this is a good proposal for shareholders and customers, but we have a lot of work to go through," Kloppers said before the meeting.

Kloppers said a merger could mean $3.7 billion in annual savings after seven years through synergies in iron ore, coal and other activities.

"We think the overlap of the operations, the fact that we have a solution on how to put the companies together, and the benefits is a very good proposition," he said Tuesday.

Tumbling dollar, inflation and short supply behind gold rally

A tumbling U.S. dollar, inflation fears and supply shortfalls have driven up gold price, which briefly pushed past the psychologically important 1,000-dollar mark for an troy ounce on Thursday, analysts said.

Gold price rose sharply last year with a 32-percent rally and was up 20 percent this year. Analysts have believed hitting the 1,000-dollar level was just "a matter of time."

The devaluation of the dollar is the main driving force for gold's price hike, analysts said. The plunging U.S. currency made dollar-denominated assets like gold look cheaper and therefore helped drive buying by investors with stronger currencies.

"It's an investor-driven story, with the investor demand coming from U.S. dollar weakness," said Daniel Hynes, metals strategist at Merrill Lynch. Hynes predicted the trend would not abate "anytime soon."

Growing fears about a shaky U.S. economy and the Federal Reserve's interest rate-cutting campaign have plunged the greenback to record lows against other major currencies, especially the 15-nation euro.

The euro rose to a new high of 1.5625 dollars before falling back to 1.5587 dollars in late New York trading, still above the 1.5526 it bought late Wednesday. The dollar traded as low as 99.75yen before recovering to 102.04 yen Thursday.

For now, market players still expect a further interest rate cut by the U.S. Federal Reserve at its rate-setting session next week. A rate cut could add to the weakness of the dollar and drive up gold.

Secondly, worries about rising inflation have prompted investors to rush into gold to hedge against the risk.

U.S. consumer prices rose 4.1 percent last year, the fastest growth since 1990, and latest U.S. data showed inflationary pressure picked up recently.

The drivers for gold remain as investors buy precious metals to create a safe haven against inflation, a U.S. futures analyst said.

Besides, short supply has also contributed to the surge of gold. Supplies were not sufficient due to fast growth of investment demand and a limited increase in output.

Gold output stood at 2,477 tons in 2006, hitting a 10-year low. At the start of the year, power shortfalls forced some gold mines in South Africa, the world's second largest gold producer, to suspend production, leading to gains in gold price.

Back in the 1980s, gold reached 873 dollars an ounce, which is tantamount to 2,235 dollars now when inflation is taken into account. Given that, many analysts believe the current price is still well below historic highs and could rise further.

But other analysts warn risks may accumulate with every gain in gold price. The price could fall on profit-taking, they said.