Wind in the UK’s Sails?

01 Oct 2010:  The cheaper pound is the UK’s saving grace.  Investment is recovering, and before long so will manufacturing.  That’s the game plan anyway.  As exports aren’t doing too badly, there is cause to be optimistic, though the biggest question remains what effect budget cuts will have on overall employment and whether the private sector can step into the gap.   So far Sterling’s weakness, and the UK’s underrated capabilities as a trading nation, has helped cushion the economy.   Don’t bet against a recovery in the UK manufacturing and export sectors, therefore – regardless how currency tensions between the North American, Asian, and European currency blocks are settled.  However, as Mayor of London Boris Johnson has warned there are stormy political waters for the financial sector and the economy to navigate before the UK can steady the ship of state on a new and prosperous course.

One of the squall’s on the horizon is the question of when interest rates will return to ‘normal’ – given the uncertain effect of the Bank of England’s Quantitative Easing program will have on inflation. For an interesting perspective on this, read Liam Hallingan’s piece ‘Policy makers must do more than print money and hope for the best‘.

The reason why the UK house market is softening again could be that buyers are now pricing in the potential for interest rate rises while working out what they can afford to pay.  UK broad money has grown rapidly over the last three months, especially the deposits of non-bank financial companies, hinting at economic growth and possible interest rises in the not so distant future.  It would appear that as long as accessibility to mortgage financing remains challenging, as the Royal Institute of Chartered Surveyors’ latest survey concluded on  30 Sep, then the cost of housing might be expected to fall to more affordable levels – as it is inexorably doing in the US.  After all, lending can’t be expected to return to credit bubble era levels.

Or can it?   The market’s appetite for corporate debt at the moment is a positive sign that investors still think their assets are worth something.  And when you look at the economic engine for growth represented by Silicon Valley and the technology industry, there shares really are valuable.

Back in rainy England, RICs chief economist, Simon Rubinsohn, remains optimistic about the UK housing market.  House prices in London and the South East should show the greatest resilience, reflecting the importance of the financial services industry and overseas interest in driving demand. “And  low interest rates will remain a major prop for demand even if accessibility to mortgage finance remains challenging,” he says.

And lets hope Bank of America Merrill Lynch are right in thinking demand in the economy will be sufficient to prevent renewed sharp rises in unemployment – as it was in the recession of 1993 – when 750,000 public sector jobs were cut.  The private sector will drive the labor market outlook, it believes, “dominating the effect of public sector job cuts of perhaps around 100k per annum over the next few years.”

Yet the Mayor of London, Boris Johnson, remains concerned about the need for banking sector pay restraint this Christmas, while remaining hopeful that the government can make the necessary deficit reductions without starting a new recession.

But whatever the pain and anger of the public at the cuts – and some pain is inevitable – that anger will be hugely magnified by the spectacle of the banks doling out hundreds of millions of pounds in Christmas bonuses to the very people who, collectively if not individually, were responsible for the financial crisis.

Whether Balls is right or wrong to prophesy a new slump, the banks have got to understand that this year public feeling may be even more inflamed than last and politicians will be facing colossal pressure to appease public indignation – and the risk is that this year they may take steps of a fiscal or regulatory kind that would do long-term damage to London as a financial centre and as a tax generator for the rest of the economy.

We need two things to happen. We need the Government to be vigilant about the risks of a double-dip recession. And we need the bankers to break the habit of a lifetime and anticipate this problem. We still have time. There are months to go before we see this combustible contrast, between public sector lay-offs and vast bankers’ bonuses. The executive jet and the passenger-laden jumbo have entered the same airspace, at the same height; but there is still time to change course.

The banks have three months to get together and work out a way of showing restraint and a real commitment to the poorest and the neediest in our capital city and the country as a whole. Many financial institutions already have excellent corporate social responsibility programmes. But they could do much, much more. If they fail, there will be many who find an unbearable contrast between the fortunes of the bankers and those of the wider public. As John Prescott might put it, we need to nip this train crash in the bud.

Whatever the outcome of that debate, at least there’s one consolation.  The UK’s banking sector is in better shape than it was – which may turn out to be a very good thing given the weather forecast for the European banking system.

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