Economic review of April 2008

The big news at the moment is clearly all about interest rates and we will consider these in a moment. But there is a lot else going on in the economy, not all of which is directly related to the mess that greedy banks have got us into.  

Stockmarkets have so far refused to collapse as can be seen below. Markets remain volatile, but looking at the FTSE over the past 24 years, when were they anything else?

Importantly, the underlying fundamentals continue to refuse to roll over and play dead. Employment continues to be strong, with the latest labour force survey showing a rise of 150,000 jobs during the period from December 2007 to February 2008 and not far short of half a million jobs since the same time last year. There are currently more than 29.5 million people in work.

Where are we going?

The housing market appears to be going into decline, but this is not necessarily a problem for householders, even those with high loan-to-value mortgages, unless they wish to move or change lenders. Negative equity really only matters if you have to repay the mortgage for some reason.

A fall in house prices – while making homeowners feel less well off and thus unwilling to spend as much as they have been – represents a real boost for first time buyers. While the 100% mortgage seems a fond memory, this is unlikely to last long, because banks always tend to over-react. The current credit crunch owes much more to sentiment amongst lenders than economic problems. Once they find that borrowers are not defaulting in large numbers, banks will wake up to the fact that their security is good and, more importantly, so is that of other banks. This should produce a fall in the London Inter Bank Offer Rate (Libor) which has quite rightly become rather discredited, in view of the way it has failed to respond to the Bank of England’s initiative this month. With Libor falling, banks will feel able to start lending again and they will start their usual scramble for market share.

Might the banks have learned a lesson from the past eight or nine months? This is unlikely, because so many executives are measured by market share and share price, neither of which is linked to prudence. Have the days of good mortgage deals gone? Yes, for the moment. Will they come back? Probably faster than most pundits believe!

The longer view

In a recent ‘podcast’ IoD’s Grahame Leach said that we are currently travelling “along a narrowing ridge”. He identifies three possible reasons to fear recession: if there be a labour market ‘shakeout’; if consumers become over-cautious; and if Bank of England interest rates cuts are not passed on to consumers. The first is currently seen as unlikely (other than within financial services) but the second two are more likely – particularly since banks seem more interested in recouping the losses they have made, rather than looking after the interests of their customers.

On the other hand, says Leach, there are three reasons to be confident: inflation is not currently high – at least not the headline rate; employment is strong; and we are not in the ERM (unlike last time there was a recession).

Markets (Data compiled by the Insurance Marketing Department Ltd.)

All the main indices we track rose during April. The FTSE100, probably the best indicator of what is really going on, gained 6.76%, reducing its 12-month deficit to -5.61%, while the mid-cap FTSE250 gained 1.62%, which is more than it lost during March.

Elsewhere the Dow Jones gained 2.21%, which means it is less than 2% down over 12 months, while the Eurostoxx50 gained 5.05%, leaving it almost 13% down on this time last year. The Nikkei225 was ‘star performer’ for the month, rising by 10.257%; even so it is still not far short of a fifth lower than twelve months ago.

As any motorist will know, Oil has continued it meteoric rise, to end April 11.03% higher at $111.36 per barrel for Brent Crude 1-month futures. Since it had peaked at more than $115 per barrel during April, we might be grateful for small mercies. However, the activities of speculators, combined with increasing demand from the far eastern economies, leaves no reason to think that prices will fall in the near future.

Oil price threat

This is a potential threat to world economies, since energy plays an increasingly significant part in production costs, which can lead either to ‘cost push’ inflation or (if manufacturers feel that cannot sell at higher prices) falling productivity. So while we must accept that oil companies are making their rapidly growing profits from extraction and refining rather than at the pumps, something needs to be done about evening out energy costs to businesses and consumers.

Unfortunately, any attempt on the government to force a cross-subsidy from production to retail would presumably result in oil giants splitting their operations, thus frustrating the effort. Increased taxation on excess profits would not be economically effective unless there were to be a corresponding reduction in taxation for consumers (which is never going to happen). It would also exacerbate the increasing trend for multinationals to consider relocating abroad, in order to avoid an increasingly punitive tax regime in the UK.

Interest rates and inflation

As has so often been written before, the Bank of England has a difficult job to keep inflation in check through interest rates. As has been demonstrated over the past month, base rate has little impact on what consumers pay for borrowing when the banks are nervous, so the Bank of England is virtually powerless, unless it starts to flex its regulatory muscle.

One impact that lowering base rate this month should have had, was to weaken sterling against the euro. If interest rates are lower in sterling, people are less keen to buy it, so the price should fall. Unfortunately, there is no evidence that this has happened.

A weakening pound is something that we should all hope for, perverse as this might sound, for several reasons. First, it would make our exports less expensive to overseas buyers and therefore more competitive in the wider world. Secondly, it increases the cost of imports and, while this is naturally inflationary, if it relates to discretionary spending, it could lead to lower consumption, which may serve to reduce growth in consumer debt.

Unfortunately, imports include food, which we seem incapable of growing domestically, so prices could increase even further. Perhaps we should take the opportunity to try to produce more at home – and be prepared to accept food that does not look as if it comes straight out of a beauty parlour – and do something to reduce carbon emissions at the same time.

Tax

At the time of writing there appears to be no clear resolution to the furore caused by the removal of the 10p tax rate, which Gordon Brown failed to announce in his last budget, while trumpeting a cut in the basic rate of tax from 22p to 20p. A few promises appear to have headed off a back bench revolt, but some employers are concerned that the solution for lower paid workers will be an increase in the minimum wage, which they will have to pay, rather than the government. At least this would generate even more tax revenue for the Chancellor!

Removal of the 10p rate has also allowed the government to help poor bankers to the tune (so far) of £50 billion in bonds which will be backed by mortgages and credit card debts. However, there is much merit in helping the banks out this time, as long as they learn the lesson, because if they become too ‘risk averse’ in the future, we could face the risk of a Japanese style recession.

Immigration

It has long been said by some that immigration (of the right sort) is a benefit to the UK. After all, we have been accepting people from overseas throughout our entire island history. New research by recruitment agency Harvey Nash suggests that we can expect to have 800,000 skilled immigrants in the workforce by 2012 and that they will contribute £77 billion to the economy. Conversely, a House of Lords committee has just come out saying that there is no economic benefit at all. Anecdotal evidence that many workers decided not to come back after Christmas due to the weakening economy, may or may not represent a hiccup; but the debate will rumble on.

Vehicle Excise Duty

While we are on the subject of tax, can anyone explain why the Vehicle Excise Duty on a reasonably sized family car like a new Saab 9.3 automatic (with a fuel efficient Euro VI engine) is so much higher than on a pre-2001 car of any size? To find out the CO2 emissions of your car, visit: www.smmtco2.co.uk/co2search2.asp. You could find that you are in for a very nasty surprise from 2010.

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