Comment: Half way to where on the King's road?

Comment: Half way to where on the King's road?

The economy is the cross on which this summer’s market is nailed. Yesterday we looked at the possible impact of events: the EU summit deal and Barclays scandal. Today we'll stick to symptoms of the underlying state of UK economic health.

Bank of England governor Mervyn King cut to the chase in an appearance before MPs at the end of June, saying the Bank had torn up its forecasts.
Britain was still not half way through the crisis, King said, arguing: “All the way I've said I don't think we are yet halfway through and I'm still saying it.”

When he added, “In the last six months I am struck by how much has changed”, he did not mean for the better. The governor confessed to “no idea what is going to happen in the euro area”.

The Bank announced a new round of quantitative easing last week, taking the total pumped into the economy to £375 billion. It’s a policy which has so far failed to make things better but perhaps prevented things becoming worse. It remains one of few options open to the bank.

Days earlier the Bank's Financial Policy Committee (FPC) relaxed minimum limits on the assets banks must hold to cover lending - a response to a fall in loans to companies and rise in costs of borrowing for business and households.

Recall that it was in part a lack of controls on bank lending (resulting in an inability to cover loans) that led to the banking crisis in the first place. This relaxation might strike you as somewhat desperate.

Whether it increases lending will depend, as investment bank Goldman Sachs noted, on “the extent to which banks are prepared to reduce their liquidity buffers . . . and are prepared to use their funds to lend”.

Simultaneously, the Financial Times reported the authorities had “reiterated the line that banks should raise capital levels so they are in a position to withstand potential losses from the eurozone crisis”. This looks like a contradiction in policy.

Add in the Libor affair and the banks must be spinning like a dog after its tail.

A significant proportion of economists are demanding a government stimulus package. The Chancellor’s eggs are mostly in the Bank of England basket save for a Treasury growth plan announced last November based on private investment in infrastructure. At the start of July the FT reported this to be “in tatters”.

The Treasury assumed private investors, pension funds in particular, would back road, rail and power-plant projects and thereby stimulate growth. There was talk of raising £20 billion from pension funds to help pay for 500 projects comprising a ‘national infrastructure plan’.

Now the government's chief construction advisor Paul Morrell says: “There won't be a barrel-load of funding coming from pension funds for Greenfield infrastructure.”

The government remains two years into a seven-year austerity programme with targets set when the outlook appeared better. Latest figures show government borrowing up and tax revenues down.

UK GDP was revised down again in June following May’s revision of figures for the past six months. So official statistics which originally showed a decline of -0.2% for Q4 2011 and -0.2% in Q1 2012 now read -0.4% and -0.3%.

Most economists greeted the original figures by suggesting they would be revised up or prove a blip and growth return in the second quarter. Latest indicators pretty much scupper that view.

Office for National Statistics figures show the service sector, which accounts for three-quarters of the UK economy, stagnating between March and April, leading BNP Paribas economist David Timsley to conclude of the second quarter “a flat performance is probably too much to ask for”.

A Markit survey of the service economy in June led the research company’s chief economist Chris Williamson to report “one of the worst months since the recovery began three years ago”.

The most recent Bank of England monetary policy committee meeting for which we have the minutes noted “the [Markit] manufacturing index fell sharply in May”.

It also identified the return of pay freezes, and not just in the public sector, noting: “Basic pay settlements fell in April, with a higher proportion of across-the-board increases clustered around zero than in 2011 or 2010.” About one-quarter of private sector pay settlements are in April.

None of this sounds promising in relation to holiday demand. What is there in travel’s favour?

One, the euro exchange rate may help. Sterling fell against the euro immediately following the EU summit deal 11 days ago and was dealt a blow by Barclays, but benefited when the euro plunged again at the end of last week.

Two, the oil price remain less strong. Having fallen briefly last month to its lowest since January 2011, Brent crude then rose back to $98 a barrel at the start of July. Yet it averaged $120 throughout May.

Three, the UK weather can pretty much be relied on to be crap and has proved more obliging than usual so far this summer.

However, the underlying economic base of UK outbound tourism is pointing in the opposite direction to a recovery in demand. Merely standing still may be the best we can hope for.


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