In trouble on all fronts

Feb 8 2008 By Ian Shepherson

The Bank of England’s quarter-point cut in interest rates yesterday will make no difference at all to the performance of the economy in the near-term.

Mervyn King wears glasses, but his similarity to Harry Potter ends there. The Monetary Policy Committee has no magic wand, just a sparsely-equipped tool box with which to fix the economy.

The problem is that the single tool in the box, interest rates, work very slowly.

Even under ideal conditions, the benefits of lower rates tax at least six months to have any effect, and the wait is often double that.

This means that whatever bad news is in the system now will take most of 2008 to be flushed out, regardless of whether the Bank continues to cut rates over the next few months.

But even if Mr. King and his colleagues were to start competing with the US Federal Reserve in the Global Fastest Rate Cut Challenge, businesses would still have to brace themselves for a very tough year.

No-one can be in any doubt now that the economy is in trouble on all fronts.

Manufacturing output has fallen in recent months, while the chaos in the markets, coupled with the realization that the housing boom is now as over as NUFC’s season, means that consumers’ confidence is fading fast. That signals pain for retailers and a squeeze on service sector businesses like hotels, restaurants and leisure operators. As a rule, miserable people buy less stuff, go out less and take fewer holidays. When the economy stalls, spending on entertainment has to take second place to the mortgage payment.

And there’s the rub.

With house prices still at stratospheric levels, despite their recent drop, people are saddled with mortgage payments which, by historic standards, are enormous in relation to their incomes.

That was just fine as long as the housing boom continued.

All you had to do to finance your leisure spending was just shake the curtains and watch the money came tumbling down in the form of equity withdrawal. Even for non-homeowners, credit had never been easier to find. Not any more.

With banks now determined to pick and choose their borrowers, we have to relearn, collectively, how to live within our means.

That includes the government which is now more or less broke, thanks to the profligacy of “prudent” Mr Brown – as prudent as a drunk in a betting shop, I’d say. Taxes now need to rise in order to meet the Government’s own rules, so Mr Brown is in no position to do what the Americans are about to do, namely, throw a huge pile of cash at the problems in the economy.

If it’s any consolation, the tax cuts in the States won’t fundamentally sort out their problems, which are rather deeper than ours, but it would be nice if the UK. government were in a position to give it a shot.

Rules are made to be broken, of course, especially when they get in politicians’ way, but all the same you should not be looking to the Government for salvation.

At least in this part of the world we have plenty of experience on that score.

Tin-hat time, I’m afraid.

Ian Shepherdson is a former Wall Street and City economist
now living in Newcastle. ishepherdson@hotmail.co.uk