Britain’s boom running on empty and ready to stall
Quite often striking success is only superficial and fails close scrutiny. Outside observers could easily envy the UK’s economic record over recent years, boasting a blistering growth rate, plunging unemployment and a booming housing market.
Britain was the fastest growing of the biggest developed economies last year, so it is hard to imagine much of a problem.
But Britain is sitting on a time-bomb. The economy looks in poor shape to deal with the onset of slower global growth. Recession risks are rising, deflation remains deeply embedded and Britain’s yawning trade and budget gaps leave little scope for possible policy antidotes.
Longer term, the picture looks unsettling. Two potential structural shocks lie in wait. The UK government is set on a collision course with Brussels over its EU membership, which could eventually lead to a damaging exit from Europe. Meanwhile, independence pressures are still bubbling up in Scotland. Both events could inflict cataclysmic future blows on the economy.
Credit rating agencies are watching from the sidelines and are not impressed. Britain’s highly-regarded international reputation and top-notch credit ratings are at stake. UK financial markets and the British pound have a lot to lose.
Having been the pin-up poster economy in recent years, the UK now looks vulnerable. The UK economy lost momentum in the third quarter with quarterly growth slowing to 0.5 per cent in the past three months, compared with 0.7 per cent in the previous quarter.
A sharp fall in Britain’s bellwether construction industry was the main culprit for the slowdown. But another tell-tale sign of trouble ahead was a 7.1 per cent slump in steel production in the third quarter. Even before the recent round of closures in the British steel industry, the slump in global steel demand has been a worrying trend.
It is a precursor to troubling times ahead for UK manufacturers. As a major trading nation Britain is already feeling the pinch of slower global growth, with the strong pound compounding the problem as dwindling export competitiveness continues to hit demand for UK goods and services.
Early signs of slowdown are starting to show up in the domestic economy. Despite the boom in UK house prices, British mortgage approvals fell in September for the first time in four months and retail sales growth is starting to soften with consumer confidence dampened by deepening uncertainty about the domestic and international outlook.
The trouble is that UK policy is firing on blanks right now. UK interest rates are already at zero per cent, while the government remains intent on balancing its budget books in the next few years. UK policymakers would be powerless to act in the event of a sudden downturn in the economy, without a major policy U-turn.
In the last two years, sterling’s value against a range of currencies has risen as much as 15 per cent, buoyed up by strong capital inflows, nearly the monetary equivalent of a 5 per cent rise in short term interest rates. The Bank of England has already achieved its wished-for monetary tightening by default. Its aim to hike rates soon simply piles extra pressure on the economy
Bigger risks lie ahead. If British Prime Minister David Cameron fails in his quest to secure a better EU membership deal for the UK, the country could be heading into a dangerous referendum on a possible exit from the single market. With recent opinion polls showing the nation split right down the middle on the matter, it could have devastating results.
It could spark a major flight of banks, businesses and foreign capital out of the country, losing a huge chunk of productive capacity from the British economy. It would also precipitate another independence push by Scotland, risking an extra 10 per cent lost from UK output. Britain could end up in deep depression, so it is no surprise the rating agencies are taking a downbeat view.
Market reports suggest currency traders are still extremely upbeat on the pound based on views that the BOE will stage an early rate hike next year. But markets have short memories and forget too easily that sterling is a ‘banana-skin’ currency that is prone to major slip-ups.
Sterling bulls may be on the warpath right now, but a delay in the BOE’s plans to tighten policy in 2016 could trigger a dramatic reversal in sentiment.
Longer term, if Britain is heading into an economic backwater, confidence in the pound would be a major casualty.