As Christmas draws closer, the British public is having difficulty entering into the festive spirit. It's not difficult to see why. Rarely a day goes by without the announcement of a major factory closure or banking "restructure". Business and consumer confidence surveys paint a universally gloomy picture. MORI's annual survey of captains of industry recently revealed greater pessimism about the prospects for the economy than it reported in the run-up to the early 1990s recession.
The Economist's recession index (which uses a computer database to count how many stories in Britain's quality press contain the word "recession") has tripled in the past quarter. Consumer spending is weak and retailers are expecting a bleak Christmas. Even the Christmas lights on Oxford Street have had to take the form of explicit advertising (for a frozen foods company, no less). In the City - an economy-within-an-economy that runs to the rhythm of international financial markets rather than domestic conditions - the situation looks less bleak following the recovery in equity prices in October and November. Nevertheless, Porsches and Rolexes are distinctly passe within London's financial community. Cigarettes and nail biting are the new rages.
Is the all-pervasive gloominess merited? Relative to most other western economies, it probably is. The outlook for Britain is worse than for continental Europe and the US and the reason is quite simple. Britain would have suffered a growth slowdown in 1999 regardless of this year's global financial turmoil. Now that this factor has found its way into the plot, the medium-term prospects look less than rosy.
Britain has not been hit especially hard by the global downturn; its starting position heading into 1999 was simply worse. The Bank of England's efforts to cool the economy following the Conservative-induced miniboom had raised borrowing costs for businesses and pushed sterling to levels that left many exporters high and dry. Add the global crisis to this turgid brew and the outcome was bound to be unpleasant.
However, in the spirit of this season of goodwill, it is only fair to highlight some reasons to be cheerful. First, the slowdown in growth is unlikely to match the negativity being witnessed in surveys. These polls will almost certainly prove to be overly pessimistic because people have failed to realise that this downturn is unlike those of the past.
Post-war recessions in Britain have consistently resulted from an inflationary build-up, which has had to be counteracted by a sharp rise in interest rates. The boom preceding the bust was often politically induced.
Such booms took place prior to the general elections of 1983, 1987 and - on a smaller scale - 1997. After the last election, Chancellor Gordon Brown made the Bank of England and the Monetary Policy Committee set about the task of controlling inflation. Through higher interest rates and sterling's strength, the Bank has managed to meet its inflation target, placing it in a position to soften the current downturn with aggressive rate cuts. Its operational interest rate has been cut by 11/4 per cent to 6 1/4 per cent in months. Rates are likely to fall much further next year (we are looking for a sub5 per cent rate by the end of 1999). As the ability to lower interest rates promptly in response to slowing growth is virtually unprecedented in a British context, the public believes that this business cycle is going to be like previous ones. Hence the excessive gloom.
Another reason to be cheerful is that it takes more than talking about a recession to provoke one. Although the media plays a powerful role in many spheres of life, pay-packets and mortgage costs are more important determinants of demand than gloomy newspaper articles. The number of times "recession" appears in articles may have been a good indicator of conditions in the past but only because it coincided with massive job losses and higher interest rates. For this reason, The Economist's recession index should prove to be a coincidental indicator rather than a causative factor.
Whilst year-on-year growth is likely to be less than 1 per cent next year (and therefore less than Mr Brown's forecast of 1.01.5 per cent), a move into negative territory is improbable. Unemployment will rise but from a very low level (we are expecting an average rate of 5.3 per cent in 1999). In 2000, we expect growth to rise to 1.4 per cent. While this outlook is far from impressive, it represents a distinctly "soft" landing compared to previous downturns.
Nevertheless, British economic performance in 1999 will be worse than that of its peers. As success is often judged on a relative rather than absolute basis, perhaps this is the important point. Certainly, the Republic's performance next year will be considered all the more remarkable when contrasted with that of its neighbour.
Kevin Daly is European Economist with Credit Lyonnais Securities Europe.
