In the old days the bellwether of the British economy was ICI, then the
country’s biggest industrial company. If ICI was hurting, so was the rest of
the economy.
Now the role of bellwether in a consumer-driven economy has been taken by
Marks & Spencer. If M&S is hurting, it seems, so must the rest of the
economy. Last week’s profit warning from Sir Stuart Rose, its chairman,
knocked already gloomy City sentiment down several notches and raised the
spectre of recession. Nearly a year after the credit crunch broke, its
tentacles are spreading. First the banks suffered; then housebuilders reeled
under the sharpest downturn since the inter-war years. Now the fear is that
consumer spending is wilting fast as worried households cut back.
For those with long memories, the parallels with Britain’s last recession are
troubling. In the first half of 1990, the economy appeared to be coping well
with sky-high interest rates and a rapidly weakening housing market. Then,
in the words of analysts at the time, the economy “fell off a cliff”.
Could history be repeating itself, with the credit crunch and record oil
prices, which hit $146 a barrel last week, doing for the economy this time
what high interest rates did 18 years ago?
“There is a high risk of recession,” said David Owen, an economist with
Dresdner Kleinwort.
“The housing-market deterioration has been sudden and spectacular and the
worry is that other sectors are following suit. Suddenly things do start to
look as if they’re falling off a cliff again.”
Lehman Brothers revised down its forecasts last week. A recession is normally
defined as two consecutive quarters of falling GDP, or “negative growth”.
Lehman expects three, beginning in this quarter and lasting until next
spring.
“There’s increasing evidence that a downward spiral between tightening credit
conditions and falling demand is now a reality,” said Peter Newland, UK
economist at Lehman. We’ve taken a knife to our medium-term projections for
growth.”
The firm expects consumers to wilt under the impact of falling real wages and
a drop in housing and financial wealth. “The Achilles heel for the UK
economy is the consumer,” said Newland.
That is the worry in the stock market, where share prices have dived in the
past few weeks. “It’s ugly and it’s going to get uglier,” said Oliver
Hemsley, chief executive of the stockbroker Numis.
Graham Secker, UK equity strategist at Morgan Stanley, said the market was
likely to fall a further 7% or 8% but there was a risk the gloom was
overdone.
“There is a lot of hysteria and negative views on the UK economy, from all
sorts of parties,” he said. “It’s not necessarily wrong, but one should
always be a bit more rational about these things.
“There’s a 50-50 chance the UK will have a technical recession. That doesn’t
mean we will have a really bad recession as we did in the early 1990s.”
Graham Ashby, head of UK retail equities at Credit Suisse Asset Management,
said: “The market is at that point where it could go one way and it could go
the other. The bears have been winning the argument up to now. While stocks
are beginning to look cheap on a number of measures, every day more bad news
comes out, and the bears look right.”
Rose’s warning of a “seismic shift” in the consumer environment came as he
announced a 5.3% drop in like-for-like sales in the 13 weeks to June 28 and
sacked Steven Esom, the firm’s recently appointed director of food sales.
“We have had 10 years of boom time,” Rose said. “Everyone is now going to have
to swallow hard and cut their cloth to suit their needs.”
If Marks & Spencer is suffering, so is John Lewis, middle England’s other
store of choice. It announced on Friday that sales at its 26 department
stores in the week to June 28 fell by 8.3% on a year earlier to £53m, with
sales of electrical and electronic products down nearly 16% and sales of
products for the home 13% lower.
Those looking for evidence that high petrol prices are having an impact on the
wider economy can find it in the John Lewis figures.
The weakest sales performances it recorded were at its out-of-town stores,
with Bluewater down by a huge 24.6%, Brent Cross 17.1% weaker and Cribbs
Causeway 16.4% lower.
SPSL, which measures shopper numbers with its retail traffic index, recorded a
strong gain in nonfood shopping trips in May. Since then, however, there has
been a weakening. Shopper numbers in the final two weeks of last month were
down by 1.9% on the corresponding period of 2007.
Analysts say it is no surprise that consumers are starting to rein back, in
spite of official figures showing a big jump in sales volumes in May when
warmer weather brought out shoppers.
An annual survey by Ernst & Young, which measures households’ disposable
income after tax contributions and monthly bills, claimed that the average
household has 15% less free income than five years ago. After tax and
essentials, the average family now has under 20% of gross income to spare,
compared with 28% in 2003.
Hetal Mehta, senior economic adviser to the Ernst & Young Item Club, which
uses the Treasury’s own model of the economy, said the situation was likely
to get worse. “We expect inflation to go over 4% later this year - double
the target rate of 2%. Companies will see profits being squeezed and
households will see a further fall in disposable incomes. The dangers of the
UK economy entering a recession are now quite significant.”
Britain’s housebuilders are reeling under a 64% collapse in mortgage approvals
to a record low of 42,000 in May. Following the failed £500m capital-raising
exercise last week by Taylor Wimpey, Britain’s biggest housebuilder, shares
in the sector tumbled again, a fall braked only by the promise of government
money to buy some unsold properties for social housing.
Next to their house, the main big-ticket item for consumers is a car. New-car
sales have been holding up surprising well in the face of soaring petrol
prices. Last month, however, they also showed a sharp fall. The Society of
Motor Manufacturers and Traders said June sales were down by 6.1% on a year
earlier, with registrations to private buyers 8% down.
Dealers called for action from the government, which has been heavily
criticised for proposals to increase road tax for new and used vehicles, a
move that has hit secondhand values hard.
Trevor Finn, chief executive of Pendragon, Britain’s largest car retailer,
which cut 500 jobs last week, urged ministers to restore consumer confidence.
“They have clearly made a bad decision with the new vehicle excise duties,” he
said. “But instead of just saying they won’t do it, they have said they will
review it later in the year. That doesn’t take away the threat, and doesn’t
help consumer confidence in the least.”
Britain’s pub chains, still coping with the effects of the smoking ban
introduced last year, say times are tough for the trade, though not as tough
as the City thinks.
“If I ran the business according to my share price, I’d go nuts,” said Giles
Thorley, chief executive of Punch Taverns. “The collective profit forecasts
for the sector from analysts are down in the region of 10% yet share prices
are down about 50%, and some even more than that. It’s a very significant
reaction to a small decline in expected profitability.” It may be that
people seek solace at the pub when times get tough. Certainly, Ian Payne,
chairman of privately owned Town & City Pub Company and Bay Restaurant
Group, is fairly upbeat about prospects.
“We are not doing too badly at the moment, but we had to go through a lot of
pain to get there,” he said. “There’s no question it’s tough. But compared
with what we were going through in November, when we could not predict
almost one day to the next, it’s far more stable, far more predictable. In
comparative terms, it’s looking a lot better.”
The jury is still out on whether Rose’s “seismic shift” is yet hitting the
consumer sector as a whole. Everybody knows, however, that the key to it is
not just the squeeze on incomes but the prospect of big redundancies.
Already the troubled housebuilders are slashing their workforces. How big is
the risk that the trickle of rising unemployment will become a flood?
For economists, the quickest way of assessing what is going on in various
sectors is by reference to the monthly purchasing managers’ indexes. Last
week they were published for manufacturing, services and construction. All
three showed falls, and all three had index readings of below 50, suggesting
falling output. Analysts have grown accustomed to disappointing news, but
the three surveys confirmed that few parts of the economy are immune from
the downturn.
They also suggested that firms were planning to cut jobs. So far, official
data have shown rising employment, up 76,000 in the February-April period,
alongside a modest rise in unemployment. The claimant count is 819,000, 2.5%
of the workforce, up 24,000 since January.
The Organisation for Economic Cooperation and Development predicts a 100,000
rise in unemployment over the next year but that is predicated on a modest
slowdown.
Not everybody is convinced that the picture is as weak as the purchasing
managers’ indexes suggest. The Engineering Employers’ Federation (EEF) said
manufacturing was still holding up fairly well.
“While life has become much tougher and firms are more wary there is no sense
that manufacturing is heading for a nosedive,” said Steve Radley, the EEF’s
chief economist. “Higher-value sectors are continuing to do well but where
there is pain being felt this is confined to a few sectors linked to the
consumer and construction.”
However, analysts agree that if business decides it faces a prolonged
downturn, job losses will follow. Typically, firms avoid getting rid of
staff during the early stages of a downturn, “hoarding” labour until they
have no alternative.
“We are in something of a phoney war at the moment,” said Alan Hudson, an
insolvency specialist at Ernst & Young. “There have been some high-profile
casualties of falling consumer demand, but it hasn’t come through yet in job
losses. I think we will get a shooting war later in the year - it’s just a
question of how nasty it gets.”
Fabrice Desnos, UK chief executive of credit insurer Euler Hermes, predicts a
20% rise in insolvencies over the next two years, as a result of the credit
crunch.
The firm, which insures companies against their customers going bust before
they can settle trade debts, has research covering 225,000 companies across
the UK. It has £8 billion of insurance cover against the retail sector
alone, and attracted attention recently after pulling cover on sofa
retailers Land of Leather and SCS.
“This is called a credit crunch for a reason,” said Desnos. “We are paying a
lot of attention to financial gearing in companies and their access to
finance.”
It is a nervous time. Two months ago the Bank of England predicted that growth
would weaken sharply over the rest of the year. Last week Charlie Bean, its
new deputy governor, warned that falling house prices could hit consumer
spending by more than the Bank expects, resulting in a much more severe
downturn.
As a result, few think the Bank will seek to follow the European Central Bank.
On Thursday, the ECB carried out its threat to raise interest rates in
response to a surge in inflation, hiking its key interest rate from 4% to
4.25%.
The Bank of England is not expected to raise interest rates, but its room for
a cut is severely limited by above-target inflation. Analysts expect Bank
rate to remain on hold at 5% until the end of the year, though Lehman
Brothers thinks the sharp slowdown will force aggressive rate cuts next
year, taking Bank rate down to 3.5%.
For business, the question is whether that will be too late. For most people
it is hard to tell the difference between a sharp slowdown and recession,
and the distinction is fairly meaningless for the sectors in the eye of the
storm.
Whether it is a recession remains to be seen. But the chances of it have
increased in the past few weeks. After all, Marks & Spencer says so.
Swept away by a torrent of bad news
Unemployment is expected to accelerate rapidly
SINCE January the official unemployment count has risen by 24,000 to 819,000 -
or 2.5% of the workforce. During the last recession, in the early 1990s,
there was an increase in unemployment from 1.57m to 2.96m - it almost
doubled.
The CBI, the employers’ organisation, expects the wider measure of
unemployment, based on the Labour Force Survey, to rise from 1.64m now to
1.79m next year, a jump of 150,000.
Job losses announced in recent days include 1,000 at the housebuilders Barratt
Developments, and 500 at Taylor Wimpey. Pendragon, the car dealer, also
announced 500 job losses. About 20,000 job losses are predicted in the City
for this year.
Continental economies grapple with high inflation and slowing growth
US employment dropped by 62,000 last month and figures for earlier months were
revised down by 52,000. Economists said the drop, together with a rise in
weekly jobless claims to 404,000, suggests the American economy is in
recession.
Europe is also grappling with a combination of high inflation and slowing
growth. The European Central Bank raised its key interest rate from 4% to a
seven-year high of 4.25% last week. Economists predict that the eurozone
economy will slow to 1% growth next year.
Several European economies are very weak. Spanish industrial production fell
by 5.5% last month. Ireland’s Economic and Social Research Institute said
the economy would contract by 0.4% this year, after 4.5% growth in 2007.
For some, conditions are the worst since the 1920s
BRITAIN’s housebuilders are suffering a worse downturn than in the early 1990s
recession, or in the recessions of the 1970s and early 1980s. Conditions are
probably at their worst since the 1920s.
The last recession to hit Britain, from 1990 to 1992, came as the result of
high inflation, which was followed by a sharp rise in interest rates in
response. The present downturn has been brought about by a sudden tightening
of credit.
With the cost of oil, the greatest shock today is that prices per barrel have
risen sevenfold in only five years. That can be compared with the first
great oil-price increases of the 1970s. Those increases contributed to two
deep recessions, in 1974-75 and 1980-81.
