Bill Jamieson: Final nails in Brown's coffin

MORTGAGE approvals slumping, but £50bn liquidity injected by the Bank of England; sales at Britain's biggest housebuilder down by a quarter, but stronger than expected numbers on retail spending; a short recession forecast for America, but no sign yet of any housing recovery there. So where are we in the credit crisis recession? How hard will it really hit?

The stock market has rallied, with talk that the worst is over. And looking at the customer flows in shops and restaurants it is hard to see where the scary headlines and unsettling numbers of recent weeks are really hitting. Indeed, after the latest revisions, retail sales volumes in Britain are up 2% quarter on quarter, the best three-month performance since Q1 2004.

But signs of slowdown are multiplying. Whether it is housing transactions or business confidence, staff hiring plans or holiday bookings, a downturn is setting in. As for the stock market, strong performances by energy and natural resource companies on the back of higher oil prices have pushed the FTSE 100 index higher. But this is deeply misleading, because 'real economy' earnings are under pressure and many earnings downgrades are likely as funding constraints intensify. So how bad is it all likely to be? And when can we expect to come out of the downturn?

First the good news: this is a necessary slowdown, and when we come out of this, economic growth will be more evenly balanced. Financial services will have lost the froth of recent years, but the production sector will lead the recovery, with improved prospects for exporters.

This process of rebalancing towards more sustainable growth is one of which Gordon Brown would heartily approve. But it is also the one that will sweep him from office. This rebalancing eluded him in his 10 years as Chancellor. Indeed, the economy became ever more heavily skewed towards public sector spending, debt-fuelled housing and domestic consumer markets.

All this will now change. As it does so, voters will target a Government whose resolve is seen to be weak and which has proved incapable of mounting a credible counter-stimulus by way of tax cuts as the Bush administration has done. Interest rates, meanwhile, cannot be cut swiftly because of the Government target to keep inflation at 2%. As a result, this downturn, slow in arriving, is likely to prove deeper and more prolonged than was envisaged just three months ago, its long tail effects stretching to the end of the electoral cycle when voters will exact their revenge.

The turning of this wheel has now begun. The latest figures for the UK economy released last Friday show that growth slowed in the first quarter, and at an increased rate. Indeed, quarter-on-quarter growth of 0.4% was the weakest since the first quarter of 2005, clearly below trend and only half the 0.8% growth rate achieved in the second quarter of last year. The annual growth rate has slowed to 2.5% from a peak of 3.2% in the second quarter of last year.

That doesn't sound too worrying – until you get into the latest numbers for the housing market and the likely knock-on effects for prices, activity, building programmes and employment. Last week the British Bankers' Association reported mortgage approvals were down 44% on a year ago. Persimmon, the country's leading housebuilder, has seen sales slump by 24% in the first quarter, forcing it to shelve building plans until the mortgage squeeze shows signs of relenting.

There is little sign of that. The latest Royal Institute of Chartered Surveyors survey showed the most widespread declines in house prices since the survey began in 1978. Housing turnover fell 28% in February year-on-year and the slide has since been intensified by the tightening of lending standards and a hasty withdrawal of hundreds of mortgage products aimed at the sub-prime sector.

The £50bn Special Liquidity Scheme unveiled by the Bank of England last week acknowledges the severity of the financial crisis but it is by no means over. Three, six and 12-month interbank rates have barely moved since the SLS announcement and – at close to 6% – they remain unusually high relative to the Bank of England's official policy rate (5%).

And as long as real mortgage rates stay up it is hard to see an uplift in consumer spending. Consumer confidence has already fallen to a 15-year low. Jonathan Loynes of Capital Economics sees house prices falling 20% by the end of 2009. Citigroup economist Michael Saunders predicts a more modest fall of 15%. But even 15% would leave 950,000 homeowners in negative equity by the end of next year. By that stage, some 35% of house mortgages taken out in 2007 will be in negative equity, along with about 15% of 2006 loans.

It looks as if a price slump will come first, and higher unemployment in its train. Persimmon warns it will stop building on new sites until the mortgage market picks up.

This makes a mockery of Government targets to build two million homes over the next eight years.

The immediate concern is employment. In the last downturn, 500,000 construction workers were laid off between 1999 and 2004.

For all the exhortations from Government on the fundamental soundness of the UK economy, that barely rings true in an environment where banks are hoarding cash and builders have been forced to make cash retention a priority. As sales fall, the flow of cash coming into the business is hit, while profit margins are squeezed by discounts and special offers to move completed homes off the books.

In the US, where the housing slump has been going for well over 18 months, there is still no sign of recovery and the consumer sector has been hit. The Weekly Consumer Comfort Index is down 10 points in the past six weeks and 20 points so far this year to its lowest level since 1993. It suggests that consumer spending in real GDP is likely to be a negative contributor during the second quarter after flattening out during the first.

Hopes are now pinned on the Bush administration tax refunds, which should start landing on household doorsteps next month. But US consumers are unnerved by the rise in petrol prices, with predictions that the price could rise to as high as $5 a gallon this summer.

America looks set for two quarters of falling output before signs of an upturn can be looked for. In the UK, much depends on the labour market and the impact of falling construction activity on employment. Inflation worries are likely to block any sharp rate reductions over the summer, but further falls by the year end can be looked for. Michael Saunders at Citigroup sees rates falling below 4% early next year, while Jonathan Loynes believes they will need to go well below 3.5% to begin the long haul to recovery in mid to late 2009.

If Brown is still Prime Minister, he can then point to recovery on the horizon. But few will be listening, and even fewer are likely to regard a forecast from the boom and bust Chancellor as credible. Tax cuts, not tax rises, will be needed to bring down unemployment and replenish Government coffers. A new age will need new measures and new men to cope with it.