Knock-on effects of UK credit squeeze

Knock-on effects of UK credit squeeze

By Delphine Strauss

Published: February 14 2008 19:37 | Last updated: February 14 2008 19:37

Prophets of doom and gloom for the economy should spend more time outside its finance-focused capital, joked Mervyn King this week as he sought to soften bleak forecasts for growth and inflation in 2008.

“It is very striking that once you get away from London . . . and away from the financial sector . . . the mood music is very different,” said the Bank of England governor. “There is caution and concern, but . . . sentiment is by no means as negative.”

Yet economists warn that the credit squeeze carries the potential for a more widespread downturn than any experienced in the past 30 years.

It would not be the first time that a downturn in the prosperous south had helped the northern regions, less exposed to the vagaries of international markets, catch up with national living standards.

In 2002, when City firms were slashing jobs in the aftermath of the dotcom crash, the north was cushioned by a greater reliance on public-sector jobs and public spending – both rising rapidly under the Labour government.

Cities such as Manchester and Leeds have long shaken off the image of former industrial blackspots, partly because the City’s contribution to tax revenues allowed huge injections of public funding, but also because of growing interest from private investors in regeneration projects.

If its effects remain focused on the international financial sector, and the global economy slows more than domestic demand, then London and the south-east would bear the brunt of the slowdown, according to Andrew Burrell, an economist at Experian.

Neil Gibson, at the consultancy Oxford Economics agreed, saying that if annual gross domestic product growth dropped no lower than 2 per cent in 2008, most regions outside the south-east could feel few ill effects, while even in London, profits – and hence tax receipts – could be hit harder than jobs. If growth slowed dramatically to 1.4 per cent, however, he forecast that London’s economy would contract sharply and several other regions experience job losses or stagnant employment. The very factors that have most buoyed regional economies in recent years – public investment, rapid consumer spending growth and a housing boom – could now make them more vulnerable to a downturn.

First, tight public finances mean there is no prospect of the government bailing out struggling regions, although areas that have a high concentration of public-sector jobs could be in better shape.

Andrew Lewis, the director at the Northern Way grouping of regional development agencies, said private investment was becoming ever more important in funding urban regeneration. With credit conditions worsening, he said: “We have concerns about that being sustained if the availability of private finance tightens.”

Adam Marshall, head of policy at the Centre for Cities think-tank, noted that regions would also suffer from the commercial property slump, as London investors lost confidence and pulled out of projects.

The crucial issue, however, will be the extent to which the housing market slowdown affects consumer confidence and spending.

In the 1990s recession, negative equity was largely confined to the south, Mr Gibson said, but over the past five years, house prices had risen faster relative to average incomes in the regions than in London. So although the level of house prices, and of mortgage debt, remained much higher in the capital and the south-east, “tighter lending practices and spending conditions could hit hard many regions who are less affected by the direct effects of the credit crunch on the banking sector”, he said.

“It really does hinge on how hard a landing the housing sector has,” Mr Burrell said.

Even the Bank of England, sceptical of the links between house prices and high-street spending, this week set out the ways in which a property downturn could exacerbate an economic slowdown.

The Bank expects consumer demand to slow sharply this year, and many regions are now more vulnerable to a consumer slump than they were in the past.