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Breakingviews.com | UK economy faces prospect of slowing

Breakingviews.com | UK economy faces prospect of slowing
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First Published: Tue, Dec 04 2007. 11 08 PM IST
Updated: Tue, Dec 04 2007. 11 08 PM IST
The UK pound could be facing its Wyle E. Coyote moment. That’s when the cartoon character runs over the edge of a cliff and does not fall—for a bit. The currency is over the cliff; it just hasn’t fallen yet.
The pound’s high appeal has rested on the UK’s record of steady growth and a high interest rate—the best in the West. A few other things have been on its side, too. While the US economy and the dollar have waned, the sterling has provided another place to park money at a decent interest rate. Central banks in Arabia have taken note. And London’s success as a financial centre, and the desire of innumerable wealthy international folk to live there has also been influential. These residents need pounds—a lot of them when they decide on the essentialness of a pile of bricks in Kensington.
This is all beginning to change. Pursued by rising global inflation, higher rates and the credit crunch, the UK has run out of road. For, the global crunch is squeezing most painfully where asset inflation has played the biggest role. In the front line we find the US, with its house price bubble. And in second place, the UK, where house price inflation and the City have driven growth.
The UK’s US-like vulnerability has been mentioned by Mervyn King, the Bank of England’s governor, but is not reflected in the pound rate against the dollar, which remains close to a 26-year high. On 14 November, King said “Clearly the UK, for a considerable period of time now, has been, if you like, a pale shadow of the issues which have been confronting the US… I think that one of the big challenges, looking ahead, for the UK economy is that we are in a world economy, where the rebalancing that we have talked about for a very long time is already now under way…”
Yet, economic prospects for the UK are arguably worse now than for the US. While the American economy has been coping with falling home prices and decline in construction and real estate industries for a year—and has so far kept growing quite strongly—the UK is about to walk the same road and may not prove so resilient. There must be a slowdown. And there must be a fall in the pound, perhaps a long one. What may be keeping it in mid-air at present is an aspect of the UK’s incipient distress.
Tuesday’s jump in one-month interbank interest rates to nine-year highs shows banks are desperate for cash. Such desperation won’t save the pound for long.
On Tuesday, London interbank offered rate (Libor) for one-month sterling rose to 6.72%—the highest since December 1998, when the Long Term Capital Management hedge fund collapsed in the US.
Housing equity withdrawal, whereby rising house prices give scope to tap mortgages for consumption, added £48 billion (Rs3.91 trillion), over 5% of after tax income, to UK consumer spending from June 2006 to June 2007, according to Bank of England statistics.
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First Published: Tue, Dec 04 2007. 11 08 PM IST