Conspicuous success can sometimes be very
superficial and fail close scrutiny. Outside observers could easily envy the
UK’s economic record over recent years, boasting a blistering growth rate,
plunging unemployment and a booming housing market. Britain was the fastest
growing of the biggest developed economies last year, so it is hard to imagine
much of a problem.
But Britain is sitting on a time-bomb. The economy
looks in poor shape to deal with the onset of slower global growth. Recession
risks are rising, deflation remains deeply embedded and Britain’s yawning trade
and budget gaps leave little scope for possible policy antidotes.
Longer term, the picture looks unsettling. Two
potential structural shocks lie in wait. The UK government is set on a
collision course with Brussels over its EU membership, which could eventually
lead to a damaging exit from Europe. Meanwhile, independence pressures are
still bubbling up in Scotland. Both events could inflict cataclysmic future
blows on the economy.
Credit rating agencies are watching from the
sidelines and are not impressed. Britain’s highly-regarded international reputation
and top-notch credit ratings are at stake. UK financial markets and the British
pound have a lot to lose.
Having been the pin-up poster economy in recent
years, the UK now looks vulnerable. The UK economy lost momentum in the third
quarter with quarterly growth slowing to 0.5 per cent in the past three months,
compared with 0.7 per cent in the previous quarter.
A sharp fall in Britain’s bellwether construction
industry was the main culprit for the slowdown. But another tell-tale sign of
trouble ahead was a 7.1 per cent slump in steel production in the third
quarter. Even before the recent round of closures in the British steel
industry, the slump in global steel demand has been a worrying trend.
It is a precursor to troubling times ahead for UK
manufacturers. As a major trading nation Britain is already feeling the pinch
of slower global growth, with the strong pound compounding the problem as
dwindling export competitiveness continues to hit demand for UK goods and
services.
Early signs of slowdown are starting to show up in
the domestic economy. Despite the boom in UK house prices, British mortgage
approvals fell in September for the first time in four months and retail sales
growth is starting to soften with consumer confidence dampened by deepening
uncertainty about the domestic and international outlook.
The trouble is that UK policy is firing on blanks
right now. UK interest rates are already at zero per cent, while the government
remains intent on balancing its budget books in the next few years. UK
policymakers would be powerless to act in the event of a sudden downturn in the
economy, without a major policy U-turn.
In the last two years, sterling’s value against a
range of currencies has risen as much as 15 per cent, buoyed up by strong capital
inflows, nearly the monetary equivalent of a 5 per cent rise in short term
interest rates. The Bank of England has already achieved its wished-for
monetary tightening by default. Its aim to hike rates soon simply piles extra
pressure on the economy
Bigger risks lie ahead. If British Prime Minister
David Cameron fails in his quest to secure a better EU membership deal for the
UK, the country could be heading into a dangerous referendum on a possible exit
from the single market. With recent opinion polls showing the nation split
right down the middle on the matter, it could have devastating results.
It could spark a major flight of banks, businesses
and foreign capital out of the country, losing a huge chunk of productive
capacity from the British economy. It would also precipitate another
independence push by Scotland, risking an extra 10 per cent lost from UK
output. Britain could end up in deep depression, so it is no surprise the
rating agencies are taking a downbeat view.
Market reports suggest currency traders are still
extremely upbeat on the pound based on views that the BOE will stage an early
rate hike next year. But markets have short memories and forget too easily that
sterling is ‘banana-skin’ currency that is prone to major slip-ups.
Sterling bulls may be on the warpath right now, but
a delay in the BOE’s plans to tighten policy in 2016 could trigger a dramatic
reversal in sentiment.
Longer term, if Britain is heading into an economic
backwater, confidence in the pound would be a major casualty.
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