The Economy – After BREXIT


On 23rd June, the UK electorate voted to ‘leave’ the EU (BREXIT). The immediate economic consequence was a collapse in Sterling, making exports cheaper and imports dearer. Over time, this might help growth and add to inflation. However, the referendum result increased uncertainty about the economic outlook and may reduce net new investment, output and jobs in the months ahead and beyond.

More firms and investors now seem less confident about the outlook for growth. The survey evidence and the forecast consensus has shifted downwards, acknowledging that there is some risk of negative real GDP growth, higher inflation and lower employment.

In addition, upheaval within the leading UK political parties, the lack of terms/a plan to smooth the UK approach to BREXIT, and concerns over the forthcoming presidential election in the United States all encourage a ‘wait and see’ attitude amongst key businesses.

With forward indicators weakening, the economy is still constrained by fundamental weaknesses: low productivity growth and competitiveness (as shown by persistently large trade deficits). For the foreseeable future, uncertainty over BREXIT will not improve these factors.

Latest evidence

  Annual Quarterly Monthly
Real GDP (%ch, yoy) +2.2 (2015) +2.2 (Q2) n.a.
CPI inflation (%ch, yoy) 0.0 (2015) +0.4 (Q2) +0.5 (Jun)
LFS unemployment (%) 5.4 (2015) 5.1 (Q1) 4.9 (Mar-May)
Trade deficit* (£bn) -36.6 (2015) -12.4 (Q1) -2.3 (May)
Base rate (%) 0.5  (2015) 0.5  (Q2) 0.5  (Jul)

Source: ONS   * goods and services

Growth in the UK economy was fairly modest and flat through the first half of 2016. Despite global/national political and economic uncertainty, as the table above indicates, real growth was maintained close to trend (just over 2% year-on-year), inflation remained well below the 2% per annum policy target (though it edged a little higher) and the drop in unemployment may have started to flatten out (at about 5%). The net trade deficit was still enormous and the loose money and austere fiscal policy stance was largely unchanged. Productivity growth remains too low for sustained and sustainable UK growth.

If real GDP growth now slips below 2% per annum, employment growth will ease or reverse and little or no improvement in productivity can be envisaged. Meanwhile, the recent (roughly 9%) drop in Sterling will boost future inflation. The economic outlook, especially in the face of having to unwind or replace trade, regulation and other business-facing agreements within the EU and other partners, has deteriorated.

Local Economy & Development

The latest purchasing managers’ index (PMI) for SW England shows SW output fairly good but employment slipping back in June. These figures were recorded “pre-BREXIT”. Moreover, the SW regional economy tended to soften through the first half of 2016.

For the PMI series, apart from momentum over time, the crucial benchmark is whether the indices are above or below 50. The former indicates growth and the latter stagnation. It will be interesting to see, in response to BREXIT, whether the next reading for SW PMI output, (to be issued mid-August), will edge below the 50-benchmark, as the UK average did in July and the SW employment index already had done in June. Thereafter, the question is whether negative “BREXIT effects” persist.

Other surveys have shown similar recent trends. For example, the British Chamber of Commerce Survey for the latest quarter pointed to “sub-par UK economic growth even prior to the EU-referendum”. With regard to the future outlook, the mood has been generally more cautious than it was, with many sectors from manufacturing, through retailing and car sales, to property and other services declaring a sudden loss of business momentum after the referendum. What little evidence we have suggests there was an immediate drop in household spending, affecting retailing, tourism and leisure locally; a decline in property movements – affecting commercial and housing sales; and a continuation of caution with respect to business investment.  We do not know whether these were temporary or persistent effects.

In response to these developments, and the aggravated risks and eventual opportunities that lie ahead, the development question is how businesses and the various public agents mitigate any negative impacts. The significant drop in sterling will help some (exporters) but not all (importers and exporters dependent on imports of components and materials). In time, the likely increase in a range of input, factory and final prices will affect some supply chains and household budgets. Moreover, there is a fear that the continuing banking malaise (with share values down sharply from already low levels) may dampen the flow of credit – a key ingredient for maintaining growth.

The Bank of England stands ready to support the financial system (e.g. by relaxing banking capital requirements, lowering base rates, and issuing more quantitative easing). It believes the banking and insurance sectors are much more resilient to shocks than they were in 2008. Also, the new “May-Hammond” Treasury has indicated that it may be more willing to borrow and spend than its predecessor. Its ‘new’ industrial/EU-funding policies, however, are far from clear, (especially as the Business Department is being reformed).

Economic Outlook

According to the latest consensus compiled by HM Treasury (see table below), growth will be very sluggish in the next 18 months. The average forecast is for growth rates well below trend in 2016 and 2017 whilst CPI inflation is now expected to exceed the target (2% per annum) during 2017 and unemployment to rise back above 5.5%.

According to these ‘experts’, the outlook has changed dramatically. Indeed, average forecasts for growth in 2017 slumped from 2.1% (June survey) to only 0.8% (July survey) after the BREXIT vote. Moreover, the current account and public debt positions are worse for 2016 and only expected to improve marginally in 2017. The Bank of England perspective (in its forthcoming August Inflation Report) is expected to show a similar warning about a deterioration in economic prospects.

BREXIT has induced a change in mood, with the consensus about economic prospects shifting markedly downwards in recent weeks. Indeed, the drop in forecasters’ expectations has gained real expression with the downgrading of UK debt by the major credit rating agencies, the drop in the value of UK banking and other stocks, and the Bank of England’s FPC recent highlighting of risks to the financial system.

UK Consensus Forecasts: July 2016

  2016 2017
Growth +1.6 +0.8
Inflation +1.3 +2.4
Unemployment 5.3 5.6
  2016/17 2017/18
Current Account (£bn) -103.1 -82.1
PSNB (£bn) 67.4 58.3

Source: HM Treasury

Some of the new negative sentiment may fade after the initial shock but the danger is that the process of extracting the UK from the EU will generate a series of economic and political ‘aftershocks’ to the markets and the real economy and this could deplete confidence at a fundamental level.

As we have written before (see previous posts), the economics of BREXIT are straightforward. In summary, the creation of economic barriers, borders or boundaries, whether real or psychological, always leads to an increase in costs. That increase in costs, exacerbated by broader uncertainty, stalls investment, reduces output and cuts employment compared with what otherwise might have occurred. Thereby, the outlook for productivity and trade deteriorates.

The resulting fall in business profits and household incomes means less revenue for the government, which requires further fiscal austerity unless the government is willing to borrow more and grow the public deficit. In turn, these factors reduce realised and potential economic activity and confidence. At the same time, as higher costs are pushed through the supply chain, more inflation is generated, which, if accompanied by higher state borrowing, means, at some point, higher interest rates – a further dampener on future domestic demand.

It is important to note that in all these economic linkages and trends, we refer to outcomes in net, macro terms. There will be companies and workers in particular sectors that will benefit from the countervailing forces that always occur within any process of economic adjustment. There will be individual ‘winners’ and ‘losers’. The key observation, however, is that the net effect, for the economy as a whole and for the foreseeable future, is one of worsening growth prospects.

BREXIT will affect many Southern businesses and households. Some of these effects will be immediate and obvious; some will be postponed and insidious and some will not have noticeable impacts for several years. But, on average, in due course, less investment means less growth and lower living standards. We must not be distracted by one-off (good or bad) data releases or items of business news over the weeks and months ahead. The important thing is the change to performance potential, and its realisation, over the long run.

In the long run (after 2020), the economy may start to recover (assuming no major global ‘shocks’) from BREXIT.   In the very long term (perhaps, eight years plus), it may be back, or even beyond, where it might have been without BREXIT. The economy is a dynamic creature made up of millions of individual and group actors with diverse characteristics and behaviours. Uncertainty creates opportunity as well as fear. Human beings are inventive, innovative and entrepreneurial, especially as new generations emerge without the baggage of history. It is reasonable, therefore, to remain a long-term optimist about the economy.

For the near future, however, the prognosis is for a period/process of negative adjustment.

  • In the short run, this is likely to harm sectors dependent on current household and business spending first, though these effects may be temporary if incomes and employment hold up over the rest of 2016.
  • In the medium term, it will be the new trading adjustments that matter: 1) sterling depreciation helping exporters unless they are vulnerable to supply chain shifts caused by political uncertainty and higher import prices and 2) trade agreements and new tariff regimes for UK businesses active across the world. Both positive and negative effects are likely to ensue here.
  • In the long run, changes to corporate investment strategies will drive the impact. It is unlikely that global companies will see UK locations and facilities as favoured areas for investment to gain access to the wider European market. Importantly, it is changes at the margin that matter, specifically the potential for erosion of commitment to existing UK operations over time. Behavioural changes will gradually impact replacement and new investment demand. In a decade, the fear is that the next family of aerospace, motors and other engineering and electronics products and services go, at least partially, elsewhere, as trading costs and regulatory frameworks adjust to a new political reality

Analysis of current economic prospects makes regional development activity to boost the drivers of productivity even more vital. The development policy and delivery question is whether the negatives can be mitigated in terms of repairing or building local competitiveness over time. Even as the BREXIT storm rolls over us, we must prepare for better days.

Autumn Statement – fortune favours the brave

In headline terms, the Chancellor’s Autumn Statement/Comprehensive Spending Review surprised many commentators, from its withdrawal from cutting tax credits to its lower than expected percentage cuts in many departmental expenditure settlements.  Nevertheless, overall, it remained an austerity budget based on higher taxation and lower public spending.  It is a settlement that, if fully enacted, will, itself, tend to detract from economic growth over the next five years.  Some of the measures, however, will re-direct activity to the private sector and, in theory, might ‘crowd in’ more private activity.

These ideas should be evident in the macroeconomic forecasts published by the Office of Budget Responsibility at the same time as the statement.  In fact, the forecasts offered are remarkably flat.  If the OBR is right, we are in for a period of rather boring overall macro trends with subdued growth in output and investment, in inflation, and in employment and productivity, leading to a gradual improvement in the public finances (see table).

OBR Forecasts November 2016 2015 2016 2017 2018 2019 2020
Real GDP (%ch pa) 2.4 2.4 2.5 2.4 2.3 2.3
Inflation (%ch pa) 0.1 1.0 1.8 1.9 2.0 2.0
Employment (%ch pa) 1.3 1.3 0.6 0.6 0.3 0.6
Productivity (%ch pa) 1.1 1.1 1.9 1.8 2.0 1.7
Investment (%ch pa) 6.1 7.4 7.1 7.0 6.6 4.5
Unemployment rate (%) 5.5 5.2 5.2 5.3 5.4 5.4
2015-16 2016-17 2017-18 2018-19 2019-20 2020-21
Deficit borrowing/GDP (%) 3.9 2.5 1.2 0.2 -0.5 -0.6
Debt/GDP (%) 82.5 81.7 79.9 77.3 74.3 71.3
Source: OBR

The more interesting facets of the announcements are micro in nature.  The local impacts of the devolution measures on governance and business rates, conformation of local development ‘growth deal’ funding, the creation of more enterprise zones, the infrastructure and house building proposals, and the buy-to-let stamp duty, apprenticeship levy and other taxes may have a profound effect on the way local economy’s develop over the next five years.  Although the central view is that this will not affect very much the underlying potential growth rate of the economy as a whole, there is plenty of cope for unforeseen consequences and distributional effects to be significant.

In SW England, we will be particularly intrigued to see how plans for devolution, (particularly the prospect of local government rationalisation in Dorset), and the new/extended enterprise zones at Dorset Green (Wareham), Bristol and Bath/Somer Valley, and Heart of the SW (Exeter and Bridgwater) will develop.  History suggests our expectations should be cautious … but, perhaps, fortune favours the brave.


Growth & Interest Rates

The SW purchasing managers’ indices (PMI) for October (just released) rebounded a bit from September’s lowish levels.  The UK recovery appears to be intact but it has slowed from the pace set earlier in the year.  Indeed, the PMI series peaked in January 2014 and they have tended to drop since then.  The latest output and employment balances were 54.1 and 52.6 respectively: the former was the eighth highest and the latter tenth highest (of 12), showing that the recovery is softer locally than in most UK regions and devolved administrations.  The slowdown is most evident in the weakness of new orders and business outstanding.

According to the Bank of England’s latest Inflation Report (November 2015), the softening of growth reflects international factors, especially slower growth in China, emerging markets and the EU.  These dampening effects come directly through physical trade but, more importantly, indirectly through financial exposures and markets: commodities, bonds and equity prices have all fallen in recent months.  Comparatively, the domestic economy is more robust, lead by some emergence of real incomes growth (+3%) and, at last, some positive change in productivity in Q2 2015 – although, so far, most of the recovery has been driven by an increase in hours.

Inflation remains about zero, largely reflecting the decrease in world import prices.  Core UK inflation is said to be more like 1% with wage increases starting to build price expectations.  The Bank says that interest rates will rise over time but, right now, it is signalling a further delay in the needed upward adjustment in base rates.  A return to ‘normal’ base interest rates of 4-5% is considered unlikely for many years.  An increase to a range of 2-3% would be welcome for normal economic working/incentives but is also probably more than two years away.

Inflation will start to rise as last year’s major drop in oil and other global prices fall out of the annual calculation.  This should mean an end to nearly 7 years of 0.5% base rates is imminent.  Central Bankers remain cautious, however, and there is a risk that policy increases come later and then have to be larger than might otherwise be necessary.  A slow rise to 1-1.5% over the next 12-18 months seems advisable but the resistance to action remains strong.  The danger is that tool little too late means more volatile adjustments … even renewed recession … in due course.

The recovery is less strong than it was.  The winter will probably see only modest growth.  SW businesses face a more difficult economy in 2016.


Pre-Election Budget … & Beyond

This is an excerpt from our latest Strategic Economics Report (see top of list alongside to right) which summarisess our view on this week’s budget and, importantly, the latest OBR forecasts.  If you need more detailed analysis, please get in touch.

The pre-election Budget of March 2014 was a little less austere than its recent predecessors, although the Chancellor suggested that ‘austerity’ in terms of overall taxation and government spending would have to remain in place throughout the next parliament (2015-20).  Much was made of the fact that the recovery is real and prospects of growth are better but, (as the table below shows), the official economic outlook remains, at best, modest.

Really, the macro perspective is little changed with the upward revisions to near term growth ‘paid for’ or ‘borrowed’ from the mid-term.  The Chancellor is promising even tighter public spending restraint after the next election and the opposition does not gainsay this approach.  The small ‘giveaways’ in recent announcements are more to do with bolstering support for next year’s General Election than any fundamental shift in fiscal policy or macroeconomic prospects.

Office of Budget Responsibility Forecasts: March 2014






Real GDP





Household consumption





Business investment





Government consumption





Net trade contribution





CPI inflation










Implied productivity





Implied real earnings










Current budget deficit





Public sector net debt/GDP





Source: OBR

Indeed, in the medium term, although a bit better, there is no significant increase in the contribution of investment and net trade (over what was thought before) whilst growth remains anchored around 2.5%.  Also, whilst productivity growth recovers to 1.6% per annum, it does not get good – certainly, not to rates really competitive with our stronger international rivals.  (It would need to get well above 2.5% for that.)  As a result of the OBR’s modest economic prognosis, the adjustment of the public debt, whilst better than was thought as recently as December, remains extremely slow.  There is no downward shift until 2016/17 and, then, we will still have a higher ratio to GDP than we have today.

Against this background, the Chancellor offered a budget for “makers, doers and savers”.  The measures to support business investment, to reduce business energy costs and to boost export engagement are welcome.  The rhetoric is appropriate, supporting all the incontrovertible arguments for rebalancing the economy towards more productivity-led growth.  The actions promised will help, yet the OBR forecasts suggest the impact will be extremely limited in macroeconomic terms.

In 2010-12, we were critical of the government’s fiscal approach for not being right for the condition of the cyclical economy at that time.  We are now much more supportive, believing that the fiscal stance is more appropriate for the current and prospective state of the economy.  The present issue is, however, whether enough has been done in terms of providing strong incentives for investment, trade and development.

There was little of specific interest to the SW economy, as opposed to any other part of the United Kingdom, in the latest fiscal announcement.  As always, the question is whether SW households and businesses react to the incentives offered in a way that boosts absolute and relative regional competitiveness, rebalancing the economy and its businesses towards higher value added and productivity-led activities.  As it has for decades, the challenge remains the dissemination of ‘best practice’, the growth of higher aspiration, and the expansion of value added capacity across the region.

Sustainable Recovery?

UK Economy

The UK economy has been advancing for almost a year:

a) real GDP growth reached 1.9% in 2013 and forecasts for 2014 are being revised higher – (I think growth could well exceed 3% this year);  b) the unemployment rate (7.1% in the three months to November 2013) is close to the Bank of England’s 7% ‘forward guidance’ threshold – (or, after this week’s Governor statement, should that now be “fuzzy guidance”); and  c) inflation is back to the 2% target (1.9 % in year to January 2014).

A current ‘snapshot’ of the economy would show, at long last, that it is approaching the peak level of activity achieved in 2008.  Perhaps, after six years of downturn, this level will be passed by the middle of 2014.

Important issues remain, however:  a) the UK’s public sector debt to GDP ratio exceeded 75% in the final three months of 2013 and is not expected to fall soon;  b) the trade deficit continues to disappoint (again over £108bn in 2013);  c) productivity ratios are poor (manufacturing output per hour fell in each of the seven quarters to Q3 2013); and  d) average real earnings are still shrinking (earnings up 0.9% versus CPI inflation of 2% in the latest figures).

So far, the recovery is being ‘pulled’ along by consumption and housing, reflecting a replacement and pent up demand cycle.  With household real incomes under pressure and interest rates artificially low, doubts about the sustainability of the recovery will persist … unless more contribution comes from the ‘push’ factors of investment and exports.

UK Manufacturing

Against this macroeconomic background, manufacturing is recovering (the latest GDP release suggested it increased by 2.6% in the final quarter of 2013 compared with a year earlier).  But, it still has ground to make up.  In 2013, manufacturing was 0.6% lower than in 2012 and total manufacturing output was still 9.1% down on the pre-downturn high at the end of last year.

Several key manufacturing areas/companies weathered the downturn well and are now on an upward trajectory – particularly, those with high added value, cutting edge products and those selling to the stronger international markets.  But, performance has varied enormously by sector.  As the table below reveals, there was a wide range of experience in 2013 from a ‘mini-boom’ in transport equipment/motors to a ‘bust’ in other machinery and clothing.

UK Manufacturing output in 2013 (% change on 2012)

























Source: ONS

Two key questions remain.  First, has the downturn resulted in a permanent or temporary loss of overall manufacturing capacity?  Second, when will investment spending pick up?  On the first question, time will tell, but the huge goods trade deficit indicates that large gaps persist in the UK’s manufacturing supply chain and suggests an on-going imperative to spread ‘best practice’ across UK manufacturing.  On the second question, recent surveys offer some positive news.

Survey Evidence

In line with the better, but still problematic, overall economy outlined earlier, respondents to the latest proprietary surveys suggest a more positive outlook for manufacturing activity generally and the SW economy in particular.  The January PMI series, for example, leaves no doubt that prospects are improving across the SW region compared with its own experience over the last few years and compared with other parts of the United Kingdom.  In this, and other surveys, larger percentages of private business respondents are expecting higher turnover and more employment in 2014.

Moreover, more enterprises are considering higher investment in plant and machinery, business premises and new technologies.  Given the need for ‘economic rebalancing’ in demand patterns and sector supply (output, employment and trade), the UK economy would be helped by a wave of increased investment that pushed growth towards higher productivity and better returns.  Any increase in innovative investment would be a welcome sign for a more sustainable recovery.

There is growing evidence that the UK economy is improving.  Uncertainty persists, especially as to whether the demand-led recovery fizzles out before new investment kicks in.  Through 2014, we will be looking for more investment-led growth and less reliance on housing-led consumption.

Downturn may be receding but upturn still far off

In the second quarter (Q2) of 2013, the UK economy expanded by 0.6% quarter-on-quarter (qoq) and 1.4% year-on-year (yoy).  This was a modest, but welcome, improvement, albeit from a low base: the economy is still mired in its downturn – in Q2, output was 3.3% below its pre-recession peak of the first quarter of 2008.  Within the total, services grew 0.6% qoq and 0.5% yoy respectively in Q2, production 0.6% qoq and 0.9% yoy , and construction 0.9% qoq but -1.0% yoy.  Services are almost back to where they were in the late 2000s but manufacturing and construction are still well down on previous highs.

In aggregate, falling real incomes, poor access to finance, public austerity and weak net exports and investment are still restraining growth.  Even if sustained, high risks remain and the apparent recovery is likely to be an uncertain affair.  Nevertheless, it seems more real than before because some of the recent business surveys are indicating a positive shift in confidence and action.

For example, the purchasing managers’ index (PMI from Markit/Lloyds) for both SE and SW England recorded expanding output, new orders and employment in each of the last three months (April to June).  By the end of the period, all were running higher than they have done for some time.  This suggests that, in spite of the dampening effects of UK stabilisation policy, an upturn has begun.  It could all fall away again, especially if further international shocks occur.  But, right now, we can anticipate better growth in the second half and, thereby, the year as a whole.

Across the south, the better economy has been reflected in falling claimant count rates.  The following list shows the latest (June 2013) rates for our nearby local enterprise partnership areas.  All of them are lower than a year earlier and lower than the English average (3.4%):  Buckinghamshire Thames Valley 1.7%, Coast to Capital 2.3%, Cornwall & Isles of Scilly 2.3%, Dorset 1.9%, Enterprise M3 1.4%, Gloucestershire 2.5%, Heart of South West 2.2%, Oxfordshire 1.4%, Solent 2.3%, South East 2.9%, Swindon & Wiltshire 2.2%, and West of England 2.7%.  Moreover, they are all lower than one might expect after five years of downturn.

For individual firms, it is still a very mixed business picture out there. Some are growing and hiring; thanks to strong order books, including exports, and good value added/profitability.  Others are barely hanging on, with low productivity, poor demand and, therefore, weak investment intentions.  A more positive mood is emerging but it is relative to where we’ve just been rather than than where we could be.  Significant output and earnings gaps remain and will not close soon.  Long-term imbalances remain to be addressed and growth of about 1% in 2013, perhaps doubling in 2014 still leaves the economy well below potential.  We are not out of the woods yet.

Despite the continuing pain of austerity, what goes down will come up in the economy.  We may just be at a point where the outlook is brighter.  Remember, however, that it will be some time before we can confine the current, long downturn to history and start to use the word upturn.

No Stone Unturned

No Stone Unturned – this week’s report from Lord Heseltine for the Prime Minister, HMT and BIS – covers a very wide range of matters related to non-macro economic policy.  It talks about a national-to-local approach for economic development, with an emphasis on a renewed spatial (localism) and industrial (sector supporting) policy.  There is a lot to applaud.  There is also a lot of deja vu.  It is good to see some sensible ideas being brought back that were lost in 2010-11.  (It is still such a shame that the integrated expertise lost with the closure of the RDAs will be expensive and difficult to re-learn).  Essentially, it offers the potential for some real impact from localism by re-recognising the imbalance of economic performance between London and the rest of our places.

The report recommends changes to central government organisation for development, including merging of existing functions and funding into a “Single Pot” for local development.  (This pot is estimated at £49 billion, taking £17bn from/for skills, £15bn from/for infrastructure, and other billions for employment and business support, housing, innovation and commercialisation).

Locally, Heseltine advocates a rationalisation of local government into a universal unitary system with a stronger responsibility for local economic development.  It also suggests greater capacity and funding for Local Enterprise Partnerships (LEPs) but, recognising their variable performance to date, it also suggests a review of ‘borders’.  This seems to infer mergers into more sensible functional economic areas that can bid to the new ‘single pot’.  Competition for funding is expected to drive investment ideas to a higher level of local impact.  A requirement will be a good Strategic Plan and state of the art evaluation.  (Strategic Economics can help with those!).

Finally, the ‘No Stone Unturned’ report talks about Local Growth Teams in government (Government Offices reborn?) and wants a bigger role for Chambers of Commerce.  It has an interesting time line too, with much to be done over the next few months and through to 2014.  It will be interesting to see which of the 89 recommendations the government accepts and, importantly, implements.  If it ends up with a permanent but flexible development structure that is focussed on the long-term competitiveness of our businesses and places, this economist will shout a huge “hurrah”.  In the short term, please excuse my scepticism.


Relationship v Deal Banking

In a previous part of my career, I worked as an industrial economist for one of the clearing banks.  At one time, I was an expert on the food and drink industries and later, I was responsible for the motors and transport industries – across the world.  In those days, I supported the corporate bankers who were, themselves, experts on the banking needs of particular industries.  They had close relationships with the ‘primes’ and other companies across each sector.  In turn, this was supported by the regional branch network where the managers knew local companies well.  This was a successful and profitable model based on ‘relationship banking’.

After ‘Big Bang’ in 1987 and the gradual merger of investment and corporate banking, the world of UK banking changed.  Initially, the ‘deal-based’ banking of the investment bank was often unprofitable.  Tying it in with the very profitable corporate bank made investment banking viable.  The irony was that the deal culture of (American) investment bankers steadily took over from the relationship culture of (UK) banking and, thereby, destroyed an important conduit of credit and growth for UK businesses.

The ‘credit crunch’ has shown us the result of this folly.  Contrast it with the federal, integrated ‘mittelstand’ approach to banking still prevalent in Germany.  With the state effectively owning RBS and Lloyds, the opportunity to restore a corporate banking structure based on local relationships is clear.  Come on Osborne, Cable and Balls, get together to create regional corporate banks that establish a relationship between local wealth/investors and local exporting/growing businesses and locally expert bankers motivated by earning returns on successful real local investment.

A SW bank for a SW economy would start to get us out of this mess.


Views from the Real economy

This week, I have been on the road with the BBC (see Points West – next three Tuesdays) gauging the opinion of businesses across the West of England.  The context was the fall in UK real GDP in the April-June period, confirming three quarters of renewed recession – a deep double dip.

First, I talked to customers and owners at a builders’ merchants in Glastonbury.  These, by definition, were the guys who have work rather than those that have been laid off. Therefore, they were more positive than the 5.2% drop in UK construction might suggest.  The negatives they mentioned were the ever increasing costs of materials, high rates of VAT and National Insurance, the lack of credit from banks (for themselves and customers), and the intense competition when tendering in the market.  They said that profits are harder to secure but there is work out there.  The positives discussed were that Somerset residents are willing to spend on repair and maintenance, extensions and other refits; at least those with cash who do not need to borrow.  The market for smaller builders is not bad.  The problem is in the larger developments and major housing developments.  Those markets are dead.  This picture fits well what is revealed by the detailed statistics on construction below the headline GDP measure.  Outside London, big infrastructure and other projects are scare but repairs and maintenance, and the ever expanding supermarkets, are still relatively buoyant.

Second, in Bristol, I met some accountants and business advisers in a couple of major local firms.  They represented the large “office worker” community in business and financial services sector in the city.  The GDP release showed this to have grown, by just 0.1% in the second quarter.  The “advisers” were more candid than I expected, recognising that their business is held up better than most by the regulatory need for all businesses, in good times or bad, to pay tax, provide accounts and meet other statutory requirements.  There are fewer major deals out there and many that exist are for distress and restructuring rather than growth.  Business services often get wind of a recovery fairly early as property and ownership deals that will see the light of day some time from now should start to be planned and discussed today.  Currently, this light at the end of the tunnel is not apparent.  One of the discussants saw at least two more lean years ahead.

Third, I went to Swindon, where there is a marked contrast between some major national and multinational corporates doing well, (although even Honda announced some production cuts whilst I was there). and a number of boarded-up shops and outlets in parts of the town centre.  There, I met some long-established retailers with interesting opinions about the mood of consumers.  To summarise, they felt they were doing relatively well in very competitive market conditions because they had lived through recessions before.  They had re-focussed on “quality products and service offering customer value” and had, thereby, retained customer loyalty.  The top-end of the retail market is still strong, because real earnings for households in that bracket are still growing, whereas the bottom-end, affected most by the lack of discretionary spending, is weak.  The main problem, however, is in the broad “squeezed middle” where the retail market has moved towards “value niches” and away from “commodity” goods.

So, what do we conclude?  For policy makers, all three sectors talked about the need to reduce the burden on business, especially with respect to the costs of taking on new staff.  All mentioned access to credit, taxes (VAT and National Insurance), and “red-tape” as a current restraint on growth.  All believed the state needs to get out of the way of business and growth, but recognised the damaging effect on confidence caused by the uncertain macro environment.  From the eurozone crisis to the austerity debate, there is a need for leadership.

This is a SW economy still in a long transition from unsustainable boom to limited recovery.  The downturn is deep and long and business people in these three areas of the economy do not see an end to it soon.  Against this background, there is no alternative to controlling costs, focussing products and services on quality and value, and investing carefully in staff.  I came away optimistic for the long run, because good SW businesses are taking the right steps to capture the opportunities of the prolonged downturn, but pessimistic for the short run, because the prospects for demand remain bleak for many.

The Great Unknowns

Further to last week’s post, we have received some very mixed signals over the last seven days.  a) Stock markets in retreat as Spain’s banking system  takes the heat.  b) Some bad manufacturing PMI readings for May both in Euro-zone and the UK.  c) Some degree of bounce in business confidence despite consumer reticence.

For example, the latest ICAEW business survey for Q2 2012 revealed a remarkable turnaround in SW business confidence, swinging from a big negative to a sizeable positive despite Europe’s travails.  If sustained, this augurs well for the second half of 2012.  Business confidence reached its highest rating since Q3 2010 and could be interpreted as meaning the ‘double dip’ recession is already over.  Sales volumes grew faster than any time in the downturn so far.

The question is whether overseas risks provide further negative shocks and domestic consumers respond to business optimism and summer parties (Diamond Jubilee, soccer championship in Europe and London Olympics).  The ICAEW survey shows businesses still hesitant about final demand.  So, the great unknowns – will these summer events be positive and more than temporary and will the euro-zone re-construct without severe disruption?