Britain heads down hill as Europe turns corner

Just as Britain seems to be heading towards a recession Europe's economy has finally turned the corner. All the latest data from the other side of the Irish Sea suggests an economy on the brink of a recession. It would appear that a strong sterling has done to the British economy what the strong Deutschemark did for Germany only three years ago push it into a period of growing unemployment and sluggish growth at best.

As Ms Alison Cottrell, chief international economist at Paine Webber points out, the graph of consumer confidence in Britain bears a disconcerting resemblance to a cartoon character who runs off the side of a cliff but nevertheless keeps going until he eventually looks down.

Business confidence is also evaporating and in the short run it seems that nothing will be able to save the economy. The only question is whether the slowdown will be short and sharp, or slow and prolonged. Either way it is unlikely to be as bad as in the late 1980s or early 1990s, but will almost certainly involve rising unemployment.

The slowdown also looks likely to arrive sooner than many had predicted. Until recently many commentators assumed that Britain would join the single currency when its growth rates converged with those in Continental Europe. That was expected to happen as Britain slowed down and Europe speeded up. But with Continental growth levels picking up dramatically, and the British slowdown appearing more broad based by the week, this could happen as early as next year far too early for prime minister Tony Blair to call a referendum on entry to the single currency.

Nevertheless it is likely that much of the credit for growth and falling unemployment in Europe will be put on the euro and much of the blame for Britain's slowdown on its lack of membership. Both contentions are probably equally wrong.

But Europe is certainly turning the corner. In the first three months of this year the euro-zone states grew at an annual rate of 3.2 per cent. Germany is predicting growth of 3 per cent this year, while France is expecting to grow even more quickly.

Overall economic sentiment is now back at levels not seen since the fall of the Berlin Wall. Following the reunification of Germany, confidence plummeted and a late recovery was stopped in its tracks as the mark soared on international markets.

Eventually, the Bundesbank engineered a fall in the value of the currency and the early signs of recovery began to emerge through export-led growth. And this year domestic demand had begun to impact even if the consumer is still reluctant to spend. Rising spending is still concentrated on cars, services and even holidays.

On top of that, the financial services and high-tech sectors are also taking off. But consumers are still staying away from the shops; soaring unemployment had dampened confidence and many have still to return.

In Italy and Spain, large cuts in interest rates have had an impact and both consumer and business confidence levels are at their highest levels for almost 10 years. And European institutions believe the confidence is here to stay. The European Commission is predicting that growth across the euro-zone will average 3 per cent again next year.

There have even been suggestions in the Financial Times that Europe is entering its Goldilocks phase, a rerun of the US's remarkable not-too-hot and not-too-cold economic performance of the 1990s.

But things are looking rather different for British chancellor Gordon Brown. His liberalisation of the Bank of England may well lead to more stable economic cycles in the long run, but in the short term the bank has pushed interest rates higher than a politically-motivated chancellor may have done.

Governor Eddie George also missed an opportunity to hike rates earlier this year which would have brought the cycle to an end sooner and may have made it easier to begin cutting.

But soaring rates and the resultant strong sterling mean British manufacturers have been feeling the heat for some time. And the malaise may be spreading even further.

Factory orders from overseas and domestic buyers have fallen to a 12-year low. On top of that, business leaders expectations are lower than at any time since July 1991, while intentions to invest in plant and machinery have also hit their lowest point since then.

Business confidence has plummeted to a low of -43 and on all three previous occasions where confidence dipped below the -40 mark a recession followed.

Academics and economists across Britain are now arguing that monetary policy in Britain is hurting manufacturing without tackling the source of most inflationary pressure the services sector and particularly wages. Analysts are expecting growth to come in around 2 per cent this year and around 1.5 next year. But with consumer sales still surging ahead they have now hit £1 billion for seven months out of eight and with credit card transactions at a high, the bank will be very reluctant to actually cut rates.

It now appears more likely that the British and German economies will pass each other when Britain emerges from recession and Germany is next slowing down, perhaps in 2002 although predicting anything more than a year out is almost impossible.

Mr David Brickham of Paine Webber says by 2001, Britain will once again be hiking rates having cut them next year and the euro-zone rates should be on the way back down having seen some hikes this year and next.