Slowdown will play havoc with Brown's fun

London Briefing: The news on the UK economy has suddenly started to deteriorate in a way that will alarm Gordon Brown and strike Michael Howard as slightly ironic.

Latest data on industrial production were shocking and were preceded by several warnings from high-street retailers about a rapid slowdown in consumer spending. It seems that the links between the housing market and UK consumption are much stronger than the Bank of England would have us believe.

City economists are falling over themselves to become the most pessimistic forecasters. Growth estimates are declining and speculation is growing that the next move in interest rates could be down.

Most of the blame for the rapid deterioration in the business environment is laid at the door of higher interest rates and the impact that they have had on consumer spending and confidence.

The central bank has stated on previous occasions that it believes the connection between property prices and consumer spending is not that strong. Given that the property market has been slightly more robust than expected, most commentators now think the bank is wrong.

Gloom merchants now expect the next phase of weakening to come via the labour market. Weak manufacturing output is expected to translate into falling employment and it can only be a matter of time before the retail sector takes the axe to headcount.

The daily headlines about a looming pensions crisis merely add to the argument that the UK consumer is about to save more and, therefore, spend less. The average British shopper now has a debt/income ratio of 140 per cent, much higher than his US cousin, also heavily indebted.

All of this has a plausible air to it and is certainly backed by an increasing amount of evidence. One puzzle, however, is the continued relative strength of sterling. If the UK economy really is falling off a cliff, we might presume that the boys and girls in the foreign exchange markets would have noticed. Sterling has recently risen against the euro and is holding its own against the dollar.

Correspondingly, the money markets are also seriously underwhelmed by the idea that economic Armageddon now looms: interest rate futures suggest that rates are going to remain unchanged for as far as the eye can see. Money market operators, if they agreed with the economic doomsters, would be rushing to price in interest rate cuts.

That's precisely the point say the economists: a key reason for expecting a severe economic slowdown is an expected tardy response from the Bank of England. A reluctance to cut rates will turn the gathering drama into a crisis. Presumably, if the economy is as sensitive to interest rates as recent evidence seems to suggest, quick cuts in rates will head off any major problems. The pessimists, essentially, need the Bank of England to make a mistake.

Which is all a bit odd really. Not too long ago we were lauding the UK central bank for a performance that was second to none among its global peer group. To base a forecast on a big mistake that the bank has no history of making looks a bit of a stretch. And, to be honest, all of these increasingly shrill forecasts of an economic collapse are based on data that could just as easily start to go the other way.

But the debate is about the size of the slowdown, not whether one is occurring. And that is going to play havoc with Brown's fiscal arithmetic. The Chancellor has trumpeted his reputation as a forecaster because his rosy prognostications have, to be fair, been accurate. But he is persisting with this optimism in the teeth of mounting evidence to the contrary. And it will only take the mildest of slowdowns to blow a hole in the borrowing numbers.

One of the factors depressing consumer sentiment is undoubtedly the prospect of higher taxes. The way the sums go, it won't take much of a slowdown to force Brown to abandon his self-imposed borrowing rules or to raise taxes. If he sticks to his rules, he could be raising taxes within a year. Which, when you think about it, isn't going to do much for the economy.

Brown's last few years (or should that be months?) as chancellor are going to be lot less fun than the first eight.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.