Telling the truth about SME life today

What do we know about the economy?

Quite a lot, is the simple answer. You’d be mistaken if you thought changing the last digit of the year on the desk calendar would usher in a happy new year. There are five tentative conclusions we can make.

The first is that the bond market was more on the money when it came to the outlook for the US economy, whose fortunes will to a greater or lesser extent determine ours.

For some time the yields on US government bonds – a ready reckoner for market views on interest rates – have been screaming recession and the need for drastic action for some time.

The second is that over that period, stock markets have priced in continued strong earnings growth and a broad disinterest in the idea of recession. On 21 January, stock traders got into line with their colleagues on the fixed income desks and sold equities.

Third, hopes that the various key regional blocs had “decoupled” from each other may be misplaced. Share values plunged around the world as markets in countries as far a-field as Brazil, India and Australia suffered a collapse in confidence.

Traders decided that concerns over a US recession, sparked by the downgrading of Ambac, a bond insurer, by a ratings agency the previous Friday, meant weaker export growth elsewhere in the world. The US Federal Reserve finally responded with a 0.75 percentage point cut.

Fourth, the UK authorities, too, will take action to prevent the situation worsening, but with nothing like the vigour shown by Ben Bernanke and his colleagues.

Mervyn King, the Governor of the Bank of England, laid out his stall last month. The current level of interest rates was “bearing down” on the economy. However, he warned higher energy and food prices along higher import prices thanks to the weaker pound would push inflation above 2 per cent, leaving the bank facing “a difficult balancing act in the course of 2008”.

This month, the bank has cut rates by a quarter of a percentage point. It’s likely that the bank will now wait to see how events bear out. If they take a turn for the worse it will cut, but not if vice versa.

As things stand, the former option looks more likely. The economy is slowing and is likely to slow further as the housing market weakens and consumer spending lags in tandem.

The hope – if that is the right word – is that this slowdown will reduce domestic inflationary pressure by enough to allow the bank to react by reducing its base rate.

The fifth tentative conclusion is that bad news can emerge from any quarter. As traders and analysts were struggling to make sense of the stock markets falls, news emerged of a €37bn fraud at a French bank.

The alleged trades made by Jérôme Kerviel forced Société Générale to write down €5bn of losses, dwarfing the provisions it was making on its investments in the US subprime housing sector.

Perhaps a more telling observation came from Gordon Brown in his speech to the World Economics Forum in Davos. He said: “There is a danger, with bad news still to come, of being over-optimistic about what we can achieve and over-emphasising the silver lining at the expense of the clouds.”

Within a business environment, this outlook gives muscle to the finance director. The chief executive’s job is to look over the horizon and see the silver linings; the FD’s job is to remind the board of the cloud.

If the UK is entering a period of declining growth, continued risk aversion and declining export markets, the order of the day will be a tight control of costs.

Picture source


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