The British Economy: Time For The Fire Brigade

The economy is so hot, the Tories may have to cool it off

Restaurateurs have never had it so good. London superchef Marco Pierre White already has three successful upscale restaurants in town, and he is about to launch two more. One will feature a collection of works owned by shock artist Damien Hirst. The pieces de resistance: skinned cows' and bulls' heads floating in formaldehyde in the rest rooms. "It will be the coolest place to go," promises the 33-year-old White, who predicts that the demand for eateries such as his, where prices reach $250 per person, will continue to grow "for another four years--minimum."

While the restaurant boom is helping the British economy, it also may be a sign of overheating. Consumer spending is racing far ahead of manufacturing, which is barely growing. With wages up and unemployment at 7.2%, its lowest level in five years, major retailers are reporting close to 10% sales growth. That old British staple, champagne, is moving at its fastest clip in five years--20% above last year. Fueled by cheap mortgages and rich paychecks in the thriving financial industry, price tags on prestigious London properties are rocketing up at a 10% to 15% pace this year. "People are thinking, `Let's get on the bandwagon before it leaves us behind,"' says Paul Tayler, director of Hamptons International, brokers to the smart set.

All of that leaves Kenneth Clarke, the Chancellor of the Exchequer, with a tough call to make as he works out the final details of the budget for the fiscal year starting Apr. 1, to be presented on Nov. 26. Should he put on the brakes out of concern that inflation and other byproducts of hot growth are getting out of hand? Or would that be political suicide for the ruling Conservative Party?

Despite Britain's having the strongest economy among the major European powers, the Tories still badly trail Labor in the polls. Their best hope is for the cheering effects of a continuing recovery to turn the tide by next May, when they have to face the electorate. Yet Clarke, who controls both fiscal and monetary policy, can't just let things rip. But the markets, already edgy about inflation, would react to big tax cuts by pushing up interest rates, which are among Europe's highest. There would also be more upward pressure on the pound. The consensus is the most Clarke can offer is about $5 billion in tax cuts offset by equal trims in spending.

The trick is to avoid the boom-and-bust cycles that have plagued Britain in recent years. After several years of recession and slow growth, the economy is doing well. Growth could hit a very respectable 3.5% next year. But there are worrying signs. Inflation has been creeping up. It hit an annual rate of 3.3% in October--far from a disaster but well above the government's 2.5% target for the year.

High yields are attracting investors to British securities, driving the price of sterling even higher. The pound has appreciated more than 7% against the dollar and almost 6% against the German mark since Sept. 30, and the momentum is building. Neil MacKinnon, chief economist at Citibank in London, thinks there's a chance sterling, now $1.67, could hit $1.90.

HARD PLACE. That would be a disaster for British manufacturers, who are already alarmed. Richard Freeman, chief economist of chemical giant Imperial Chemical Industries PLC, a major exporter to the Continent, says the zooming currency is trimming the company's margins. And Brian Moffat, CEO of British Steel PLC, warns that the strengthening pound is a concern for his British customers who export.

The truth is that Clarke doesn't have much choice but to try to cool things off. The Tories may have more votes to gain from diners-out in London and homeowners comforted by rising house prices than from factory workers worried about jobs. But an overheated economy will eventually shut down consumers as well as plants.

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