Britain: Will Consumers Keep the Economy Afloat?

The Sept. 11 terrorist attacks on the U.S. and the global fallout will pose a stiff challenge for Britain's two-track economy.

Prior to the attacks, slumping world demand had already pushed British manufacturing into a recession, dragging down overall growth. However, buoyant consumer spending, lifted by lower interest rates, strong labor markets, and rising home prices, had kept the service sector vibrant--and the economy chugging along. Plus, a U.S. recovery was waiting in the wings to lend support to manufacturers.

Now all that has changed. Economists believe Britain will struggle to grow 2% both this year and next, but the outlook could worsen, depending on the severity of the U.S. recession and the hit to British consumer confidence and spending. Exports, already falling in the third quarter, will drop further, and business investment is sure to suffer as businesses put capital projects on hold. Stock prices are down 9% since the attacks.

The manufacturing slump will only deepen. Based on a pre-Sept. 11 survey by the Confederation of British Industry, September factory orders fell to a 2 1/2-year low. Post-Sept. 11, travel and tourism are down, and British Airways PLC (BAB ) is cutting payrolls and flights. The CBI's quarterly survey and the purchasing managers' report, due in October, will give the first key readings from the factory sector.

Domestic demand, while vulnerable to new weakness, will retain important supports. Rate cuts by the Bank of England, from 6% in February to 4.75%--including an intermeeting quarter-point cut on Sept. 18--will help to shore up private consumption. The monetary authorities are expected to follow with another quarter-point cut at their Oct. 4 meeting. Other major central banks made half-point moves after the crisis.

Also, government spending on health, education, and transportation is starting to pick up in line with previously announced spending plans. In the next few months, however, measures of consumer confidence and spending hold the key to the outlook.

By James C. Cooper & Kathleen Madigan

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