Britain: The Perils of a Fast-Slow Economy

Britain's two-speed economy continues to challenge both economic forecasters and policymakers. Consumer spending and services are running fast, while foreign demand and manufacturing remain stuck in the mire. The question now: Will this year's nearly 30% slide in stock prices slam the brakes on consumer spending and force the Bank of England to cut interest rates?

So far, the outlook for consumer demand remains bright. Borrowing is strong, as consumer credit rose in August by the most in 20 months, and September data were broadly upbeat: House prices kept up their relentless surge, providing an offset for wealth losses in the stock market. Consumer confidence rose, while surveys show continued strong activity in the service sector.

Moreover, labor markets remained robust in September. Although layoffs in manufacturing are rising, retailers are hiring at a healthy clip, and unemployment continues to fall. Also, average earnings are rising 3.8% annually, much faster than the 1.7% pace of retail inflation.

But at the same time, plunging stock prices and a deteriorating global outlook are hammering confidence among manufacturers, pushing down business investment to its lowest level since 1997. August industrial production was especially disappointing, reflecting sharply weaker exports to the 12-nation euro zone, which accounts for half of Britain's foreign trade.

Indeed, the most effective monetary policy for Britain might well be an interest-rate cut by the European Central Bank. Despite factory weakness, the Bank of England is wary that a rate cut at home would only further fuel the unsustainable housing boom, which has powered domestic demand and helped to push service-sector inflation to 4.8%, even as goods inflation has fallen to -0.9%. Plus, the bulk of last year's rate cuts are still percolating through the economy. The ECB is still talking tough, but economists are starting to expect a euro zone rate cut by yearend, a move Britain's monetary authorities would welcome.

By James C. Cooper & Kathleen Madigan

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