The credit crisis?

Those who are based in London but venture further afield now find that things are quite cheerful away from the ‘smoke’. Manufacturers have been doing well. The Engineering Employers’ Federation looked hard for bad news in its fourth quarter survey of industry but it was difficult to find.

When they get back to Euston or King’s Cross, however, they find that the credit crisis has resulted in a mood of deep gloom in the financial markets, and in London’s banking parlours.

Will these two worlds come together during 2008, so that the credit crisis drags down the rest of the economy? Or will this turn out to be one of those scares that Britain has been pretty good at shrugging off in recent years?

Even the 9/11 attacks on America, the bursting of the dotcom bubble, and a four-year climb in oil prices from just over $20 a barrel to nearly $100 failed to derail the UK’s 15-year run of economic growth. Can the credit crisis succeed where all these shocks failed?

The potential for the credit crisis to do some damage comes in three main ways. The first, as discussed here in the wake of the Northern Rock ‘rescue’ in September, is that it could undermine global economic growth, the main source of the current strength in manufacturing.

Here, several things have been happening. Forecasts for the US economy have been getting progressively gloomier, with some prominent economists warning that recession will be hard to avoid. Growth forecasts for Europe and Japan, similarly, have been revised down. There has not, at time of writing, been a corresponding adjustment in growth forecasts for China, India and the other fast-growing Asian economies.

The big picture, however, is that after four years of very strong global growth, averaging five per cent a year, something slower is in prospect for 2008. That does not mean very weak growth, something close to four per cent remains likely. But it will feel slower and, to the extent that Britain’s main export markets are in Europe and North America, maintaining sales growth will be more of a challenge.

Secondly, the credit crisis will impact directly on business’s borrowing costs. I had hoped by now that we would have said farewell to the very high money market rates of August and September, as we did for a while in October and November. But as the end of the year approached and banks once more scrambled for liquidity, the three-month Libor (London interbank offered rate) rose sharply again.

This, of course, has a significant real-economy effect, with 60 per cent of business borrowing in Britain Libor-linked. The Bank of England cut base rate from 5.75 to 5.5 per cent in December, for which many in business were grateful. But the rise in Libor was equivalent to a rise of one per cent in Bank rate. The hope is that it turns out to be temporary. If not, many businesses will feel the squeeze.

Finally there is the squeeze on the household sector. Rising food and energy prices, and higher mortgage costs for many families (particularly those ‘re-setting’ the fixed rate mortgages taken out a couple of years ago), imply that spare cash will be in short supply. The talk is of a rise in consumer spending of only one per cent, the weakest since 1992. The housing market will not be providing any impetus either, and could act as a significant drag on activity, as discussed last month.

So there will be effects from the credit crisis on the real economy. Some of the gloom currently enveloping London will spread. If the economy grows by two per cent overall in 2008 it will have done well.

We should not, however, get too gloomy. It is possible to paint a picture of a self-reinforcing downturn in which the supply of credit, the lifeblood of a modern economy, dries up entirely. That, however, seems unduly pessimistic. The economy has acquired a lot of resilience over the past 15 years. 2008 will be a chance to prove it.