British Economy in Deep Trouble Sterling to Suffer

By: MoneyWeek

Hopes that Barack Obama's 'New Deal' spending spree can save the global economy saw share prices bounce sharply yesterday.

The FTSE 100 ended more than 6% higher, climbing 250 points to 4,300.

However, the excitement over the extra $500bn to $1 trillion set to be splashed out on the US economy hid a raft of gloomy economic news on this side of the Atlantic . Stock market investors might have been happy to ignore it – but currency traders were paying more attention...

The British economy heads into deeper trouble

The pound took a tumble yesterday, as it became ever more clear that the British economy is heading for deeper trouble – which in turn, likely means lower interest rates.

For one thing, the threat of deflation still looms large. The cost of goods leaving British factories fell by 0.7% last month. Prices were 5.1% higher year-on-year, from an annual rate of 6.7% in October. Manufacturing costs also fell, down 3.3%, cutting the annual rate of inflation from 13.8% to 7.5%.

And despite falling prices, consumers aren't being tempted into the shops in numbers large enough to help retailers. The British Retail Consortium reported that the total value of high street sales fell 0.4% on the year before. In October, it was down 0.1%. That's the first time the survey has shown a consecutive drop in total sales since the data started being compiled in 1995. Like-for-like sales, stripping out new retail floor space, were down 2.6% year-on-year.

That's grim enough. But a report from retail consultancy Verdict, suggests the downturn could last for longer than even the most downbeat forecasts. Next year will be the worst for the high street since 1965, the group says. Neil Saunders, consulting director at Verdict reckons that consumers still don't appreciate the scale of the recession, and that spending will be slashed next year.

In fact, the group doesn't expect retail spending to start growing again until 2014 or so. James Flower tells The Times : "The length and depth of the retail downturn will test even the strongest of retailers and some will not last the course – at least in their present form."

Falling sales means falling profits, and that means cost-cutting. So it's no surprise to learn that employers aren't keen to take on more staff. Employment services group Manpower says that employers' hiring intentions for the first quarter have hit a 15-year low.

And with all this insecurity about, who'd want to buy a house? So again, not a big surprise to hear this morning that in the three months through November, house sales managed to hit a new 30-year low, according to the Royal Institution of Chartered Surveyors (RICS). Estate agents sold an average of 10.6 properties over the period – less than one house a week.

The strength of the pound looks set to fall further

So it's little wonder that investors are betting against sterling. The pound hit a fresh all-time low against the euro at one point yesterday, with one euro costing 87.38p at one point. The slide is becoming so bad that it threatens to shove Britain right down the pecking order of global economic powers.

In 2007, Britain was the world's fifth-biggest economy in dollar terms. In 2009, the Centre for Economic and Business Research says it could be reduced to seventh place, behind France and Italy .

In a way, this doesn't mean that much. After all, few people would describe Italy as a model economy, so your ranking on the list isn't necessarily any indicator of quality. But it does give quite a graphic picture of Britain 's reliance on the financial sector. Without the finance boom, we'll lose a lot of clout in the world. And the downturn means we can't rely on consumption to keep our economy propped up.

Something will take its place eventually. But right now it's hard to see what.

The FTSE 100 is detached from the British economy

So why were stock markets so buoyant? Well, they've been looking for an excuse for a Christmas rally, and Mr Obama gave them it. And apart from anything else, it just shows how detached the FTSE 100 actually is from the British economy. A hefty chunk of the profits in the index are accounted for in dollars, so the fall in sterling is no great disaster, particularly for sterling shareholders receiving dollar-denominated dividends. The importance of the British economy to multinationals such as BP, GlaxoSmithKline and BHP Billiton is negligible. Their main problem is that this is a global slowdown, not just a local one.

But that said, even with the global outlook as grim as it is now, some stocks look cheap. We wouldn't say it's time to buy the index, but for those with a long-term view, some big blue chips look very attractive at these levels. We'll have a rundown of the ones we like in the next issue of MoneyWeek, out on Friday. If you're not already a subscriber, then get your first three issues free here .

By John Stepek for Money Morning , the free daily investment email from MoneyWeek magazine .

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