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Confounded

Daar Gordon, Now Might Be A Good Time To Call An Election

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If GB had actually had his fingers on the pulse he would have called an election before NR in the summer, he may be cutting it a bit fine now! Having said if he really did understand what was going on, in his time as Chancellor he could have avoided this mess and negated the need for this rushed election.

http://business.scotsman.com/economy.cfm?id=1559692007

Memo to PM: things can only get bitter...

BILL JAMIESON

Dear Prime Minister

YOU have asked us to prepare a summary report on the immediate outlook for the UK economy. This, as you said in your telephone call, was to cover inter alia an assessment of the turbulence in financial markets, the ongoing effects on the banking system with particular emphasis on lending capacity and constraints.

You also asked for an impact assessment on the UK housing market over the next 12 months and how these factors, singly or in combination, might impact on public confidence in the economy and specifically the government's macro economic management.

This request places us in some difficulty. As you will be aware, unforeseen events can impact very quickly on the financial system and economy. And as the Northern Rock affair demonstrated, public confidence in the arrangements for banking supervision can evaporate with lightning speed. As the problems in the wholesale money markets are still playing themselves out, it is impossible to make any prediction with any certainty given the way problems have suddenly appeared in the most unexpected places.

The pace of economic slowdown in America and Europe has also to be considered given the impact on demand for UK exports as well as for overseas investment in the UK in the immediate term. However, there is an added difficulty. In recent weeks both you and the Chancellor have stressed the strong outlook for the global economy and asserted that the UK economy is fundamentally sound. While we are of course personally sure that this is indeed the case, there are some who consider this not to be quite so. This camp, moreover, appears to be growing. And as this assessment is concerned with how our immediate prospects are perceived, rather than what we may consider them to be, our assessment may seem to be at some variance with the Treasury's official line.

Much emphasis has been placed by the present Chancellor on the American origins of the difficulties in credit markets (the US sub-prime mortgage crisis). While this is of course wholly correct, the UK economy is unusually sensitive to the problems in financial markets. This is because of the very high level of residential mortgage debt (and its sharp pace of acceleration in recent years) and the marked indebtedness of non-bank financial companies - that is, hedge funds, private equity, banks' off balance sheet conduits and wholesale mortgage lenders. Citigroup economist Michael Saunders now estimates this has risen from £553bn - or 68% of GDP - 10 years ago to £2,238bn (160% of GDP) in the second quarter of this year. This has helped fuel the expansion of the financial services sector and the housing boom. As lending itself is now being restricted by constrained supply, and the criteria for mortgage lending have also been markedly tightened, some retrenchment can now be expected across the UK.

The household sector is especially vulnerable. Its financial deficit - the excess of spending over income - is, on Saunders' calculations, almost certainly the highest recorded in the last 40 years. At the same time real income growth has slowed to 1.5% year-on-year from 2.6% in the first quarter. So the recent 2.7% rate of consumer spending growth can only be sustained if pay growth raises sharply (highly unlikely) or savings are cut.

There is now little doubt that a general economic slowdown is already under way. Recent figures on mortgage lending show a sharp weakness in housing demand while both the CBI Distributive Trades Survey and Gfk consumer confidence readings are heading lower. At the same time a new credit conditions survey from the Bank of England shows a marked tightening in bank lending standards to companies in the coming months. Business investment growth, which had already started to slow through the first half of 2007, looks set to decline from 6.6% this year to 1.6% next. In particular, some M&A and private equity deals are likely to be postponed to the second half of next year.

This does not augur well for growth in what was until recently the fastest growing sector of the UK economy. Retrenchment can now be expected. And the most troubling feature of this is that any increase in unemployment would exacerbate the slowdown in the housing market, joblessness being the prime cause of mortgage arrears and default.

The signals from the euro zone economies provide no cause for comfort. While growth in the euro zone appeared solid just a month ago, signs are multiplying that activity, particularly in the service sector, is cooling. UK exporters will not be able to rely for much longer on robust continental markets. The month on month drop in the Euro area Economic Sentiment Indicator in September was the third biggest since the onset of monetary union. As around half of UK exports go to the euro area, the slowdown cannot but hit UK manufacturing.

You asked about immediate impact effects. Data to be released this week is expected to show sharp declines in mortgage approvals and in the September Purchasing Managers' Index.

As for the impact on the economy overall, Citigroup is forecasting a slowdown in GDP growth from about 3% this year to 2.3% in 2008. This is among the more benign forecasts. The Centre for Economics and Business Research now foresees a slowdown in 2008 to 1.4%, with GDP almost stationary in the first three months of the new year. Its latest economic assessment says that your current substantial lead in the opinion polls "could be put under considerable pressure this winter and into next year as both households and businesses are squeezed by the toughest economic environment since 1992", though it does add that "there would need to be a competent parliamentary opposition to take any political advantage of this".

Much now critically depends on an easing of monetary policy by the Bank of England. A cut in interest rates now looks almost certain by the end of the year. But a helpful reduction as early as this week is unlikely: this would be widely seen as a somersault too close to the one over Northern Rock to carry credibility in these highly febrile markets.

Our conclusion, Prime Minister, is that the economy is turning down fast and the "feel-good factor" that has characterised the last decade is likely to evaporate. While we are sure that electoral considerations could not be further from your mind at this time, we would note, from a purely academic standpoint of course, that election conditions will not be as favourable to the current administration as they are now until late 2009 or even 2010.

We hope the foregoing will be of some help in any decision you may have to make at this critical time.

Yours

Francis Leak and Tony Mole,

Special Economic Assessment Unit,

HM Treasury

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Bill Jamieson is a very shrewd analyst who makes a lot of good points in his writing. He does not run with the pack of financial journalists.

There have been other threads on election timing. One point that has not been made is that there is the possibility of a backlash from the electorate over a very early election. Gordon has an enormous Parliamentary majority and, rationally, there is no reason for a general election. Voters may well resent being asked to return to the polls a couple of years into a Parliament.

There is now just enough negative economic prognosis in the public domain to make people smell a rat if a snap election is called - the 'what have you got to be afraid of?' line.

It is also possible to portray a snap election as bad for the country. With the financial markets still fragile, and just weeks after the first British bank run for 150 years, is it right to make things unnecessarily uncertain?

One final point. There hasn't been an autumn/winter election since 1974. For over 30 years, general elections have been conducted in the early summer sunshine of May and June. History weighs against a November poll.

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Bill Jamieson is a very shrewd analyst who makes a lot of good points in his writing. He does not run with the pack of financial journalists.

There have been other threads on election timing. One point that has not been made is that there is the possibility of a backlash from the electorate over a very early election. Gordon has an enormous Parliamentary majority and, rationally, there is no reason for a general election. Voters may well resent being asked to return to the polls a couple of years into a Parliament.

There is now just enough negative economic prognosis in the public domain to make people smell a rat if a snap election is called - the 'what have you got to be afraid of?' line.

It is also possible to portray a snap election as bad for the country. With the financial markets still fragile, and just weeks after the first British bank run for 150 years, is it right to make things unnecessarily uncertain?

One final point. There hasn't been an autumn/winter election since 1974. For over 30 years, general elections have been conducted in the early summer sunshine of May and June. History weighs against a November poll.

Very good analysis yourself! I am hoping for GB to take an early election because I think the current polls are very misleading and there may be the fun of an upset. I totally agree with your point about the electorate either smelling a rat or resenting what they may see as a pointless exercise. It is interesting how the media are goading him into taking an early election, I think they are looking forward to a bit of fun themselves.

On balance I don't think he will risk it but I am enjoying the fact he must be sweating over the decision! :rolleyes:

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