Europe’s in a grim old state, no doubt about it.
We’ve got Portugal heading for a bail-out. Ireland’s banks remain troublesome. Greece has been downgraded yet again (from ‘junk’ status to ‘don’t touch with a bargepole’).
And politicians in the likes of Germany and France are having to contend with irritable electorates.
It’s a mess all right. So here’s a question: why is the euro still doing better than the pound?
The European Central Bank is more credible than the Bank of England
In the past six weeks or so, the pound has fallen from just below €1.20 to around €1.14 against a surprisingly sturdy euro. This is at a time when confidence in the eurozone could hardly be described as high.
So what’s going on? There are a number of reasons behind this. First off, the European Central Bank is still promising to raise interest rates in April. Hard as it is to believe that they’ll do it, given the state of the periphery nations, the ECB has raised rates into a recession in the past. So their inflation-fighting credibility remains intact, even if most analysts think they’d be daft to hike rates now.
Our own Bank of England on the other hand, has little credibility left on that front. Inflation may be running at more than twice its target rate, but it’s becoming clear that Mervyn King worries more about the weak economy than about inflation. Mr King believes that his main job right now is to create a relatively forgiving backdrop for the coalition government’s cuts.
And that brings us to the other problem. The outlook might be grim for Portugal and the other eurozone countries. But Germany is just fine right now. And as long as the periphery – and therefore Germany’s banking sector – continues to be propped up by the ECB, the country looks sound. That may change, but everyone is ignoring that for now.
Britain looks set for a very tough 2011
Britain, on the other hand, is looking distinctly fragile. The first take on UK GDP for the fourth quarter of 2010 had the economy shrinking by 0.5%. The second take put it at 0.6%. Yesterday’s final revision had us back to 0.5%. Without snow-related disruption, we’d have been flat. But this is hardly good news.
Britain’s economy remains dependent on consumption. And that’s under serious pressure. In 2010 as a whole, real (inflation-adjusted) disposable incomes fell by 0.8%, according to the Office for National Statistics.
That was the first such fall since 1981. That’s quite incredible when you think about it – for 30 years we’ve known nothing but continuous growth in our pay packets. Not anymore.
And it’s hard to see things improving this year. Britain’s inflation rate is already among the highest in the Western world. Taxes are going up. Energy prices don’t look like falling either. Between the disaster in Japan and the havoc in the Middle East, the already-tight global energy picture has got worse.
And consumer-facing companies are already suffering, as a profit warning from Dixons (see the markets section below for more) shows this morning. Holiday firm Thomas Cook also expects UK holiday bookings to be lower than it had expected. Yet if fuel prices stay high, the cost of holidays is also likely to rise, The Times reports this morning.
Retailer Next recently warned that its prices will have to rise too. It’ll be interesting to see if it can push that through against the backdrop of a weak consumer. But it’s worth remembering that while banks may have been too big to fail, clothes shops aren’t. Following the recession, there are fewer competitors out there on the high street. It may be easier for big chains to raise prices than anyone currently expects.
We’ve had the boom – this is the bust
This is all necessary. It’s healthy that consumers are taking a breather. If we ever want the economy to rebalance more towards the manufacturing sector (“the march of the makers”, as Osborne put it in his budget), then a weak currency and lower consumer spending are probably part of that.
In short, we’ve had the boom – now we’re enduring the bust.
But it’s still not very pleasant. And of all the threats facing us, inflation is the most potentially damaging. Pundits argue that inflationary influences will drop out of the figures next year, but we’ve heard that line for several years now.
The BoE is wary of raising rates, and making life even harder for those with home loans to repay. But high and rising inflation is bad for confidence too. If consumers feel that they have to run to stand still, then their immediate instinct is to be more cautious. If anything, the sense that your wealth is being eroded by inflation just makes you want to save harder, not spend.
My colleague David Stevenson will be looking at the impact of Britain’s ‘big squeeze’ on investors in the next issue of MoneyWeek magazine, out on Friday. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
But in the meantime, from a pure personal finance point of view, I’d look out for the best cash individual savings account you can find and make sure you use your £5,100 allowance before the tax year ends next week. Also, keep an eye out for National Savings & Investment relaunching its inflation-linked savings products – I suspect they’ll be in demand this year.
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