The Bank of England's surprise decision on August 2nd to trim another quarter point off base rates has caused a rash of doom-mongering. Despite the rate dropping to just 5% - the lowest in some 40 years - startled experts concluded that the Bank knew something the rest of us did not. Its gloomy prognosis was revealed in the quarterly Inflation report on August 8th: outlook for growth is "weaker than previously forecast" and reflects a more "pronounced slowdown of the world economy, a weaker investment outlook, and an unwinding of unplanned stock building."
Collective anxiety had been ratcheted upwards by data showing that a recession in the manufacturing sector is now "official". Manufacturing as whole declined by 2% in the 3 months to June (despite a slight recovery in June itself) having also shrunk by 0.7% in the 1st quarter of the year. More worryingly, it was the engineering sector that took the hardest hit - with output declining by almost 5% in the 3 months. By contrast chemicals, artificial fibres, construction, aerospace and pharmaceuticals increased their output.
Food and drink manufacture also grew. That was less surprising because the consumer economy is still as robust as ever. And this is what puzzles so many analysts. How can manufacturing slide by 5½% (annual equivalent) when the service sector is still clocking up growth of 3½% a year? This gap between the growth of services and manufacturing is the largest since 1980. How can it be that house prices are growing by 11% annually (according to the Land Registry report) and sales of consumer products like CDs have jumped 18% in the last year? Indeed, annual growth of all retail sales to the second quarter of this year was the highest since 1988.
Whilst manufacturing, ITC and other export-led sectors are feeling a slowdown coming from the USA, the rest of Britain is still spending. So the dilemma for the Treasury and the Bank is stark. They need a policy that fits boom and bust.
Conventional thinking says that interest rate cuts are needed to bring down the value of sterling and reduce the costs of borrowing for industry. But if they are cut too much, consumer spending may cause inflationary pressures to grow.
Today, these traditional analyses are irrelevant. How far do rates have to drop? Japan has had nearly zero percent rates without any obvious fillip to its torpid economy. And in the UK, bank borrowings are not the main cost problem faced by most businesses. Equally, the pound is not over-valued against the US dollar and is even beginning to slip against the euro - as many tourists coming home this summer will attest. What's more, inflationary pressures from consumer spending or a weaker currency are not that significant - the Bank of England still predicts price rises staying comfortably below the Chancellor's 2½% target.
Instead, our problems stem from slowdown in the world economy and - in particular - a collapse in the previously booming market for computers, electronics and telecoms equipment. That's why companies like Marconi, Motorola and Ericsson have ended up with piles of unsold stock, few orders and have decided to lay off workers.
Britain has been more exposed than other countries partly because of the pound's recent strength against the euro. But it is also vulnerable because so many firms have UK plants that only assemble products - these are the "inward investment miracle" companies that revived so many areas of Britain previously blighted by closure of more basic manufacturing industry in the 80s and 90s. So a recession in manufacturing impacts disproportionately on the UK's least affluent regions.
Some say we can do without manufacturing. It only accounts for 20% of GDP and less than a fifth of employment. Others have sentimental attachments to traditional work patterns and to craft skills.
Both views are wrong. We need a manufacturing sector that adds high value to its products, has export strength and has a "multiplier" effect in local economies. Successful manufacturing needs to be more home-grown with Government action to encourage more domestic investment, higher skills and stronger R&D.
That's for the longer term. What is going to happen in the short term?
Unemployment is still falling - although 4 regions have seen recent increases using the LFS measure. Employment is still growing quite strongly - and in most regions too. But forward indicators show a slight worsening of the labour market. Notified redundancies have been rising slightly whilst inflow to the JSA claimant count has increased by 18% over the last year - with increases in all regions.
But these do not mean a catastrophic recession is looming. Instead we are witnessing a repeat of the 1998 phenomena - when three successive quarters of manufacturing decline led the industry to shed 150,000 jobs that year - and to lose a further 260,000 in the following 3 years.
This downturn can be averted. But in its place, there will only be very weak growth - similar to the USA. But economic growth could be insufficient to keep the lid on unemployment. We predict a mild increase in unemployment over the next 12 months followed by a return to its historic downward trend.
Although the Government will have to entertain some new measures that help the short term unemployed - and many of those will have lost high skilled jobs - it should not be shocked into thinking that mass unemployment is on the rebound. The long term economic circumstances are good - the trend growth rate in jobs is at least a quarter million annually. And in the last year, three quarters of all new jobs have been full time. Demographic conditions are also favourable. Until 6 months ago, most new jobs were filled by new entrants to the workforce - mainly young people leaving education. But this is now changing - not least because population growth is flattening out and. So, of the estimated 3 million extra jobs required by the end of this decade, most will have to be filled by people who are currently unemployed or economically inactive.
Although the jobless totals may inch upwards this year, full employment remains entirely achievable this decade.