According to polling, the British public started to get seriously gloomy about the economy last September. They have not got much cheerier since.

What The Bank of England Is Doing

The Bank of England cut its rate by a rather derisory quarter point to 5% yesterday, citing continued inflationary concerns.

It was a stark reminder that the Bank’s purpose is not to sort out relations between an almost ridiculously mismanaged banking sector and a disappointed and anxious populace but to keep the numbers straight.

Lurking behind this is the fact that, in order to reassure precisely those capital markets that now seem to have failed the nation, the Chancellor gave the Bank its independence a decade ago. He has no room for manoeuvre if he now regrets the decision.

In essence, the Bank is saying that a slowdown in business activity is a ‘good thing’ if it helps to bring down inflation.

So, if you are a small business dependent on credit, be warned – you are secondary to the maintenance of macro-economic stability in a world where growth rates well above 6% in the East are pushing up prices regardless of anything that might be done or not done by Her Majest's Government.

For example, OPEC continues to reject US and European calls for more production – the oil price was at $112 around about the time the rate cut was announced and there is no sign that it will fall much below that level this year. Staple food prices are also rising fast. Global gas is going in the same direction.

What HMG Says - Regardless of the IMF

The UK Government is claiming that the IMF's growth estimates for the UK [1.6% in 2008 and 2009] are too low and is sticking with its original estimates [av. 2.0% in 2008 and av. 2.5% in 2009].

Although history will tell who is right and who is wrong, the instincts of the population are probably with the IMF even if old Labour hands remember how the IMF screwed up Labour in the 1970s with incorrect assessments.

This difference of opinion with the IMF is important because it seems that it is the IMF that is sending signals about the need to reduce interest rates in the West while the UK authorities do not seem to have the same sense of urgency.

Things are getting scary out there as the crisis in the financial system leaches into the housing market and will soon cause problems in the so-called ‘real’ economy. So why are the Bank and the Government being so cautious?

Some economists certainly think that the Bank is getting it wrong. They think that it has underestimated the British economy's close link to the US economy.

The US is clearly slowing down. The argument is that its very aggressive rate cuts make the need for pre-emptive action within the UK far more important than caution.

The Bloody Banks Again!

The proof of this particular economic pudding lies in what is actually happening in the UK banking sector.

The markets scarcely noticed the Bank's interest rate move. The public and the media are getting dismayed that any changes made by the authorities seem to be designed to get the banks off the credit hook of their own making and that interest rate improvements are not being passed on to hard pressed mortgage payers.

Without getting conspiratorial, we must have the suspicion that the Bank is holding its fire because it thinks it may need to respond much more vigorously and dramatically later and that it needs to hold back as much as possible in order to give what it can when it really needs to.

As we write, there are widespread fears that British banking is entering into a new and more serious phase. The 'real' economy is going to be hit in any case but a major meltdown in the City would push the UK from the European (moderate growth) to the American (minimal growth) side of the equation.

The banks began this week to increase their borrowing facilities with the Bank of England in anticipation of another lending panic. Somewhere there may be a bank on the edge and the sector as a whole is trying to build up reserves at the Bank to deal with any consequent panic-driven cash calls.

We should be careful not to promote a scare. It is far too easy for outsiders to comment without those facts that cannot be provided precisely because, out of context, these facts may cause the very panic we all fear.

We seem to have no alternative but to give the Bank the benefit of the doubt for a while longer.

Looking To Save Their Skins

But this is now not only about the crisis but what happens after the crisis. The banks are acutely aware that a) their herd-like stupidity has created the crisis and b) many political interests will emerge to demand differing levels of control and regulation depending on ideology.

Already the banking sector is tentatively trying to manage the reaction by simultaneously apologizing (now de rigeur advice from PR consultants in order to take the heat off a client) and preparing the ground for resistance to the regulatory lobby.

Economists committed to the free market are already saying that, whatever errors took place, the banking system has (in effect) to be forgiven and saved because there is no alternative in a free market society. Some comfort for the poor, the jobless, the bankrupt and the repossessed!

The instincts of the New Labour Government are so embedded in the free market system inherited from the Thatcher Revolution that it would find it exceptionally difficult to do more than collaborate in international efforts to manage the globalization of capital.

In practice, international regulation is now going to be a process conducted at the grace and favour of the East. Non-Western sovereign wealth funds have not kow-towed to the regulatory impulse of the West but are beginning to demand equal treatment.

There are two ideological alternatives to the free market preferences of the leading political parties in the country and, until now, of Middle England – democratic socialism or social democracy on the one hand and, to the right, national populism.

Between these extremes are various mildly populist fixes and regulatory approaches that will irritate and discomfit the banks, but will not change the system by much and will certainly not turn the UK into a European corporatist state.

Housing & British Politics

Euro-corporatism is the fall-back position only in the event of the most obvious failure. The driver of British politics is, of course, the housing market.

Although not strictly comparable, analytical attention is turning to comparison with the 1992 recession – even the Prime Minister has used the ‘R’ word – that undermined the Thatcher revolution and led to a New Labour landslide in 1997.

In March, house prices fell by 2.5% nationwide (although they are still marginally rising in London). The political consequences will soon become ever more interesting.

Whether there will be a lurch to the left or the right ideologically will depend on how much Middle England fears repossession (not as a reality but as a lurking anxiety as inflation eats away at salaries that are not being increased), how much their children are forced to stay at home because they cannot get on the housing ladder, and how much those in their 50s and in work fear that the rest of their lives are going to be pauperized because their prime asset cannot be realized at the level they had expected.

Even the record lows of the sterling against the Euro have their effects. We should not worry too much about the tabloid headline stories about holidays costing 20% more than in 2007, but many middle class retirees expected to live better by moving overseas. Their disappointment will be of greater importance to their voting intentions than futile wars overseas.

First time house buyers without cash deposits or parental guarantee are now completely excluded from the British mortgage market. The next stage seems to be a limitation on the size of individual mortgages with Nationwide already capping at £1m.

These measures will tend to drive down starter flat and top-end middle class housing prices. However, a correction to the correction has already started – HSBC decided to match existing fixed rate deals for a period in order to increase its own 3% market share (low considering that it is the UK’s largest bank).

The political effects of problems in this market should not be underestimated. We are even seeing the first signs of some serious ‘red lining’ with credit agencies identifying those areas most at risk of negative equity.

What seems to be happening is that the entire country is being quietly zoned in ways that will work against future attempts to sustain social cohesion. This is a worrying development for a government already fighting a battle against organized crime.

Where Next?

Another major shift in politics (from New Labour to Conservatives) is, perhaps prematurely, postulated even if this may be just a case of rearranging the deckchairs on the Titanic.

Opinion polling shows a major collapse in confidence in the Brown Administration. There are also serious difficulties in the administration of the New Labour Party which may be placing it on the brink of a serious financial crisis. There are strong rumours of (admittedly early stage) splits within the Party.

Unless there is a meltdown of exceptional proportions (although we think that this is very unlikely), the political game for the next few years is one of shuffling the cards in order to make the system work despite public irritation and, in some sectors, anger.

Forcing through changes may result from competing factors that work against each other as much as they work against the current establishment consensus in favour of full globalization and the free market.

Within the establishment, there will be a powerful lobby for the intensification of financial regulation, if possible as a joint Western effort.

This is likely to be the mood of New Labour's establishment and be associated with a growing commitment to Europe, but it is likely to be resisted by the City and by the Tories. Only a very limited regulatory framework could achieve full bipartisan consensus.

New Labour is thus working against some powerful interests as it attempt to shuts the stable door after the horse has bolted. Its problems do not end there.

With little credibility in the street, it now faces a growing ideological revolt from its own Left, too weak to capture the Party or the nation but strong and angry enough to force the Government into half-baked populist measures and to threaten a split.

The trades unions (who are loyal to the Government) are said to be very worried by the intensification of moves to create what are, in effect, parties within the Party that may eventually split off and compete with New Labour in 2009. This is, after all, what has happened in Germany.

This only leaves the national populism of the extremist BNP. The BNP undermines New Labour working class votes more than it does those of the Tories and it potentially provides a menu of one-off ideas for a cynical Tory establishment to plunder as we near the election.

National populism against the banks is not a credible option in a country that remains a service economy dependent on the effective functioning of capitalism and on international trade, but it is not a negligible force in creating uncomfortable headlines in the right-wing tabloids as we get closer to a General Election.

And To Conclude ...

All in all, this is a time of considerable uncertainty.

We are still seeing aftershocks from the original credit earthquake. The management of the crisis means that the capitalist system can only be saved by privileging the fools over the victims – this is not justice but it is reality.

Once it is all over, there may be a lot of angry victims of banking greed, selfishness and stupidity. The British political establishment may soon descend into a period of vicious infighting designed to capture this anger for this or that faction.

It is inconceivable to believe that the credit crisis will not affect the outcome of the next Election.

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