Is Blair jumping a sinking ship?

By SAM FLEMING FOR MAILONLINE
Updated:

 

As Tony Blair basked in the adulation of Sedgefield supporters yesterday, borrowers were facing up to the grim reality of another jump in interest rates.

Tony Blair

Four rises in 10 months have pushed borrowing costs to their highest level since before Labour's landslide 2001 election win.

Having benefited from a decade of economic stability and unprecedented growth, Blair is exiting as the economic outlook gets unpleasantly choppy.

An overheating housing market, inflation that has burst through the Bank of England's upper limit and rapid money supply growth make for worrying economic conditions.

As a result, the Monetary Policy Committee lifted rates to 5.5% yesterday, and signalled further hikes could lie ahead.

A powerful spurt in world growth should help sustain Britain's economic locomotive, as will Britain's breakneck 10.9% rate of house price inflation.

'Relative to the 2% target, the risks to the outlook for inflation in the medium term remain tilted to the upside,' the Bank warned.

Some economists think the BoE should aggressively tighten the screws. A Reuters poll of 62 City soothsayers yesterday showed 21 expect base rates to hit 5.75% this year. Roger Bootle, economic adviser at Deloitte, fears rates may need to reach 6% to keep the economy from overheating.

Yet the Bank's aggressive stance comes at a time when household finances are perilously weak. Incomes grew only 1.3% last year - the slowest for nearly 25 years. That forced many families to dip into savings and borrow against the rising values of their homes to prop up spending.

Research from Dresdner Kleinwort last month showed that, excluding pension contributions, the savings ratio has now turned negative, which could be a harbinger of recession.

With debts reaching 150% of annual incomes, personal insolvencies have soared by 400% since Labour took power in 1997, and higher rates will only make matters worse.

A significant slowdown in the housing boom would prompt a dramatic spike in repossessions. Against that backdrop, there is a real risk that the recent rate hikes could force a sudden slowdown in consumer spending - the main driver of the economy.

'The MPC should resist calls for early further action,' said Simon Ward, Chief Economist at New Star Asset Management. 'A Bank rate of 5.5% is modest by historical standards, but represents a heavy burden on consumers carrying record debt.'

David Owen, of Dresdner Kleinwort, said: 'We think the bank has done enough to slow the housing market quite significantly this year already.' Although another hike is likely, 'the more they raise rates the more likely it is the economy doesn't only slow, but slows sharply'.

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Bank of England

Despite pushing rates to the highest in the G7, the Bank will be reluctant to prop consumers up with a quick reversal of its tight monetary policy.

Alan Castle, of Lehman Brothers, said: 'Even if there is a consumer and housing market slowdown, there could be other reasons why the Bank doesn't feel able to cut rates.'

Among these are the global threat of inflation and strong export growth. On top of that, a cut could send the wrong message to the country's over- stretched homeowners.

'They don't want to be seen to be underwriting any expansion in debt and the housing market,' said Castle.

The departing prime minister piously told voters yesterday that 'I always did what I thought was right for the country' - even when it hammered his opinion poll ratings.

Bank governor Mervyn King should take heed. He could find his efforts to keep Britain's economic locomotive from jumping the tracks will exact a heavy toll on his own popularity with Britain's over-indebted families.

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