Bill Robinson: If home owners lose heart, panic

Last year's question was "How bad a recession?" This year's is "How soon the recovery?"

This column was optimistic about UK prospects last year, because the authorities had so much room for manoeuvre. Low inflation permitted the Bank of England to cut interest rates aggressively. Sound public finances allowed the Chancellor to announce an increase in public spending. So despite the collapse of the TMT sector and the world slowdown, the UK still managed to grow by 2.4 per cent last year, according to official estimates released on Friday.

Will this year be better than last? The consensus of forecasting opinion is that growth in the G3 (the US, euroland, Japan) will be slightly worse. Last January's consensus G3 forecast for 2001 was 2.6 per cent; by December this had been revised down to a mere 1 per cent. The consensus for 2002 a year ago was 3 per cent. It is now only 0.8 per cent.

Clearly the professional forecasters performed poorly last year. Between October 2000 and September 2001, growth expectations for 2001 fell in every single month bar one. But the downward revisions are coming to an end as key monthly indicators suggest that the US economy may be bottoming out. The forecast consensus was unchanged at 1 per cent in October, November and December.

Year-on-year growth in 2002 is unlikely to be much better than in 2001, but there could be a brighter picture as the year progresses. The main cause of the downturn – the correction to the over-investment boom, symbolised by the dot-com bust – is behind us. It would be surprising if the global environment did not improve.

So what can we expect in the UK? There has been a lot of hand-wringing over the plight of our manufacturing industry. While GDP continued to rise in each quarter last year, industrial production and manufacturing output fell steadily. Poor manufacturing performance has in the past been due to serious structural weakness (making the wrong things at the wrong price). But today's problems are simpler: exporters have been struggling in the face of falling world demand and a strong sterling exchange rate. Manufacturing industry will be the biggest beneficiary of the world recovery when it comes.

The main worry for the UK is its dependence on the remarkable willingness of the British consumer to go on spending. The UK savings ratio remains low by historical standards because households continue to go into debt to finance consumption. That situation depends on two things: the cost of borrowing; and the level of confidence. Over the past year the cost of borrowing has been falling, but the fall in interest rates is probably at an end, while the effects of the manufacturing slowdown will mean rising unemployment.

So although the economic weather may be brightening across the Atlantic, an early improvement in the UK is unlikely. Output growth is still slowing, and the December retail sales figures showed the first fall for many months.

Last week some mortgage lenders went public with their worries about overheated house prices in London hot-spots. Consumer confidence, and hence the health of the UK economy, is uniquely linked to the housing market. Home owners with substantial mortgages don't mind borrowing a bit more to finance consumption – as long as house prices are rising. This is particularly true in London. Anything that shakes confidence in those prices is a threat not only to the housing market but to the recovery.

So keep a close eye on consumer confidence and its bellwether, London house prices. You have been warned!

PricewaterhouseCoopers