Jeremy Warner's Outlook: Caution reigns as recovery runs out of steam

I've returned from my summer break to discover that little has changed in the world of finance during my absence. There's been a bid for Abbey National, but otherwise the stock market remains stuck in a rut, the pensions crisis continues to trundle along as before, and Philip Green still languishes on his beach, angrily dreaming of what might have been had he possessed the gumption to go the whole way with his bid for Marks & Spencer.

I've returned from my summer break to discover that little has changed in the world of finance during my absence. There's been a bid for Abbey National, but otherwise the stock market remains stuck in a rut, the pensions crisis continues to trundle along as before, and Philip Green still languishes on his beach, angrily dreaming of what might have been had he possessed the gumption to go the whole way with his bid for Marks & Spencer.

As a footnote to this particular saga, I learned while away that Goldman Sachs and HBOS were prepared to back him right up to 425p a share, a level which would certainly have won him the prize. Quite why he bottled is still something of a mystery, to them as well as everybody else, but I guess that underneath the bombast, he's a more cautious operator than he pretends. Either that, or his wife Tina, ultimately the holder of the Green family purse strings, determined to reel him in.

Yet there is perhaps one important change which has taken place since I've been away. Everyone has grown noticeably more cautious about the outlook for the world economy, from the Federal Reserve in the United States to the Bank of England. When the Fed raised interest rates last week, it blamed this softer outlook on the rising oil price, the effect of which is both to stunt growth and raise inflation. Likewise, the Bank of England in its latest Inflation Report indicated that the peak of the interest rate cycle was much closer than financial markets had believed, indicating a weakening in the economic outlook.

Japanese growth in the second quarter was disappointing, the US recovery seems to be running out of steam, and although a primary policy aim for the Bank of England has been to bring the British housing market under control, no one is too sure what's going to support growth in the UK if it succeeds. Indeed, figures published today by the Royal Institution of Chartered Surveyors indicate that house prices froze in the three months to July, while in some areas of southern England, they are actually falling.

In China too, the engine room of recovery this past year, particularly for Japan and other areas of the Far East, growth is slowing rapidly after the imposition of domestic credit controls.

The upshot is that I've returned to a mood in financial markets which is decidedly more cautious than the one I left. Both the London and New York stock markets managed to lift themselves out of their gloom a little yesterday, but I suspect it's only a brief reprieve. All the same, there's no cause for panic just yet. At this point, the recovery still looks secure, if a little less robust than we'd hoped for. The world economy ought to be able to cope with an oil price of anything up to $50 a barrel without undue harm, if only because advanced economies are less dependent on oil than they used to be.

The bigger worry remains the old one - how the US economy, and to a lesser extent, its UK counterpart, are going to be weaned off debt without severely damaging growth. Central bankers in both the US and the UK are trying to raise interest rates gently to more normalised levels after an exceptionally long period of easy money, but there are already signs of cold turkey setting in. The jury is still very much out on whether they will succeed.

Abbey National bids

The other big story to have broken over the summer is the Spanish bid for Abbey National. This has prompted a flurry of interest from rival British banks, all of which cloak themselves in the union flag in arguing that they would make a better suitor for Britain's sixth largest bank than the Spanish interloper. A cash or shares bid from HBOS or some such other British bank would be far preferable to most Abbey National shareholders than the largely paper offer already on the table from Santander Central Hispano (SCH), but I don't rate any British bank's chances with competition regulators.

Lloyds TSB was sent away with a flea in its ear by the Competition Commission when it tried to acquire Abbey National three years ago, which given what's happened to the beleaguered mortgage lender since, might be counted as a blessing in disguise. None the less, Lloyds still harbours designs. Its chief executive, Eric Daniels, is prone unfavourably to contrast the rigidly pro-domestic competition public policy stance pursued within these shores with the national champions' approach to banking mergers allowed by some continental countries. Mr Daniels' fear, and that of a number of other banking CEOs, is that unless the market is allowed further to consolidate in the UK, eventually he and others will fall prey to the larger banking behemoths being created elsewhere in the world. Regulators appear perfectly happy for foreigners to take over British companies provided competition isn't harmed, but are extraordinarily reluctant to allow the creation of companies with the size to do the same overseas.

Personally, I've never bought this argument, which in any case is factually incorrect. Britain has a higher number of large internationally based companies than any other country in Europe. Two of them - HSBC and Royal Bank of Scotland Group - are in the banking sector. Innovation and job creation in the British economy are more likely to be served by fostering the greatest possible levels of competition - including unfettered foreign access to our markets - than domination by a few national champions. Which is why the competition authorities won't in the end tolerate any of the mooted British bids for Abbey National. Even HBOS, which as the smallest of the big five is credibly able to argue that it might enhance competition if only it were allowed to take over Abbey, will struggle to convince. The Government will take one look at the potential loss of tax revenue that would result from the bloodbath of cost cutting involved in any domestic consolidation and just say no.

Inheritance tax

Oliver Letwin, the shadow chancellor, raises a matter of growing concern to householders across the country in pointing out that the number of towns or boroughs with average house prices above the threshold where inheritance tax becomes payable has risen from one when Labour came to power to 86 today. This is because house prices have risen 130 per cent during that period, but the threshold has been raised by just 22 per cent. More and more people are finding themselves caught in the inheritance tax trap, to the delight of the Treasury whose internal projections see inheritance tax becoming one of the Government's more important sources of revenue.

There is nothing wrong with inheritance tax as such. Indeed, there is something morally degenerate in the idea that accident of birth should allow the enrichment of one group of individuals regardless of merit over others. The wealth of generations should be perpetually redistributed, not passed from one to another. On the other hand, as presently structured, inheritance tax is a particularly pernicious way of taxing the basic human instinct of accumulation for the purpose of handing it on to one's offspring.

As house prices skyrocket, the middle classes are caught with growing frequency. Yet the seven-year rule, which allows wealth to be given away without incurring any tax provided it is seven years before death - in combination with extensive offshoring - means that for the super rich, inheritance tax is almost entirely voluntary. Few of them pay much of it. If you are going to have inheritance tax at all, this is plainly wrong.

A much fairer way of imposing such a tax would be to levy it as if it were received income on the lucky beneficiaries, rather than as at present on the estate. I'm not sure this is what Mr Letwin had in mind when he lambasted the Government yesterday for "eating more and more of people's money", nor do I think there's any prospect of the Government adopting it. Yet that doesn't excuse what is at present a singularly bad tax.

jeremy.warner@independent.co.uk