Jeremy Warner's Outlook: Just how resilient is the UK economy as the IMF slashes its growth forecasts?

The last Budget was less than a month ago, yet conditions have deteriorated so much since that economic forecasts which even then looked overly optimistic today seem positively heroic. Just to recap, the Chancellor forecast that UK output would grow by between 1.75 and 2.25 per cent this year, with a swift recovery to between 2.25 and 2.75 per cent the year after.

Yesterday, the International Monetary Fund slashed its UK growth forecast to 1.6 per cent for each of the next two years.

The shortfall on the Chancellor's predictions is not so great for this year as to give undue cause for alarm. Growth as low as the IMF is forecasting would only modestly miss the bottom end of the Chancellor's range.

The difference the year after is on the other hand a lot more striking. Even using the bottom end of the range, the gap would be 65 basis points.

The Chancellor's projections for the public finances are already running on vapour. A shortfall of this magnitude in the absence of corresponding tax rises would cause Government borrowing to spiral out of control and result in an overt breach of at least one of the Treasury's two rules for governing the public finances.

The Chancellor professes himself to be more optimistic than the IMF and insists that at this stage he's no intention of further reducing his forecasts. He also reasonably points out that though the slowdown projected by the IMF looks big, the IMF still forecasts UK growth to be stronger than virtually all other advanced economies.

More evidence, in his opinion, of the UK's resilience to the travails of the wider global economy. This faith in the underlying resilience of the UK, much asserted by the Government in recent months, has never seemed to me to be justified by the fundamentals.

Yet the Chancellor is right to insist that he's not alone in holding it. The IMF seems to believe it too, despite also arguing that the UK housing market is 30 per cent overvalued.

Maybe they are right, and the UK economy will fare better. It seems hard to credit, nonetheless. In many respects, the UK economy appears even more vulnerable than the US to dislocation, with personal indebtedness at higher levels, a much more serious house price bubble than we have seen in the US, and a very high exposure to financial services industries, which at present are contracting fast.

The City and related business services are a core part of the UK economy and a key driver of growth in recent years. What's more, the UK Government is mildly increasing the tax burden, not reducing it as in the US. Inflation also remains a bigger medium-term problem in the UK, limiting the scope for interest rate cuts to alleviate the slowdown. On the face of it, then, we seem worse placed to weather the storm, not better.

The key reason for thinking otherwise lies in the flexibility of our labour markets. Ronald Reagan, the former US president, famously defined recession as when your neighbour loses his job. "Depression is when you lose yours," he went on.

The big bogey in any econ-omic slowdown is rising unemployment. When this starts to occur, the downturn can become self sustaining, with lower demand leading to more layoffs and still further reductions in demand. Belief in Britain's resilience rests on the notion that flexible labour markets ought to allow the economy to avoid this downward spiral.

Rather than face mass layoffs, workforces might be persuaded to agree wage freezes, or certain members of staff, part-time working. Immigrant labour, which filled the gaps in the workforce during the boom, can also be expected to act as something of a shock absorber, with many of these workers returning home in the face of looser labour market conditions.

All these phenomena would cause consumption to suffer, but not by as much as if there was a steep rise in outright unemployment. In any case, the theory looks as if it is about to be tested on the anvil of practice. We'll know who is right soon enough.

Mortgages keep getting dearer

The Bank of England is expected to cut interest rates again today, the third such reduction since the credit crisis started to bite last summer. Yet it doesn't seem to be making any difference. It is not the cost of money which is the problem, but its availability, or rather, lack of it.

There was more evidence of the growing scarcity of credit yesterday, with the Woolwich raising its rate for two-year, fixed-rate mortgages, and Alliance & Leicester threatening the same. A&L has already raised rates once this week.

The good news from HSBC that it will match homeowners' existing deals rather than charge them more when they seek to remortgage, is in fact no more than a sales ploy designed to grab low-risk market share. HSBC won't accept anything less than a 20 per cent deposit, and, of course, there are unspecified remortgaging fees involved. The offer is in any case only open for five weeks.

Yet what it does demonstrate is that those with big balance sheets and ready access to cash are now in the happy position of being able to cherry pick the best mortgage business around. Less well capitalised banks can only look on and weep.

The big picture is that in the round mortgages are continuing to get more expensive not withstanding the reduced level of official interest rates.

According to the Bank of England, fixed-rate mortgages are now at their most expensive in eight years. Many lenders would prefer to shed business rather than take on more. Restrictions and costs are being driven up accordingly.

The fashionable way of looking at this phenomenon is as a return to normality after years of dirt-cheap deals that had encouraged householders to borrow recklessly. Instead, we are seeing a welcome re-establishment of good, old fashioned lending standards, with borrowers forced to put up a reasonable chunk of equity and rates more properly reflecting the risk of default.

All the same, after so many years of plenty, it is bound to feel painful. The mortgage market is going cold turkey, and for many it will be a decidedly uncomfortable experience.

As for further cuts in interest rates, that's unlikely to help much in the short term. Libor remains well above base rate anyway, so whatever the Bank of England does to official rates today may seem largely irrelevant. This is not really a case of profiteering banks failing to pass on the benefits of lower rates to their customers. Rather it is to do with the absence of funding after the extreme losses incurred in American mortgage lending. It's become a strangely upside down world we live in, but these days many lenders are more interested in getting rid of business than taking it on.

Eventually, more orderly credit conditions will re-establish themselves, but there will be no early return to the easy mortgage conditions of a year ago. Get used to it.

For heaven's sake, stop shopping

Here's an anecdote from the downturn which partially explains the mystery of why the economy keeps motoring even as gainful activity dries up.

A well-heeled private equity acquaintance of mine who employs four people in his immediate office says he hasn't done a deal in months, yet he's kept everyone on in the hope that things might pick up. As a rich man, he's also been able to sustain his household expenditure despite the absence of fees. It's only a matter of time, he says. He knows he must wield the axe soon but hasn't had the heart to tell his staff they are out of a job, or indeed his wife to stop shopping.