January 14, 2008	Monday	Muharram 04, 1429

On the very first day of the New Year the Confederation of British Industries (CBI) warned that 2008 would be a “difficult year” for the British economy.

The most likely outcome predicted is a slowing down of the economy as a result of the exposure to twin shocks from rising commodity prices and the continuing credit crunch.

However, the CBI listed a couple reasons for not feeling all that bad about the future - including the equity that many households have got locked away in their homes. Around 60 per cent of mortgage borrowers have more than £100,000 of equity in their homes, compared to less than 10 per cent in 1993. That is expected to give them “a comfortable cushion to fall back on if times get tough. Another plus point is said to be the prudent way Bank of England has been managing inflation expectations.

There is a growing awareness in the UK that the global economic balance of power is shifting East to China and India, who, it is believed, have driven growth as the US economy has slowed, and that alongside this the world appears to have moved into an era of high energy prices, and one where investment decisions will be dictated in part in the rich world by the price of carbon.

Meanwhile, the UK is also facing national skills shortages and deteriorating transport and power infrastructure, its tax system is losing its competitive edge and its regulatory regime is becoming too lax. Additionally it has to continue to fight the growth of protectionism in the developed world, and put in the “major effort” required to take on climate change.

The two-year-long run of strong growth in financial services went into reverse over the past three months, as business volumes in the sector fell at their fastest rate since March 1991, a new survey said.

The latest Financial Services Survey from the CBI and PricewaterhouseCoopers LLP shows that, as the credit squeeze continued, income values fell sharply and business sentiment worsened, while costs continued to rise.

Yet despite all this, the survey said several sectors of the industry managed to increase their profitability over the past three months, and are still hiring staff and planning to invest more, particularly in IT.

Business volumes shrank heavily in the three months to early December: 10 per cent of respondents said that volumes had grown, while 44 per cent said they had decreased. The net balance after rounding of -33 per cent is the lowest since March 1991 (-44 per cent) and markedly worse than expected (-11 per cent). Firms expect this slide to continue in the coming three months, though at a slower rate.

A drop in business with private individuals and financial institutions was behind much of the slowdown in business volumes, though demand from individual consumers is expected to stabilise over the coming three months. Lending to companies held up rather better, and is expected to pick up again over the next three months.

A balance of 11 per cent of firms reported a drop in income from fees, commissions and premiums, which was broadly as expected, but income from net interest, investment and trading fell at the fastest rate since the survey began in 1989 (a balance of -36 per cent). Both are expected to fall further in the next three months.

Despite this, firms reported a surprise fourth consecutive quarter of growth in profitability (a balance of +6 per cent, slower than last survey’s +14 per cent but better than the predicted -14 per cent), although this is not expected to continue into early 2008.

Behind the aggregate picture there were big differences in volumes and profitability by sub-sector. The slowdown was felt most keenly by securities traders and building societies. While banks saw business fall quite sharply and profitability dip slightly, fund managers and insurance brokers fared much better.

One-off survey questions on the financial market conditions reveal that they are having a direct impact on several key aspects of firms’ operations and that they do not expect the storm to clear soon - seven out of every ten respondents (70 per cent) believe the squeeze will last longer than six months. Meanwhile, a majority believe that further deterioration in credit conditions is likely over the next six months – 24 per cent said the likelihood was high, and 65 per cent said it was medium.

In a further sign of the impact of the credit squeeze, a survey-record proportion of financial services firms (24 per cent) felt that their ability to raise funds would be a constraint on their growth over the next 12 months. This was a particular concern for building societies, with 92 per cent of respondents from that sector flagging it as an issue. A record high of 36 per cent of banks were also concerned that fund raising ability would constrain expansion.

Business sentiment among financial firms has worsened further in the past three months; with a balance of 49 per cent saying they are less optimistic about the overall business situation in the sector than they were in September.

Total operating costs (excluding cost of funds), which had been expected to fall slightly, grew for a fourth quarter running (a balance of +17 per cent), but are predicted to slow. Average operating costs per transaction grew at their highest rate (+19 per cent) since December 1990 (+25 per cent), but firms think they will stabilise.

Average spreads, the difference between the rates at which money is borrowed and lent, narrowed again (a balance of -15 per cent) and are expected to compress further in the next three months. The value of non-performing loans, or bad debt, was unchanged from the previous survey, although it is expected to rise in the coming quarter.

Despite the shock of the credit crunch, new jobs continue to be created, though the rate of growth has been slowing over the past year, and is expected to come to a near standstill over the next three months.

An indication of the resilience of the sector lies in planned increases in capital investment, which are higher than three months ago and above their long-run averages, particularly for IT, where plans are at their strongest since September 1997. The main spur to invest remains to increase efficiency, and a much lower level of respondents now say they are investing to expand capacity.