The economy - still on budget?

John Whiting: Welcome to this PricewaterhouseCoopers podcast, I'm John Whiting, tax partner at PwC, and with me today are John Hawksworth, head of the PwC macro-economics unit, Mark Hudson, head of retail and consumer and Andrew Ratcliffe, UK assurance top tier Leader.

We will be discussing the current state of the UK economy its affect on UK and retail confidence and the overall ramification of the current state of affairs that has on non executives, Directors and Boards.

So let’s start with the economy, John the economy seems to be drifting a bit but it seems to be basically sound?

John Hawksworth: Yes I think our conclusion essentially is there is more likely to be a slow down than a recession is bottom line message. I mean so far clearly there has been an impact on the credit crunch on the banking sector, clearly the housing market is certainly slowing down although that was probably necessary anyway at some point. But the overall state of the economy in terms of the hard data we have at the moment is very much of a slow down but there is always some growth so we are trying not to be too pessimistic.

JW: But confidence is a key word there isn’t there Mark? Is it all about retail and consumer confidence?

Mark Hudson: I think that is very important and one other thing that we have seen over the last three or four years is that consumer confidence is really driven by four things, which way house prices are going which is probably the most important one, what is happening to unemployment, what is happening to interest rates and what is happening to inflation and towards the back end of 2007 we had a period which is quite the same timing as in 2004 when house prices were wobbling a bit, inflation was ticking up, interest rates were all rising and the consumers actually took a bit of fright and in 2004 we had a shocking start to 2005. At the back end of 2007 the consumer was a bit more uncertain and certainly their confidence in this shows that but house prices have broadly stabilise but it doesn’t appear to be going down as John mentioned. Unemployment is actually going down rather than going up. Interest rates are going down and inflation is under control. So I think the consumer is generally being quite resilient and certainly if you look at the retail sales over Christmas they were fine and in January retail sales picked up and speaking to clients in the leisure sector they are seeing strong growth in the restaurants and things so actually I think the consumer is in better shape than many of people give them credit for.

JW: Being a little more caution in the New Year.

MH: I think they are being a little more sensible to be perfectly honest.

JW: That sounds good!

MH: The other thing is that the hit have been taken from one end by very wealthy people inthe hedge fund services financial services and at the very other end the people at the social spectrum who perhaps have a lesser impact on the economy as a whole.

JW: OK it doesn’t seem too bad of a picture in the UK but we cannot just look at the UK we have got to look at it in an international context haven’t we John? So is there a cold wind blowing over from America?

JH: Well I think definitely the US economy has fallen quite a lot further. In the fourth quarter it was very close being in recession but not quite there. In a way in the housing market it has fallen there and there’s been a bit of a tailspin. So I think in the US, they’re heading for a recession or something close to a recession. On the other hand, even there they are cutting interest rates very rapidly, the Government’s pumping money into the economy through some tax cuts, so even there I think the hope is that by the end of this year things might be on the upturn again so it might be a fairly bad 2008 but 2009 might be a bit better.

JW: Is that how you see it Mark, on the retail side?

MH: I think that’s exactly right – the US retail is different from our retail scene but I think we’re looking at a slowdown rather than a crash. There are certain sectors which have had problems but generally the market is in positive territory and the consumers still seem to be prepared to get their wallets out at the moment.

JW: No particular problems in Euroland(?)

JH: Well I think there is a bit of an emerging feeling – initially people were hoping for an initial decoupling but I think we are beginning to have projections for Euroland growth even might be by European commission last week revised down so I think Germany, France, particularly Italy has got rather stagnant growth at the moment so I think there are some problems there that will hit our export a bit although they were helped a little bit by the fact that the pound has actually come down a bit over the last couple of months so that will offset it a bit but again I think we’re talking about a slowdown and not a recession in Euroland and hopefully later this year the European Central Bank will also realise that there is room for a few interest rate cuts and that will help to ease the pain there a bit. And we have to remember there are parts of the world economy – China, India and Asia that are still booming so it’s a balanced picture and somebody said that the world economy needed to cool down a bit – it was overheating a bit and so if we get a fairly soft landing that won’t be a bad outcome.

JW: Let me bring in Andrew Ratcliffe at this point. Andrew, you see a lot of the international business scene with the clients you deal with – John and Mark are painting a reasonable picture economically – is that how you see it? That there’s no big recession on the horizon? A few problems but not too bad?

Andrew Ratcliffe: John, I think broadly yes, I mean we do seem to be getting a little bit more stable now after all the banks have made their year-end announcements so I wouldn’t disagree with John and Mark that there is a good likelihood of a relatively benign scenario – a slowdown yes, and some commentators have said well maybe 2008 is going to be the reverse of 2007 – a weak first half and a stronger second half.

JW: The US might not give us any particular problems.

AR: Well this is the point – I think there is still the chance of another path here although I think that would be the highest probability of this working it’s way out slowly and the market frankly readjusting and recycling the credit problem and dealing with it and we’ve got a sophisticated and a big enough market that we should be doing that, you would think. I guess my reservation; my concern is the nature of these instruments which has kicked this thing off is that nobody really knows where this comes to land yet. I think we’re still in the process of unwinding all of this and even in the last few weeks we have seen that some banks have continued to be surprised by this, in a way they’ve been able to cope with, but surprised. So I guess my worry, would be, if I wanted to look to a downside case, would be, does something come along at the first quarter result stage, at the second quarter result stage, that kicks the thing off again because I think that would be of concern, not only of itself but in terms of what it would then do to confidence.

JW: And presumably this is something that non-executive directors have got to keep an eye on in particular because you’re painting a picture where things are going on OK but you might be lulled into a possibly false sense of security.

AR: Exactly right John. I think if I was a non-executive I would be saying lets hold these two potential tracks in our minds. Yes things are going along, looks like we are coping with this but what is our downside scenario.

JW: What are the risks?

AR: Yes lets be asking ourselves what if questions here. Yes so around the general problem I mean this will affect different companies in different ways. Easier if you got immediate evaluation issues depending where your funding is with your banks, when is that going to be renewed that may be something going out longer, OK even if there is a slow down in the economy, what does that do to your business, how linked is your business to that, how linked is that to your suppliers and customers. How far, how deep does this go but also what is the possible downside? What is the other contingency we need to think about?

JW: Does any of this have any concerns or resonance for an audit committee that any extras that they need to be looking at?

AR: Yes I think so, I think one particular area, I mean given that we said this is an issue of confidence and this still an area where there is a lot of judgement going into these valuations, there is a lot of judgement going into evaluating these positions. To me where does that come to land in a set of accounts it’s a disclosure so I was saying audit committees should be clearly doing their usual job and there is some very good guidance from the FRC as to remind them of some of the risk areas as they should be looking at but when it comes down to it and you are looking at those final accounts go to the paragraphs that are talking about the particular judgement that are putting the key of set of accounts together. So it might be in the accounting policies, it might be around a particular provisions note it might be in the OFR talking about the risks to the company. Those are the things that the audit committee should be focusing on and in particularly make sure they are clear and happy with that.

JW: Yes because the risks fundamentally have not all fundamentally gone away.

AR: Exactly.

JW: So looking forward to the budget the Chancellor is going to stand up and say well we are actually doing pretty well and there is no cause for alarm, although hang on a minute those figures are not looking that healthy are they?

JH: Well he kind of cut a lucky break recently with the January Tax figures was very good when the tax figures have been better than expected both in terms with income tax and corporation tax and Oil Sea revenues.

JW: From Mark’s Christmas sales, VAT flowing in.

JH: Well not so much VAT but corporation tax and North Sea with high oil prices generating quite a windfall for him so following that he looks like he is going to hit his target that looks like it what was being projected this year spending his revenue he is going to be more or less on target. He is not doing too badly I think there will be economic slow down, I think made a bit worse than predicting back in October but he wont have to make radical revisions to his forecast so it wont be too embarrassing for him.

MH: I’m hoping what he does do is he doesn’t add more inflating into the economy. Clearly there is the previous fuel price increase which he can choose to continue with or drop but anything that he adds on top of that to petrol prices or any consumption taxes or anything that he does with income taxes which increase the tax take on individuals at the very tunnel of which taxes disposable income is squeezed could contribute to the accelerating or driving adaptor.

JW: So it’s a confidence factor he doesn’t want to damage this slightly fragile confidence.

MH: Richard Tomlinson’s Financial Services Team are estimating the average remortgager has an extra £100 - £150 per month to find for anybody who is remortgaging off a two year fixed rate contract. So the consumer is no doubt that the UK consumer is actually suffering.

JW: They are not in trouble are they?

MH: No they are a little bit cautious with their money.

JW: They are being more cautious a little tighter. So do we think that he will be sending a little signal in the budge to the Bank of England. Hey another rate cut please.

JH: I don’t think he would be that obvious but what he would be doing is saying steady as she goes budget pretty neutral neither tax rises or tax cuts in the balance. Basically he is not preventing the Bank of England from cutting rates and if he was to cut taxes the bank would probably say if you are pushing money into the economy we don’t need to. I think we will have a fairly neutral budget and that will leave the door open for maybe a couple more interest rate cuts later this year.

MH: It seems to make sense to me stimulating the economy via spending which seems to be what the Americans have done on route but as John has said the Bank of England are they going to take the opposite course and avoid the inflation spiral by holding interests high. He is trying to work one way against the other.

JW: He has got to find a little bit more spending for some of his favourite things perhaps a little more defence in one or two more areas and spending is a little bit tight isn’t it?

JH: Well I think he has announced his spending plans in the next three years and I wouldn’t expect him to do much to those and we are seeing spending is going to grow just less than two percent a year about 3 years I think he will stand pact on that he might have the odd tweak but I don’t think he is going to start writing the plans having taken the best part of the last 3 years preparing that spending review so I wouldn’t expect big changes on the spending side. Spending is more or less on target this year. I think he will be happy to stick with what he has got.

MH: He has also got to keep public sector pay inflation down, and he has taken some fairly major hits in the press and in the media because of decisions that they have made about not backdating salary increases for example so for him to go back on those having taken the punishment would seem to be strange, I think keeping public sector pay growth down is really important in the fight against rising inflation.

JW: OK steady as she goes not a bad outlook. So to sum up are we going to feel better off after the budget or do you think just kind of unmoved?

MH: I suspect unmoved. I hope that the chancellor doesn’t actually introduce the sort of changes to the capital gains tax regime which he has been talking about to an extent that we haven’t previously understood, so more unexpected in the small print and it comes out later because that could have an outward impact on the adverse entrepreneur economy in the UK and I also hope he doesn’t do anything silly with non domiciles that again hasn’t being discuss because that could have unanticipated consequences for adrift some of the higher wealth individuals who are actually create a lot of it momentum in the economy through their spending activities.

JW: Risk factors John do you go along with that? Will we feel unmoved or what do you think?

JH: Yes I think we had a big budget last year where there was a lot of changes some of which hasn’t come through yet and I think a period of calm and not trying to do anything scares the horses either in the city or elsewhere would be a good policy and not introduce new policies on the hoof and just keep a fairly stable tax environment that would be the best advice I would think.

JW: From a tax point of view I would go along with that we have plenty of tax changes in the system and have a nice steady as she goes. Sound sad but boring budget might be best this time. Gentlemen thank you very much

You can find more information on the issues affecting the UK economy on our website: pwc.co.uk. Thank you all very much for listening.