Rising manufacturing output prices create a vicious circle

By John Cranage on Aug 11, 08 11:07 PM in Economics

Like a slow-to-die Hollywood movie monster thrashing around until the credits roll, the bubble created by central bankers and politicians who mistake living on tick for prosperity may have been pricked, but it is going to do a lot more damage before it deflates to manageable proportions.

The worse of the credit squeeze may be over, with inter-bank three-month spreads well off their peaks, but the retail banks are only now starting to count the cost of their near-criminal profligacy.

Rising bad debts are now wrecking whatever slim chance Northern Rock ever had of re-establishing its capital base let alone its credibility.

And these are delinquents of its own breeding: remember the 125 per cent mortgage for those who couldn't afford to buy a stick of furniture, least of all put down a deposit?

Northern Rock's insane attempt to grab market share from better capitalised competitors such as Halifax mean that such loans account for probably a quarter of its book. Its more credit-worthy customers are decamping to safer shores leaving the potential defaulters behind to wreak their havoc.

It's a grisly scenario and watching it unfold won't be a spectacle for the weak in spirit and faint of heart.

And the fact that mortgage rates are now coming off their recent peaks isn't much consolation, given the overall economic condition. The Bank of England said yesterday that fixed-rate mortgages, which have been at their highest for eight years, fell last month for the first time since February.

Homeowners looking to remortgage as their fixes unwind may find some marginal relief, but analysts were fast to point out that it is too soon to call an end to the squeeze.

More significantly yesterday, the latest monthly report from National Statistics showed that manufacturing output prices are rising at their fastest rate since records began 20 years ago - up by 0.4 per cent since July and by an appalling 10 per cent year on year.

With inflationary pressures like that on the boil, the Bank of England won't exactly be falling over itself to cut interest rates, welcome as that would be.

Howard Archer, an economic analyst at Global Insight, was, however, able to take a grain of comfort from the ONS numbers, saying they "may be a tentative sign that the recent slowdown in manufacturing activity and orders is starting to undermine companies' pricing power".

In other words, manufacturers can't pass on higher costs to their customers for much longer. And when companies can't pass on rising costs they cut jobs. Job cuts inevitably mean more mortgage-holders defaulting on their obligations. And the more that happens the rockier the lenders' balance sheets start to look.

It's a vicious circle that's going to take some squaring.

Still, there are some glimmers of light on an otherwise black horizon. Oil prices are retreating amid signs that the commodities bubble might have burst and the dollar was continuing to rally last night. That, however, might have something to do with the fact that prospects elsewhere look even bleaker than they do in the US and, as one FX specialist put it, the greenback "is winning the least-ugly competition".