Is Britain too reliant on the financial sector?

Oxford Economics recently predicted that a downturn in the financial services industry could cut 0.4% of British GDP. In light of current stockmarket turmoil, is the UK economy overly dependent on the City?

Interest-rate hikes have "hit families hard", said Gabriel Rozenberg in The Times. Home repossessions have jumped by 30% to a seven-year high, while Morgan Stanley is forecasting a sharp consumer slowdown in the second half as five rate hikes begin to bite. Retail sales are finally beginning to show signs of slowing, last month notching up the lowest annual growth since November. The Bank of England ups the ante The squeeze is only going to get worse.

The Bank of England's quarterly inflation report signalled this week that interest rates would have to rise to 6% for consumer price inflation now at 2.4% to hit the 2% target within the next two years. What's more, it reckoned that the balance of risks to inflation was "slightly on the upside". Food prices are on the rise and could jump further owing to the recent floods while strong oil militates against further cuts in utility bills. Moreover, the latest sign of fading goods price deflation has emerged in women's clothing: according to research group Verdict, prices will rise by 5% over the next five years as the cost-cutting fillip from outsourcing fades. Meanwhile, GDP growth has remained strong.

One area showing particular strength is manufacturing, where output grew for a fourth successive month in June, the best run since 1999; the manufacturing index hit a six-year high, and industrial production rose by an annual 0.8%, in line with the overall economy. Still, compared to our direct competitors, it's not that impressive, said Ian Campbell on Breakingviews. Germany and America managed 4.6% and 1.4% in May and June respectively. The strong pound is partly to blame, but the underlying problem is unproductive factories; output per hour is 13% below Germany's, according to the London School of Economics. Low skill and research levels are also part of the story.

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What next?

Where Britain does do well, of course, is finance. Financial and business services (the latter includes accounting, lawyers and advertising) accounted for 28% of overall GDP 42% in southeast England and half of GDP growth last year. According to Oxford Economics, given the credit market slide, a downturn in the financial services industry alone could cut 0.4% off GDP growth. If City activity dries up, so does growth, said Damian Reece in The Daily Telegraph. "The entire southeast, from house prices to employment, is a geared play on global financial markets." Great in a bull run, but "rather more precarious" since the credit crisis began.