Leader: Leadership needed as banks wobble

cross Europe and America, the shadow of recession now lies heavily. Troubling pointers on the health of the US economy, combined with news of a market slowdown in Germany, fuelled another week of severe falls on world stock markets. Here in the UK unemployment showed a notable rise, while Scotland saw the first increase in claimant count unemployment for almost a year.

But it is not simply the spectre of a dip back into recession that has triggered this change of mood. Over the week, the FTSE100 index lost 5.2 per cent while the yield on government bonds fell to its lowest since 1899. The biggest and most troubling declines were in the banking sector. Lloyds Banking Group plunged 16 per cent over the week, Royal Bank of Scotland lost 22 per cent. Both shares are now back at levels not seen since the depths of the banking crash. These are troubling falls because banks are the vital conduits of finance in our economy. While their balance sheets have been strengthened in the past two years, it is the prospect of a bank failure in continental Europe that could cripple them. Such an outcome would have severe repercussions across Europe and America.

The fear is not simply of a return to recession, unpleasant though this would be. It is of a recession lasting for years. Markets are responding to the prospect of a period of low to negative growth stretching to the end of the decade as deficit reduction austerity programmes kick in. Japan provides the most prescient example of an economy, once among the fastest growing in the world, where a massive debt overhang choked growth. Japan suffered “a lost decade” of opportunity.

It is this sense of epochal step change that explains the sharpness of the falls in recent weeks. Adding to the bleak mood has been a sense that governments – in America and Europe – are failing to provide the leadership required. President Obama is no Roosevelt. He seems unwilling or unable to engage with voters on what he will do in the period ahead. In Europe, Angela Merkel and Nicolas Sarkozy seem diminished with every mini summit that fails to provide either a compelling impetus for joint action across the Euro zone or a strategy to help encourage growth.

Here in the UK, figures showing a sharp fall in government net borrowing in July disguised a slower rate of deficit reduction than planned. Government spending continues to outpace revenue, and with increasing signs of slowdown, tax revenues are most unlikely to improve from here.

Flexibility is now needed. As recession would bring a sharp rise in unemployment, the Bank of England now needs to put monetary easing (“QE”) back on the agenda. Government could help with measures to cut taxes on employment. Above all, leadership is now required to stop the market’s forebodings from becoming a self-fulfilling prophecy.