Bloomberg News

London's Dominance of U.K. Threatens Carney's Aim of Balanced Growth

March 19, 2014

UK LONDON AERIALS

An aerial photograph taken with a tilt-shift lens over the City of London. Photographer: Matthew Lloyd/Bloomberg

London’s dominance in the U.K. may be the cost of Bank of England Governor Mark Carney’s bid to spur the rest of the economy.

Keeping the benchmark interest rate at a record low of 0.5 percent is inflating London’s potential property bubble and boosting banking as Britain’s other major cities struggle to catch up after the recession that ended in 2009. While higher borrowing costs may cool the capital’s real-estate market boom, they would weigh on the rest.

It’s a “classic bind,” said Richard Holt, a regional economist at Capital Economics Ltd., a London-based research firm. “The point at which you feel the need to slow growth in the economy to avoid inflation comes earlier in London.”

Setting a one-size fits all policy is complicated as the European Central Bank has already discovered in the 18-nation euro area, said Nicholas Crafts, a professor at Warwick University. That probably gives the London property market more room to run.

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“The fact that is likely to emerge is that the BOE may be too slow to raise rates for London and the southeast and too fast to raise them for elsewhere,” said Crafts, who has written papers on the U.K.’s economic geography.

London’s sway is reflected in a run of recent reports. A February study by Ernst & Young LLP warned London’s property market is beginning to display “bubble-like conditions,” with the average house set to cost almost 600,000 pounds ($996,000) by 2018, three-and-a-half times a dwelling in the northeast. The City of London, the financial hub, created 34 percent more jobs during the three months ended in February than it did in the same period a year earlier, calculates headhunting firm Astbury Marsden.

Skyscrapers Planned

Rightmove Plc (RMV), a London-based online real-estate firm, said house prices in the capital climbed 2.1 percent this month to a record 552,530 pounds, taking the annual appreciation to more than 11 percent. New London Architecture, a policy-research center, projected 236 buildings topping 20 floors are on the cards for the capital, most of them residential properties.

Amazon.com Inc. (AMZN:US) and Google Inc. (GOOG:US) are among international companies establishing outposts in London. Insurance broker Aon Corp. morphed into Aon Plc (AON:US) when it became the first member of the Standard & Poor’s 500 Index to headquarter in the U.K.

It’s not just multinational giants. BCL Legal, a recruitment company based in Manchester, opened an office in the capital last year after a decade focused on the regions. The new office houses about a half-dozen staff with the expectation it will be the biggest division within two years and lead to a planned overseas expansion, says James Batt, a BCL director who lives near Manchester and regularly takes the two-hour train trip to London.

‘Unimaginable Amount’

“The thing that hits you most is you know the market is bigger, but it outstrips everything by an unimaginable amount,” said Batt, 38, who jokes he’d be retired by now if he’d set up in London rather than Manchester.

While London has always contributed the most of the U.K. economy, the imbalance has never been greater. In the 1870s, it accounted for about 16 percent, compared to 14 percent for the northwest, where Liverpool and Manchester thrived, according to a 2004 paper by Crafts, who was then at the London School of Economics. In the years following World War II, manufacturing hubs like Birmingham grew faster. Now, amid the growth in services and banking, London accounts for 22.4 percent, up from 19.4 percent in 1997, according to government data.

‘Asset Class’

The average price of a London dwelling jumped 345 percent to 409,881 pounds between January 1995 and this year, according to the Land Registry. The average national increase was 171 percent to 168,356 pounds. London Mayor Boris Johnson has called property in his city a “new asset class” for investors.

A Canadian with an Irish passport and 250,000-pound annual housing allowance as part of his central bank contract, Carney for now is signaling an acceptance of London’s march as he tries to nurse the U.K. economy back to health. Interest rates are on hold for now, he has indicated.

Carney is fond of saying officials “don’t just make policy for inside the Circle Line, but for the whole country” -- an allusion to the underground train route that circumnavigates central London.

BOE Tools

Carney said March 18 the BOE “shouldn’t be trigger happy” in responding to house prices, noting the bank has tools it can use in a “proportionate, graduated way.” He has already ended incentives to banks for making mortgage loans. A Bank of England spokesman declined to comment for this story.

Deutsche Bank AG strategist Oliver Harvey reckons Carney and colleagues may need increasingly to heed events outside of London when changing their benchmark rate, which has been at 0.5 percent for five years.

His research shows the capital is skewing the performance of the overall economy, potentially masking weaknesses, creating asset bubbles and distorting labor markets elsewhere. While London’s economy grew 107 percent between 1997 and 2001, the rest of the U.K. expanded 74 percent, according to Royal Bank of Scotland Group Plc data.

The U.K.’s gross domestic product is still 1.4 percent beneath its pre-crisis peak and unemployment tops 7 percent. Inflation is below the central bank’s 2 percent target.

Widening Gap

To be sure, London’s rise isn’t a zero-sum game for the rest of the U.K. The Centre for Economic and Business Research calculated in 2012 that one pound of every five earned in London is redistributed elsewhere. Savills, a real-estate firm, predicts London property prices will soon push people elsewhere. It forecasts the southwest and east will outperform the capital through 2018. Accounting firm UHY Hacker Young said in a report this month the U.K.’s poorest areas, such as Blackpool, are recovering fastest as falling wages lure investment.

The gap between London and the rest, though, will remain wide even in recovery, said Holt at Capital Economics, who sees the London economy expanding 4 percent through 2015, versus growth of 3 percent in the rest of the U.K.

Bristol, Sheffield and Glasgow are among those that lost more than 3,000 private-sector jobs between 2010 and 2012 as London payrolls rose 216,700, according to the Centre for Cities, a London-based consulting firm.

It estimates Hull -- the city with the lowest share of working people, about 62 percent, and the largest count of jobless-benefit recipients -- would need 16,500 of its 260,000 residents to find jobs for it to meet the national employment average.

Imbalance Risks

The risk is that unless the gap is narrowed, the U.K. will fall behind by relying too much on London, once the world’s largest metropolis and the U.K. capital since the 12th century.

Centre for Cities research shows it already accounted for 79 percent of private-sector job growth since 2010 and is the source of 19 percent of the country’s employment.

It’s also drawing talent from elsewhere. One third of Britons between 22 and 30 years old are leaving their hometowns to migrate to the capital, with 12,300 quitting Leeds for London between 2009 and 2012, while 3,200 went the other way.

Such imbalances are rare internationally outside of city-state economies like Singapore. As of 2011, London contributed 13 percent of U.K. output on a gross value-added basis versus 7 percent for New York, according to Deutsche Bank.

“Not enough attention has been given to the two-tier, two-speed economy for such a long time that we’re out of kilter,” said John Dickson, 52, chairman of Owen Pugh Group, a closely held construction company based in Dudley, near Newcastle. “Whilst London and the southeast and a bit further north is starting to move out of recession, and that process is gradually moving north, it hasn’t reached us yet in terms of order intake and work flow.”

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net Melinda Grenier


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