Leading Article: The real economy takes a hit

It has become depressingly clear this week that the global credit crunch is now percolating through to the real economy. Yesterday it was announced that Britain's services sector, which represents about 75 per cent of the economy, shrank in September at its fastest rate since records began 12 years ago; businesses there have been cutting jobs for the past five months, with hotels and restaurants among those hardest hit. Manufacturing has also contracted strongly, with new orders and output at their lowest since the early 1990s.

That the situation is similar in much of the industrialised world, with the exception of China, is small comfort. The 15 per cent depreciation of sterling over the past year has brought scant relief. Among the first to feel the pinch are car manufacturers; Ford is moving to four-day working; the Range Rover night shift has been suspended; luxury car maker Bentley is now on a three-day week; Honda will extend the Christmas holiday at its Swindon plant.

All this comes on top of the steepest annual fall in UK house prices for 17 years (12 per cent down on last year). New housing starts are at their lowest level for 60 years, and the construction industry faces a three-year slump after 13 years of unprecedented growth. Mortgage lending came to a near standstill in August, as approvals for new home loans hit a record low. And times are tough for the nation's shops with the bellwether Marks & Spencer registering its worst performance for three years. Shoppers are veering away from premium quality and switching to bargain stores.

Having said that, the signs so far are that this downturn is not on the scale of the one that succeeded the Lawson boom of the early 1990s. Interest rates this time are low and the exchange rate has fallen sharply. And although companies are cutting investment plans and unemployment will rise, the increase will probably not be as fast or high as in the 1990s. We can still hope that what lies ahead is a stagnant or mildly declining economy rather than a full-blown recession.

In the light of this, the temptation will be for the Bank of England to reduce interest rates next week. So long as confidence between banks remains a problem, lower interest rates will not of themselves free up more credit. The Treasury should, however, keep putting more money into the markets through the special liquidity scheme, which could be expanded by increasing the range of assets the banks can offer to the Bank of England as security. And Gordon Brown should make more clear that no major bank will be allowed to fail. Yesterday's decision to increase to £50,000 the Government guarantee on savers' deposits was a step in the right direction, after the Irish government's unlimited guarantee to savers. But a clearer statement that the Government stands behind the banking system would help as the nation battens down the hatches.