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Slow recovery needs a flexible outlook

Despite the scars of the recent past now is the time to prepare for the future, however uncertain it looks. So testing your business model against extreme scenarios will leave you in a strong position

Gary Styles
Gary Styles Strategy, risk and economics director Hometrack

The signs are that the economy will wobble its way into 2011 with mixed signals of strength and weakness as it struggles to follow a consistent recovery pattern. Most of the economic agents, whether they be firms, government departments or indeed consumers, are finding it difficult to overcome the fears of the recent past.

We all know it can take several years before confidence is restored to more normal levels after a major financial shock. The current economic cycle is broadly similar to previous downturns but it has been a long time since all the economic actors appeared to be living in fear of the unknown and responding to events in such a uniform negative way.

The events in Ireland and potentially other European markets have reawakened fears of a return to 2007 and 2008. Escaping the past is difficult but reshaping mindsets, business models and behaviour is even harder.

If history is any guide then the lacklustre performance in the mortgage and housing markets is likely to be with us for some time to come. It is realistic to assume that house prices will change little over the next three or four years and mortgage lending will also show limited growth.

During this period firms and businesses need to take advantage of low activity to rethink their business models and priorities. It is a high-risk strategy to assume that it won’t be long before volumes are growing strongly and house prices are increasing 10% a year. Hibernation is also not a viable option as managing existing customers requires innovation and new strategy.

Worrying about what could go wrong rather than what could go right has become the most prevalent mindset. You only need to read the various views on the risks surrounding fiscal tightening and the economy to see that the way people are thinking is predominantly negative.

Despite the huge economic uncertainties we face this is the time to think through longer-term plans and shape your business for the future. Scenario planning, which is often seen as the academic window dressing of business plans, should be at the forefront of this process.

Testing your business model against the more extreme views of the world over the next five to 10 years will leave your company in a much stronger position. The need for flexibility, adaptability and the right people to manage your business in the current environment and the future could not be more important.

The level of vested interest and people sticking to old business models makes me nervous of many of the forecasts and assessments produced in the market. Having lived through the last major recession in the early 1990s as group chief economist and head of group planning at a major bank, I have still not forgotten the pressure that was placed on businesses to focus on returning to strong growth.

This time we need a more open review of what is appropriate for our economy and businesses in the long term. Rapid borrowing growth and house price inflation is neither desirable nor achievable in the short term.

Banks have now achieved much wider margins than two to three years ago when competition was vigorous and economic expectations lofty. There is little sign that these margins and spreads will reduce in the coming years.

The economy of the future is likely to be more balanced and less dependent on debt. This will mean more exports and investment, and less consumption, private and public.

The change in mindset is particularly prevalent among consumers and this will have a long-term impact on the mortgage market. The graph below sets out different views for the size of the mortgage market in the long term and shows the recent history back to the late 1960s.

The figures show the number of outstanding mortgages in the UK rather than the debt level or the annual level of gross lending.

The total number of mortgages rose sharply over the 1970s and 1980s reaching 8.5 million in 1988 before rising to a record peak of 11.9 million in 2007. Since the recent peak in the housing market the number of mortgages has fallen by over half a million and is currently 11.3 million.

Our view is that the mortgage market will only gradually recover and the number of mortgages will only return towards 2007 levels by the end of the forecast period.

But it is also likely that we could see a permanent shift away from home ownership combined with lower consumer debt levels. This scenario is shown in red and under this scenario the number of mortgages falls to 10.7 million by 2021.

The final scenario shows the mortgage numbers remaining flat at 11.3 million in the medium term and is very consistent with flat nominal house prices and a continued drift away from mortgage lending.

Whatever probabilities you attach to these scenarios, your business must be able to do well under all three. Consumer mindsets have changed, so make sure this is fully reflected in your business plan.

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