THE unaccustomed arrival of traditional winter weather in the UK in early February coincided with further evidence of a deep freeze in the economy.

In both cases, the authorities appeared powerless to cope with the immediate crisis.

Unfortunately, the processes of rebuilding savings in the UK, together with repairing the damage caused to the banking sector by past mistakes, will take longer than the arrival of spring.

A rapid increase in savings to historically more normal levels is undesirable because it would deepen the recession.

So, the authorities worldwide are trying to smooth the process, by reducing interest rates and cutting taxes, to encourage consumers to keep spending.

However, the problems of the banking sector continue to unfold, like a cross between the dance of the seven veils and a slow motion car crash, and it is hard for the authorities to calibrate their response until the problems are fully in the open.

There has been controversy over government money being used to “bail out” the banks. Although there will be further inquests over who was responsible for the worst mistakes, policymakers now have to concentrate on countering the economic fall-out. The economy cannot revive unless companies can obtain finance for new investment through a functioning bank sector.

So far, increased injections of capital by the Government and greater liquidity provided by the Bank of England have lagged the sector’s problems and failed to alleviate the credit squeeze.

At present, the UK economy is trying to cope with a simultaneous outbreak of precautionary saving and a cut-back in bank lending.

The result has been a major disruption in economic output, as sales fall short and companies lack funding for working capital.

Lower interest rates should eventually encourage spending and will help direct savers’ funds towards companies (whose bonds and equities offer greater yields, albeit at greater risk).

March has seen a further cut in base rate, taking rates to yet another 300-year low of 0.5%. Having taken rates as low as they can go, the Bank of England is set to embark on unconventional means of boosting the money supply, having announced a plan to buy up to £75bn of corporate bonds and gilts in coming months.

This is intended to offset the increased “stickiness” of money as owners of cash hoard it rather than spending or lending.

Although a policy of “printing money” to buy bonds could have inflationary consequences if implemented in an economy where money was circulating rapidly, in the near term these risks seem low because the fractured credit system is rendering the economy moribund.

As 2009 unfolds, the positive effects of official policy moves and falling fuel inflation should help engender a recovery in 2010.

Although it is proving hard to nurture optimism, the best opportunities seem likely to appear among the fallen assets (equities, corporate bonds and commercial property), whereas the safe havens may prove to offer expensive insurance beyond the immediate uncertainties.

Andrew Bell,

Head of Research

Rensburg Sheppards