If airlines are slashing jobs, can investment banks be far behind? Following the atrocities in the US, the City of London faces grim employment prospects as plunging markets, political risks and a heightened danger of recession weigh on a financial services industry that was already poised to cut into its fat.

Even before the attacks, the City faced a shake-out. The bear market, faltering economic growth and a collapse in corporate finance work mean the sector has been carrying many more staff than needed.

The industry has been trimming since at least the start of the year. Some houses have announced formal cutbacks, others quietly showed staff the door. But many put off draconian action in the hope that US growth would rebound this autumn. Those expectations were looking vain before the terrorists struck and recovery now seems a long way off - longer than can be borne by those businesses, such as investment banks, where salaries represent a large proportion of costs.

A report two months ago by the Centre for Economics and Business Research, a consultancy that analyses the London economy, forecast City employment would fall by nearly 20,000, or just over 6 per cent, from the cyclical peak of 324,000. The cuts are certain to rise following the attacks. Some analysts reckon a further 5,000 jobs could be lost, though the tally could be higher still if there is a prolonged Middle East crisis.

Nevertheless, the gloom needs keeping in perspective. First, the financial services industry, grown fat and arrogant in the years of plenty, was overdue a cyclical correction and a reminder that investment is not a one-way bet - though no one would have wished on it the horrors of the past two weeks. Second, even if 30,000 jobs disappear, that will be far fewer, in absolute and percentage terms, than the post Gulf war recession, when 40,000 people, or about 16 per cent of the workforce, lost their jobs.

Why may the City fare better this time? Douglas McWilliams of the CEBR points to the relative robustness of the UK economy, the fact that in the early 1990s the industry was badly in need of post Big-Bang rationalisation, and London's emergence as a more international financial centre over the past 10 years.

The sheer scale of this transformation is chronicled in a book* published this week by two business historians, Richard Roberts and David Kynaston. City employment shot up by more 50 per cent between 1992 and 1999. Some of that was market froth, but a lot was due to the growth of global investment, a wave of European corporate and financial restructuring, and American banks' rapid expansion of their regional presence. These forces are not about to disappear, though they will be muted over the next year or so.

Some paint a more gloomy picture. Philip Augar, an ex-broker and author of a book on the decline of the UK-owned securities industry+, argues that the bear market will encourage US banks that now dominate London to cut overseas overheads, employing new electronic technology out of New York. London, with its particularly high wages and infrastructure left over from the old UK banks, will suffer particularly badly. What will emerge is a hub and spoke model. New York will be at the centre. A diminished London will be one among many offshoots on the rim.

I think he overstates the threat. Yes, some commodity functions may move to New York. In the aftermath of the attacks, the big American banks may also be reluctant on humanitarian and political grounds to cut back heavily in New York, where staff have undergone appalling traumas. They may look disproportionately overseas for cuts.

But the City, in many respects now a hub in its own right, should escape the worst. Many of its high value-added functions can only be done with a presence on the ground. And the attack on the World Trade Center has cruelly underscored that there are benefits to geographical diversification.

Roberts and Kynaston, writing before the terrorists struck, seem broadly to agree. They quote a senior investment banker with a Wall Street firm as saying that "when the downturn comes, it's New York that will take the brunt of the firings. Europe is where the action is, and London is where that business is done." Well, we should find out soon enough.

Tesco

When the world seems to be falling apart, at least Tesco can be relied on to provide a touch of stability. Britain's biggest and most profitable food retailer produced a strong set of interim results on Tuesday, in line with City expectations and ahead of most of the competition, with same-store sales up 7 per cent against an industry average of 5 per cent.

As a little added bonus, it was also admitted this week to the FTSE4Good index, a yardstick for ethical investment, after clarifying its position on environmental issues. Quite right too. It was always a touch bizarre that the compilers should have left out a company with such a strong record of corporate social responsibility, including computers-for -schools and urban regeneration projects.

The second half looks tougher for Terry Leahy, the chief executive, who expects sales growth to drop to between 4 and 5 per cent. On top of that, a prolonged global political crisis could affect the group's extensive overseas operations and undermine consumer confidence at home, hurting its drive into non-food sales. Still, Tesco remains a core holding in a sector with great defensive strengths in a recession - along with the smaller Wm Morrison, which this week produced better results than Tesco and is more of a food pure play.

Tesco's stock has risen so much relative to its peers that it now stands at a premium not just to the UK sector but to continental competitors such as Carrefour and Ahold, potentially opening the way for the kind of big European merger that the food industry has speculated about for years.

No one is thinking of takeovers in the middle of a bear market, and the low-key Mr Leahy seems unpersuaded of their merits. Let us hope, for the sake of Tesco's shareholders, that he does not change his mind. It is hard to see the synergies available in a big continental tie-up outweighing the severe cultural clashes that would follow.

Tough call

Since the terrorist attacks on the US, equity strategists have been unusually honest about their inability to predict the markets' direction. But none, I think, have been more frank than the global strategy team at ABN Amro, which wrote this week: "We have few, if any, adequate tools for analysing the consequence of events that are without historic parallels. In a very real sense we have to assert that what happens next depends, in large part, on what happens next." You cannot argue with that.

*City State. How the markets came to rule our world. Profile books + The Death of Gentlemanly Capitalism. Penguin