UK economy 'already in recession'

Business Materials 20 October 2008 12:48 (UTC +04:00)

The UK economy has "deteriorated dramatically" in the past three months, and is already in a recession, top forecasters have suggested, reported BBC.

The Ernst & Young Item Club says the UK will shrink by 1% next year, before recovering in 2010 and growing by 1%.

The Item Club's chief economist, Peter Spencer, told the BBC: "Recession is already baked in the cake."

But one "bright spot" is that inflation is likely to fall, enabling the UK to cut interest rates further.

The group said that company profits had already been damaged by very high commodity prices.

While recent actions taken by the government to shore up the banking system are welcome, the credit crunch will hit the economy "very hard", Ernst & Young warned.

Mr Spencer said: "Even if equity markets stabilise and we begin to see capital flowing around the international financial system again, we are still looking at a domestic and global economy that will be in recession for the next 12 months."

However, Ernst & Young forecasts that with plunging interest rates, falling inflation, and a fundamentally strong economy, the recession will be "relatively short and shallow".

The group is not alone in thinking the UK has entered a recession - which is typically defined as two quarters of negative growth.

A recent quarterly survey of 5,000 businesses by the British Chambers of Commerce (BCC) also said the UK was in a recession.

Companies are likely to see their profitability squeezed further, prompting firms to invest 5% less in 2009, the Item Club predicts.

As a result of the slowdown, widespread cuts in investment and employment are "inevitable".

While the largest job cuts so far have been in finance and housing - the sectors most closely linked to the recent turmoil - the effect will spread further.

It said it expected unemployment claims would hit 5% by the end of 2009, double the rate at the end of 2007.

The report comes after recent data from the Office for National Statistics underlined the weakening labour market.

The number of people out of work in the UK rose sharply in the three months to August by 164,000 compared with the previous quarter, marking the biggest rise for 17 years.

Until September, accelerating inflation had been a major concern - latest figures show the annual CPI rate reached a 16-year high of 5.2% last month.

But prices have fallen recently, most notably for energy, and analysts expect September's figure to mark a peak.

However, real disposable incomes are set to remain flat in 2009, before rising in 2010, the Item Club said.

The research group forecasts that consumption will fall by 1.2% next year, with credit continuing to be hard to obtain and unemployment expected to rise.

The Item Club predicts house prices will fall 14% by the end of this year, and drop a further 10% next year.

Until the bottom of the market is reached and confidence returns the housing sector will be in "deep freeze", it says.

"Last year consumers were able to handle the income squeeze by borrowing and dipping into their savings," said Mr Spencer.

But this year "it is a very different story with credit harder to access and far more expensive".

The Item Club said recent government intervention had pulled the UK back "from the brink" but the banking system was "in intensive care".

Earlier in October the UK government set out a number of initiatives to rescue the banking system by making £400bn available.

But the report said that addressing problems in the UK's finance system could not be dealt with in isolation.

"We desperately need a global solution given the heavy dependence of our banks and borrowers on cross-border banking flows".

Longer term it said the recent financial crisis had left huge question-marks over bank regulation and governance, as well as fiscal policy.