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Financial Crisis

The UK economy has got itself into a mess – probably the worst financial crisis since the 1930s.

Recession is here. UK economic growth during 2008 is the lowest in 17 years. Pre-Christmas 50% Sale signs in shopping malls indicate weak consumer spending and so businesses and consumers must prepare themselves for tough times ahead.

2008 Crisis
The pound has fallen 25% over the year and future economic growth is forecast to be negative 0.1% in 2009. Mortgage lending has virtually ceased and house prices are predicted to fall by a further 30% over the next year. Repossessions are up by 71% and unemployment has risen to record levels.

The UK banking sector is experiencing the biggest reformation in its history. According to the Bank of England, UK financial intuitions have lost over £1.7 trillion. This figure is astronomical and the impact of the crisis is spreading into the economy and people’s everyday lives.

The City of London is losing its edge as many US investment banks such as Lehman Brothers, Bear Stearns and Merrill Lynch have become casualties of the banking turmoil. The UK economy has enjoyed a good ride over the last 10 years but now the very basics of western capitalism and its strong financial bedrock are being questioned.

The government has played its part as regulators often adopted a soft touch approach to institutions who, in order to balance their books, used complex financial vehicles such as collateralised debt obligations (CDOs) to sell debt on to banks, pension funds, insurance companies or private investors. This is why banks, that have no US presence, have ended up owning billions of sub-prime debt with bad credit ratings. Some label this crisis as “Made in America”.

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Future outlook
The UK economic outlook is very bleak with recession predicted throughout 2009 and a continuing trade deficit. If the pound continues to weaken the cost of foreign goods such as Chinese or EU imports will become more expensive, thus pushing inflation higher. The Bank of England is cutting interest rates to help businesses and boost lending. Most economists predict interest rates of just 2% in 2009, however there are now calls for 0% rates as occurred in Japan in 1989. With US interest rates hovering around 1%, we may see low interest rates for years to come. Still, current inflation stands at 5.2% and there is a danger that too low interest rates will accelerate inflation to over 7% which would then be extremely difficult to contain.

The part nationalisation of some UK banks and the provision of a £400bn government rescue package to guarantee interbank lending provide some comfort and hope that a situation similar to that in Iceland, where banks have collapsed, interest rates grown to 18% and the currency devalued by 70%, will be avoided in the UK. However, as the UK economy is service based and heavily involved in global trade, global economic downturn will have more severe implications than in any other EU economy.

The government is taking shares in some UK banks and putting restrictions on cash payouts, dividends or bonuses, to executives. Also, the banks are expected to make a commitment to continue lending to small businesses and house-buyers. To boost employment, the government is bringing forward projects such as Olympics projects and other construction projects which were not due to start within the next 2–3 years.

All this extra government spending and cash injections have their cost. In the years to come the government will need to plug holes in its own borrowing and the first source of new money will be taxpayers’ pockets. We need to prepare for tax rises once the UK is out of recession and GDP output is growing again.

By Richard Plašek
Photo: Fotolia