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Saturday, 24 January 2009

When will the global recession end?

It came as no surprise yesterday that the UK is now officially in a recession. With the economy shrinking in the third quarter of the year, the economy certainly hadn't improved in the final three months of the year. The economy contracted by 1.5% in the final quarter of the year, having shrank 0.6% in the third quarter.

These figures confirmed that despite the government's attempts to stimulate the economy through measures such as a cut to VAT and capital injections into the banks, and the Bank of England's historic interest rate cuts, the economy shrank at an accelerated pace.

Like the USA, Japan and the eurozone, which were confirmed as in recession at the end of the third quarter, the UK is now officially in recession, and is unlikely to emerge from recession for some time.

Historically recessions tend to last about fifteen months, but given the global nature of this recession and the severity of the economic imbalances in the UK this recession could last longer. It will almost certainly be longer before the UK returns to its natural rate of economic growth (approximately 2.5% per annum).

Given that the USA is further through its recessionary cycle than other economies, it is likely that they will emerge from their recession before other parts of the world. The country also has the capacity to spend its way out of this recession. Given the massive fiscal stimulus planned by the new Obama administration, this could pull the US out of recession by the middle of 2009.

Increased optimism following the election of President Obama should also help to stimulate the economy as consumers feel positive enough to spend and businesses prepare for an upturn. This break from the old could have a significant impact on the economy.

The eurozone and Japan are likely to follow the United States. Once the US starts to grow again global demand and global confidence is likely to improve. Japan and eurozone countries like Germany rely heavily upon exports and therefore global demand is fundamental in their economic revival.

These countries also benefit from having less consumer debt and fewer economic imbalances (e.g. house price over valuation) than countries such as the UK and USA. Therefore the downwards economic cycle should have less corrections to make before stability returns. Less personal debt and higher savings will mean that consumers in places such as France and Germany will be able to benefit from falling prices, prompting an increase in consumption that will aid the recovery.

The UK is likely to be one of the last developed countries to come out of the global downturn. It faces a number of problems that will prolong the correction in the economy. For one the UK economy relies heavily upon global finance as a proportion of GDP and as an employer. Therefore with this sector in chaos the economy has been hit hard.

Secondly UK households do not have a massive amount of savings to protect themselves through the economic slowdown. Having spent heavily and saved little in previous years the UK consumer is likely to sharply cut consumption in order to build up protective savings. This will reduce retail spending, a key part of the economy.

Third, with the UK government attempting to support the banking sector it has built up a massive debt. Like the UK consumer the British government did not save in the good years and therefore does not have a surplus available to add much extra stimulus to the economy.

Finally, UK house prices were some of the most over valued in the developed world and as a result will need to fall further than in other countries. This will again weigh on consumer confidence and will also hit bank balance sheets.

This is not to say that the UK will be in permanent decline. The rapid weakening of the pound will stimulate exports from the UK. This will take some time to occur as the world economy slows and as international importers adjust their supply chain to the UK.

The UK also benefits from a highly skilled and flexible labour market. Unlike some European countries the UK's labour laws encourage the use of temporary workers and place less barriers to employment. They also allow employees to be sacked or made redundant more easily. Although not a great thing if you are one of the people losing their job, but it will mean that British businesses can reorganise and cut costs more quickly and cheaply than other countries.

Finally the Bank of England has cut interest rates quickly and will continue to cut to near zero. Along with quantitative easing ("printing money") this will act as a further stimulus.

In all these countries, particularly the USA and the UK, the way out of recession will require the banking system to move back to some sense of normality. This is not going to be easy and could be some way off. Without it though, businesses will continue to be unable to borrow and therefore invest and consumers will be unable to get mortgages or loans to buy houses, consumer or start entrepreneurial activities.

So as it stands here are my forecasts for when recession will end (i.e. first quarter of positive growth):

USA - Q3 2009

eurozone - Q4 2009

Japan - Q4 2009

UK - Q1 2010

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Friday, 18 January 2008

Belt tightening at Christmas

The Office of National Statistics today produced the December retail sales providing further evidence that the United Kingdom is entering a significant slowdown. These figures add further evidence to suggest that 2008 will be a tough year across the whole economy, not just financial services.

The figures showed that despite it being Christmas and prices being slashed, people have been either unwilling or unable to spend their money either at the shops or online. As a result sales volumes in the three months to December rose by only 0.4 per cent compared to the previous three months and between November and December sales volumes actually fell by 0.4 per cent – mainly in the non-food sector.

Even though many will not have felt the pinch of higher interest rates, lower house prices or higher unemployment, most believe it is coming. Therefore consumers are tightening their belts in anticipation of a rough year. Many people will be looking at their savings (or more likely debt) and wondering how they will be able to pay their mortgage when it is set at a higher rate, or how they would survive if they lost their jobs.

Economic slowdowns are created as a result of both fundamental problems with the economy and people reacting to them. Without this reaction economic activity can receive a significant boost making a downturn less severe. However, without these reactions the economy is merely making the problem worse in the long run. Economic fundamentals become ever more stretched – such as savings, debt and household budgets – and eventually a significant correction is required. This correction could come as a short, sharp shock or it could be a sustained period of below average growth. Either way, this will be painful process for many.

In many ways the UK economy has been putting off a slowdown for too long. Economic fundamentals are looking unbalanced and in need of correction. The extent and timing of the correction is still not clear, however, it seems certain that it will begin in 2008 and will be unpleasant for many.

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