British Economy Could Be Heading Into Depression

On January 8th the Bank of England cut its benchmark rate to 1.5%, the lowest level since the central bank was founded in 1694. For some, this was an admission of defeat. For others, this was a desperate step to help the sinking British economy.

Indeed, the last few years of the debt boom, soaring house prices, falling savings and a surging trade deficit brought the country to the recession not seen since the World War II. Moreover, it seems the downturn intensified at the end of last year according to recent economic data. For example, UK GDP fell in the third quarter by 0.6% and manufacturing reported the weakest reading since the survey started in 1992 and construction activity reached new lows. In addition, despite the temporary reduction in value-added tax, consumer spending is likely to fall sharply because households will spend less money as unemployment rises and wealth is deteriorating as the stock market is falling.

So, the important question is if lower rates could bring any help for the British economy. In our view, they won't because as long as banks continue to restrict credit the influence of the lower interest rates will not be strong enough. And what's the worst, banks reluctance for lending may last for the next few months as they need to repair their overstretched balance-sheets.

Also, the benefits of having a weak sterling for the economy are doubtful. In the long run, it may improve the UK's export performance by lifting investment and jobs. However, in the short run, the result of a low exchange rate is likely to be insignificant as UK exports rely on financial and business services and more than 60% of it goes to countries that this year may record a negative GDP growth.

British Economy Could Be Heading Into Depression

Anna Fedec,
1/14/2009 7:05:08 PM