British Economy Could be Heading into Depression (Update)

In the last quarter of the 2008, the U.K. gross domestic product fell 1.5 percent from the previous quarter, the most since 1980. What is behind this unprecedented slump? Can interest rates reductions and a weak sterling bring relief to the deteriorating British economy?

Indeed, last few years of the debt boom, soaring house prices, falling savings and a surging trade deficit brought the United Kingdom to the recession not seen since the World War II. Moreover, it seems that the downturn has intensified during the last few months. For example, house prices keep falling, mortgage approvals remain low and investment already is down 9.7% YoY, the biggest drop since 1980.  Moreover, the European Commission’s Economic Sentiment Indicator for the U.K. (which combines surveys for consumers, service sector, manufacturing, retailing and construction) is at a record low. To make things even worst, 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 people expect further deterioration of the economy.

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 U.K. 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.

Anna Fedec,
3/3/2009 8:36:32 AM