British Economy Is Sinking

The United Kingdom economy shrank 2 percent from a year earlier. Has the British authorities used all available measures to boost the economy? What else can be done to stop the downturn spiral?

During the last few months the British government along with the central bank has implemented various measures to help the sinking economy. For instance, since October the Bank of England has cut its benchmark interest rate by an unprecedented 4.5 percentage points to 0.5%. Nonetheless, the cost and availability of credit still remains poor and banks are not likely to lend yet as they need to repair their overstretched balance-sheets. Moreover, if overnight rates reach zero, the BoE deposit facility and the overnight rate will offer the same rate. Under those circumstances, the interbank market may fade away even more with banks depositing excess funds at the BoE rather than in the money market.

To make things even worst, firms and households are cutting spending and increasing savings in response to high debts, falling asset prices and poor credit availability. For example, the overall net savings of households and businesses combined has climbed from minus 1.7% of GDP in Q4 of 2006 to a net surplus of 6.1% of GDP in Q4 of 2008. Furthermore, rising private savings has not yet created a significant drop in private debt levels from recent highs.

Looking ahead, at Trading Economics we think, the only hope to stabilize the British economy may be further fiscal stimulus and quantitative easing. But can the U.K. handle more debt? In fact, the aggregate external debts reached a new record high of 450% of annual GDP in last quarter of 2008. Also, the influence of quantitative easing is very controversial since it is very difficult to assess how much money supply is needed to boost credit markets and for how long those measures should be implemented. There is also another danger by the corner since the ability of new money to boost incomes depends on its velocity”. In fact, institutions expecting further deterioration of the economy may simply put the capital obtained from selling treasuries into deposits instead of investing them.

British Economy Is Sinking

Anna Fedec,
3/31/2009 2:56:11 PM