GLOBAL CREDIT CRISIS AND PREVIOUS INTEREST RATE INCREASES SET TO TRIGGER SHARP UK SLOWDOWN
12/11/07 | 09:24
David Kern, Economic Adviser to the British Chambers of Commerce, said:
"UK prospects have worsened considerably as a result of the global credit crisis and the threats facing the international banking system. The dangers facing the UK economy are now much bigger. Since the trade-off between growth and inflation has almost certainly worsened, the risks have increased and the policy options have narrowed. But the immediate priority is to avoid a nasty downturn. Near-term inflationary pressures are fairly small, the correct policy response is to cut interest rates in the near future, even if some of the cuts will have to be reversed at a later date.
“Our November central scenario, which assumes that Interest Rates will be cut to at least 5.25% before mid-2008, predicts a sharp slowdown in UK average GDP growth, from 3.1% in 2007 to 1.9% in 2008. Our August forecast predicted growth of 2.8% in 2007 & 2.1% for 2008.
“UK GDP growth, having been very strong since early 2006, is set to fall to a below trend pace; growth is forecast to remain below trend during much of 2008. Year-on-year GDP growth is forecast to decelerate, from an above-trend 3.3% in Q3 2007 to 1.6% in Q3 2008. But there is a risk that the UK slowdown could be even sharper, particularly if the MPC decides not to cut interest rates in the next few months.
“The expected sharp UK slowdown will be mainly driven by the damaging effects of the credit crisis and the cumulative impact of previous increases in Interest Rates. Much weaker growth in household consumption, a worsening balance for net trade, and lower growth in investment will be the main contributors to lower GDP growth in 2008.
“The worsening squeeze on household disposable incomes, and the softening of the housing market, will weaken household consumption in 2008. A major additional risk is that the recent credit crisis could harm severely the financial sector, which is the one of the main drivers of the UK economy. The UK corporate sector is still relatively strong. But business reaction to the tax changes in the recent Pre-Budget Report has been hostile, and confidence is likely to worsen.
“Following the outbreak of the credit crisis and the Northern Rock problem market interest rate perceptions have changed. UK Interest Rate forecasts have been revised down. Our central scenario envisages that UK Interest Rates would be cut to at least 5.25% before mid-2008. But a Bank rate cut to 5% is a realistic prospect, particularly if the situation worsens.
“The cumulative effects of previous Interest Rate increases are now squeezing personal disposable incomes, and there are clear signs that the housing market is softening. Credit conditions have become tighter since August, both globally and in the UK. The worsening threats to the international banking system heighten the dangers of a sharp economic downturn.
“UK inflationary pressures are subdued. Labour costs are under control, with earnings growth below 4%. Annual CPI inflation fell below the 2% target in recent months, and was below the levels predicted in the August Quarterly Inflation Report. UK GDP growth was strong in Q3, but it is clear that growth is set to weaken from now onwards more sharply than was envisaged in the August Quarterly Inflation Report.
“Moderate cuts in UK Interest Rates would not pose serious risks to inflation, but waiting unduly before easing policy would worsen considerably threats to growth. The immediate priority is to limit the risk of a major downturn. UK business has been resilient so far; but easier credit conditions are needed without delay, to avoid a nasty reversal.
“UK public finances are set to remain under pressure. The new economic cycle is starting with large deficits, and it would be difficult to meet the fiscal rules in the current cycle. Businesses are concerned that that the effective tax burden is set to increase, through new “stealth taxes” and through allowing local authorities to increase business taxes.
“Recent tax changes (notably the capital gains tax reforms announced in the recent Pre-Budget Report {PBR} and the higher small business tax rate) have been badly received and have undermined business confidence. The business sector is still strong. But the climate facing UK businesses has worsened, and the position will become riskier and more difficult over the next year. We urge the Government to pay particular attention to the threats facing small businesses.
ENDS
MEDIA CONTACT:NOTES TO EDITORS:The British Chambers of Commerce (BCC) is the National Voice of Local Business.
The BCC sits at the heart of a powerful nationwide network of Accredited Chambers of Commerce serving business across the UK, which employ over five million people.