In many ways the economy is in a good position. The main economic indicators suggest a strong and sustainable economy, which offer good prospects for 2008.
- Economic growth, at 2.6% is close to the long run trend rate.
- Unemployment, according to JSA measure, is under 1 million. At 3% of the labour force this is fairly close to full employment. (although the more reliable Labour force survey suggests the true level of unemployment is higher.
- CPI Inflation is 2.1%. This is almost exactly the government’s target of 2% +/-1
The main economic predictions forecast similar statistics for 2008. Economic growth is forecast to continue at around 2.5%. In the latest Bank of England inflation forecast, they predict inflation will rise slightly before dropping back to 2% at the end of 2009.
All these statistics and forecasts suggest that the government is correct to claim that the UK economy is in a very strong position for 2008.
However, there are several trends which suggest that this optimism may be misplaced.
1. Housing Boom and Bust.
Several different reports have shown a slowing in the housing market. Many claim UK house prices are fundamentally overvalued. When the market turns this could cause a drop in house prices, similar to the current US experience. Because housing is the biggest form of wealth, a drop in house prices could seriously impact on consumer confidence and consumer spending. The last time house prices fell (in 1992), the UK entered into a recession. Admittedly house prices fell 15%, and interest rates were very high. Nevertheless, a drop in house prices would significantly impact on forecasts for growth of 2.5% A lot will depend on whether we just see a stagnating market, with a slowdown in house price growth or an actual fall in house prices.
2. Continual fall out from US sub prime mortgage crisis.
The sub prime mortgage crisis has caused a serious credit crunch. This means it is difficult for banks to borrow funds. Consequently, they are being much stricter with lending – this will reduce consumer spending. Also, because credit is more restricted, the cost of borrowing has increased a little. The governor of the Bank of England has indicated that the worse is yet to come. As US house prices fall, more homeowners may be in a situation of defaulting. Therefore, this will cause further bankruptcies. In an unusual move, the governor Mervyn King, suggested that stock markets are overvalued as a result.
3. Possible recession in US.
With the US housing market in turmoil there is an outside chance of the US going into recession. Although the US economy is less influential than it was 20 years ago. A US recession would nevertheless have a knock on effect to the global economy. The UK would not remain unaffected.
4. Personal debt levels in the UK.
The UK savings ratios is very low. This is reflected in high levels of personal borrowing and also a growing current account deficit. This debt could be a constraint on future growth. It means that any small rise in interest rates can have a serious negative impact on growth.
Is a Recession in the UK Likely?
At the moment, I think it would be premature to talk about a recession. UK growth is currently positive. Also there is no evidence of a boom and bust economic cycle. In the past, it was the boom and bust that invariable caused recession. Also, if there was a slowdown in growth, the MPC have indicated that there is room for cuts in interest rates. This would soften the impact of any unexpected slowdown.