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Ernst & Young ITEM Club Winter forecast

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      01-20-2009, 06:13 PM
If it doesn’t kill us, it will make us stronger

But 2009 will be grim even with much needed further Government support

London 19 January 2009: The Ernst & Young ITEM Club Winter forecast
released today predicts that the next 12 months will see the largest
contraction in GDP since 1946 and that without additional Government
intervention a deep recession could evolve into a depression.

The forecast sees UK GDP contracting by 2.7% in 2009 with a further
contraction of 0.5% predicted for 2010. ITEM forecast a rise in
unemployment to over 3 ¼ million by the end of 2010 and consumer
spending declining by 2.5%.

Inflation and interest rates will both stay close to zero, benefiting
those on tracker mortgages and pensioners, but giving very little
assistance to a beleaguered housing market which ITEM believes has a
further 22 % to fall over the next 18 months.

However, ITEM believes that the Government’s actions since September
have been constructive and helpful and without them the situation that
the UK economy is now facing would have been far worse. Brown and
Darling have to think boldly and creatively and then with a fair wind
the UK economy will emerge from this recession rebalanced and
ultimately more robust.

Peter Spencer, Chief Economic Advisor to the Ernst & Young ITEM Club,
said, “It is easy to criticise and conclude that none of the
Government’s policies are working. However, we must not lose sight of
the fact that they have prevented the collapse of the monetary system
as we know it. But, more needs to be done urgently otherwise the flow
of credit will remain frozen and the economy will remain in

Banks are in intensive care
The banking system in the UK and around the world remains in a parlous
state with banks unable to lend to companies and consumers because of
their worries about loan losses and the need to back loans with new
capital and honour credit lines to secondary banks.

Spencer explains, “Ultimately the unfreezing of the global and hence
the UK banking system requires the US to resolve their domestic
banking problems. This is because most of the world’s surplus savings
– in particular, central bank funds and petrodollars – are recycled to
borrowers through dollar markets. UK market rates will remain a
premium to the base rate as long as dollar rates remain at a premium
to the Fed’s zero-interest rate. Credit will stay very tight in the UK
until the US inter-bank markets spark back into life and all of these
premia shrink back to normal levels.”

Corporate sector in paralysis
With a stuttering banking system and the UK economy heading for a deep
recession, business sentiment will continue to deteriorate. ITEM
expects business investment to fall by nearly 16% in 2009, with a
further drop of almost 6% in 2010. Spencer explains, "Precautionary
behaviour has begun to spread with corporates planning for the worst.
Investment intentions and recruitment plans have collapsed. Company
treasurers are very worried about what lies around the corner in 2009
and prefer to be sitting on cash."

Consumers in the shadow of the dole queue
ITEM predicts that consumer spending will decline by 2.6% in 2009
followed by a further fall of 0.6% in 2010. This is consistent with a
rise in the savings ratio to 5.5% by the end of 2010, but there is a
significant risk of a deeper consumer retrenchment. For the first time
in a generation it will be the fear of being out of the work that
drives consumer behaviour. And with good reason as ITEM forecasts that
unemployment will reach 3.4 million in 2011.

Spencer elaborates, “In this harsh climate, people will be very
worried about job security. The workforce is directly in the firing
line, making consumers much more cautious in their behaviour this
year. Earnings growth will subside, reinforcing the pressure on
disposable income. We see average earnings growth falling below 2% in
2009. Some relief will be provided by inflation, which is set to fall
below the 1% CPI threshold next summer, but real disposable incomes
are set to fall by 0.4% in 2009, and to recover by just 1.1% in 2010.”

Housing market remains in dire straits
The forecast predicts that house prices have further to fall and
forecasts a 16% fall in house prices over 2009 and a further 6% in
2010, with a peak-to-trough decline of over 33%.

Spencer said, “The housing market remains in dire straits, starved of
new mortgage finance. Net lending will remain at negligible levels
until overseas mortgage –backed loans are repaid. Although bargain
hunters are active, there seems very little reason to buy until house
prices stop falling. We do not see that happening until the end of

An aggressive monetary policy can prevent a lost decade
ITEM is calling for a more aggressive monetary policy. The MPC needs
to push base rates towards the zero bound, without fretting unduly
about the pound. Like the US, the UK may head towards Japanese style
policies – the zero interest rate policy, or ZIRP, may well have to be
deployed for the worst case scenario.

Spencer added, “Quantitative monetary policy techniques should be
adopted immediately, without waiting for lower interest rates. That
would mean government purchases of gilts, mortgage-backed or other
securities, pushing down their running yields and effectively
replacing them in private portfolios by notes and coin or bank
deposits with the Bank of England, which form the monetary ‘base’. The
aim would be to supply any cash that people want to hold – and some –
in the hope that these surplus funds would be spent or invested.”

The weak pound does offer opportunities for beleaguered manufacturers
ITEM expects world trade to fall by 2% this year, while exports are
likely to fall back by 1.5%. Nevertheless, with sterling at these very
competitive levels, UK exporters are in pole position for the recovery
ITEM anticipates in international trade next year with exports
increasing by 4% in 2010 and 6.5% the following year.

Spencer concludes, “The unprecedented fall in the pound presents many
businesses with heaven-sent opportunities to switch production away
from the home market and ultimately to develop new outlets and
products. Furthermore, large multinational companies that can access
the necessary finance will surely boost their capital expenditure
programmes to expand UK manufacturing base in anticipation of a
recovery in the world economy.”[$file/EY_ITEM_Economic_Outlook_Winter_2009.pdf]
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