Ernst & Young ITEM Club Winter forecast

Discussion in 'UK Finance' started by Daytona, Jan 20, 2009.

  1. Daytona

    Daytona Guest

    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]
    Daytona, Jan 20, 2009
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