Britain’s Economy Starting to Falter
Posted on: August 12, 2008 - Email Article - Printable Version
As the housing crisis and credit crunch continues to unfold in the United States, it seems as though the slowdown in America is catching up to economies abroad, as some are starting to struggle from similar problems to the US. If you remember this crisis started with the collapse of the sub-prime/housing market, which led to the deterioration of the credit markets and the likely recession that we find ourselves in today. Many European countries, particularly Spain, Britain and Germany, are starting to suffer from what could be prolonged downturns as the drivers of these economies are beginning to falter. I will try to highlight the problems plaguing Britain, where after 17 years of growth, the area could see a very prolonged recession due to very similar problems plaguing their economy as the United States’.
Britain
Britain is the area where I feel that problems could continue to worsen at an alarming rate sending the economy and the markets there into a panic. Britain has had a heavy reliance on the financial and housing sector of their economy in the past few years, 
but it looks like these are in for a significant correction, particularly housing. The average interest rate on a mortgage rose to 5.8% compared to 5.6% in the previous month. Year over year there has been a decline in housing prices of 8.8%. This paints an eerily similar picture to the deteriorating US housing market, which has been affected by much higher interest rates (which has led to many foreclosures), declining housing prices and over a years worth of inventory. While Britain’s problems have not reached America’s level yet, there seems to be a beginning to a significant downturn in their housing sector, which their economy has depended on for the past few years.
Unemployment is also causing a huge problem in the country, as its unemployment rate currently stands at 5.2%. The latest uptick in this measure, represented the 5th consecutive rise, as 15,500 more people claimed unemployment benefits, over consensus estimates of 10,000, which represented the biggest rise in 16 years. Coupled with the high rate of inflation, this should weigh very heavily on the average British consumer as they find their spending power reduced. They could very easily fall into a consumer recession much like the US could, as they are suffering from some very similar problems. There is also a record personal debt of $2.7 trillion in the country, as people borrowed without thinking of the long term consequences. It seems like households in Britain will have to de-lever their balance sheets, much like the households and banks in the United States as a recession looms.
Inflation crept up to 4.4% as rising food and energy costs crippled Britain’s consumers last month. This inflation rate represents a 16 year high for Britain and is double the Bank of England’s target inflation rate of 2%. While oil prices have come down the past few weeks, the pound has not performed well relative to other currencies, which should continue to put pressure on the British consumers as inflation continues to spiral out of control. Analysts view this as a very disturbing number as many of them were expecting a rate of 3.8%.
GDP for the second quarter grew at an anemic 0.2% in Britian. With inflation outstripping growth by a wide margin this puts the Bank of England’s Monetary Policy Committee in a tough spot. They would like to increase interest rates to battle rising inflation, but can not do so due to the current housing crisis unfolding in the country and low growth rates. At their latest meeting they held rates steady at 5%, but the question is just how long can they stick at that rate, without being severely impacted from an inflation or housing standpoint. Retail sales also fell 0.9% YoY, as the overall economic situation seems to more closely mirror the United States, with every new piece of data that comes out.
From an investment point of view there is one thing that I would highly consider at this point. I would look at a pair trade of buying the dollar and shorting the pound. With the deteriorating environment in Britain just beginning, the dollar, which has already rallied to a 21 month high vs the pound, can see some more significant appreciation in the future, as the United States has already cut rates significantly and could be done cutting in the future. Britain on the other hand could find themselves cutting rates, but even if they do not skyrocketing inflation will continue to weigh on the pound. There should be definite reason for concern in the British economy as the effects of the US downturn start to filter throughout the rest of the global economy.
-Vinay Ayala
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