Is a Recession Likely for UK Economy
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With growth forecasts in the UK currently of 3% it seems highly speculative
to start talking of a recession in the UK. However there are certain factors
that cause an element of concern.
Reasons for Recession
1. Fall in the Savings Ratio. Excluding pension contributions the UK
savings rate has dipped below 0. This means we are borrowing more than we are
saving. This is dangerous because it means household consumption is stretched.
True there was strong growth in consumer spending in January; however this
growth in consumer spending is likely to be unsustainable. There is a limits to
how much more borrowing consumers can generate.
2. Very low savings rates are often a precursor to recessions. The
last time the UK has a savings rate so low was in 1989. Two years later the UK
entered a recession as consumers sought to build up their savings after years of
borrowing and over spending.
3. Mortgage Equity Withdrawal Much of the borrowing has been financed
by an increase in Mortgage Equity Withdrawal. In 2006 MEW rose to £14.6bn or
6.7% of incomes. This equity withdrawal is often to consolidate other debts such
as credit card loans. However it means that if house prices were to fall those
who had taken out equity withdrawal would be vulnerable to negative equity.
4. UK sensitive to higher interest rates. The high levels of debt mean
that significant sections of the population will be very sensitive to rises in
the interest rate.
5. Inflationary pressures are forecast to rise due to several factors
such as, rising commodity prices. Therefore to keep inflation close to the
governmentís target of 2% it may require higher interest rates. Even a small
rise in interest rates of 0.5% could make mortgage payments unaffordable for
many new homeowners. This fall in consumer spending could lead to a recession.
UK Recession Unlikely because:
1. No Boom and Bust. Inflation is still within the governments target,
therefore there is no reason for the MPC to increase interest rates to very high
levels, (as in 1991 when they reached 15%). Many economists predict interest
rates may soon peak. Also real interest rates are still relatively low. (Real
interest rates = interest rates-inflation)
2. Growth is strong. With growth forecasts in the UK currently of 3%
it seems highly speculative to start talking of a recession in the UK. However
there are certain factors that cause an element of concern.
At 2.7% the economy is growing close to its long term trend rate, there is no
obvious reason for this to change in the short to medium term.
3. Low savings rates donít have to cause a recession. In 1989 the
economic situation was different.
4. World Economy growing strongly. Despite fears over the US housing
market the OECD has stated that the world economy is enjoying one of its best
years of economic growth.
5. The £ is overvalued. Therefore there is potential for a devaluation
in the £ which would improve the competitiveness of exporters in the UK.
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall,
Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US
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Article Published/Sorted/Amended on Scopulus 2007-05-30 01:15:40 in Economic Articles