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As the saying goes, when America sneezes, Britain catches a cold. What began as a local downturn in the US housing market has spread to the UK – and over the next year, analysts at Barclays Wealth think the British economy and the FTSE are likely to struggle more than their US counterparts.
Why is Britain particularly badly affected? Three factors stand out. Firstly, UK consumers are highly exposed to the credit crunch. Personal debt (as a proportion of income) is higher in the UK than in either the US or Europe. This suggests that a larger hit to consumer spending is likely.
Secondly, the housing market correction has further to run. Barclays Wealth analysts expect house prices ultimately to fall more steeply in the UK than the US.
And thirdly, government intervention will be less in the UK than in the US. Interest rates have fallen more slowly, and Obama is expected to propose a larger fiscal stimulus than has been announced here.
The UK economy contracted in the third quarter of 2008; Barclays Wealth analysts expect another year in which the economy shrinks, with only an anaemic recovery in 2010. While the economic downturn is unlikely to be as sharp as previous recessions, it will probably take longer to bounce back.
Consumers are likely to batten down the hatches and save more of their income. And although the fall in the pound will help business exports, the effect will be partly offset by weaker demand in Europe and the US, the UK’s main trading partners.
The end of inflation
It feels like just yesterday that inflation was the new fear, with food and oil prices rising sharply. Now, inflation looks likely to fall sharply next year.
Why is this? First, energy and food prices will continue to drop. Second, the cut in VAT to 15% should deduct around 1% from inflation in 2009 (though it is temporary, and will be reversed in 2010). And last, falling high street demand will be reflected in lower prices.
All in all, Barclays Wealth analysts expect consumer price inflation to fall from 4.8% in the third quarter of this year to around -1% at the same time next year.
More rate cuts on the way
The Bank of England is likely to cut rates further in an attempt to stimulate the economy. While it has already slashed interest rates from 5% in September to 2% in December, Barclays Wealth analysts say rates will be as low as 1% by March.
“The Bank will be alert to the need to raise rates again once a recovery is under way, but we doubt that this will be a story for 2009. Instead, we have pencilled in 1.5% of rate hikes in 2010.”
Shares likely to struggle
Short-term fear has seen markets fall sharply, but in the long run, they should reflect the growth of private sector profits and, therefore, economic activity. Next year, the UK stock market should reverse some of its recent declines. However, weak economic growth is likely to mean that the FTSE underperforms the US and Europe.
The pound came under severe pressure in the second half of 2008, falling from above $2 earlier in the year to below $1.50 now. It should recover somewhat by the end of 2009. However, there are definitely risks of further weakness, especially in the next few months, conclude Barclays Wealth analysts.
