Why there's a 95% chance of a recession

By Associate Editor David Stevenson May 22, 2008

David Stevenson

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Life’s about to get much tougher…for all of us…

It’s that R-word again. Loose talk of a ‘recession’ has been bandied about for some time, particularly amongst those of us who keep a keen eye on what’s happening in both the money markets and the high street. But now the idea that the good times are over is going mainstream:  not only is the “nice” decade – Non Inflationary Consistently Expansionary - ending, but the “nasty” one could well be starting, says analyst Tim Bond of Barclays Capital.

But what does that really mean? And how will Britain be dragged down into another recession?

Over to the strategy team at Legal and General. They’ve charted a ‘heat map’ of factors that could push us over the cliff edge. And it’s enough to get anyone steamed up…

…Legal and General’s SatNav is now on red alert. According the them there’s now a 95% chance that Britain is heading for recession!

While you’ll find plenty of commentators who will happily chat in gloomy terms about all sorts of possible problems, and then make a comparison with some point in history, Legal & General has taken the analysis a stage further.

Having totted up all the potential perils facing UK plc, the L&G team then rated each risk on a scale between ‘Good’ to ‘Danger’. Everything in the latter category, you won’t be surprised to hear, is coloured bright red on the heat map.

Why the likelihood of a recession is so high

So after examining sky-high personal debt levels, soaring oil prices, crimped bank lending and tension in the money markets, as well as a few other areas of possible pain, the strategists reckon that the odds of Britain suffering a recession are now about 95%. And what raises the stakes so high is the likelihood that everything will go wrong at exactly the same time. Which also makes it a racing certainty that the recession will prove to be just as bad as both the early 1990s and early 1980s.

How long will it last? The official description of recession by economists is “two quarters of negative growth” (only economists could actually talk about minus numbers as negative growth).

The Legal eagles have been pretty downbeat for some while, but until now have been telling us to expect perhaps two years of the economy going nowhere.

But recently the L&G ‘recession model’ has taken a real turn for the worse, and is now warning of a long decline in economic activity, by as much as 2% year-on-year. That may not sound huge, but if it happens, life could get very unpleasant and we’ll all feel the squeeze.

Cheap Asian imports are getting more expensive

Already there’s lots of talk about the dangers of Asian inflation and what this means for us here in the UK. Instead of picking up all those nice cheap Far East-made goods on our credit cards, we’ll soon find that the prices have gone up quite a lot (see this week’s Moneyweek for more on this).

But in future, the Legal analysts suggest that little luxuries will soon be off the menu anyway. If we do have a little leeway before hitting our credit limits, we could soon need it, plus any spare cash we can lay our hands on, just to pay the petrol bill to get to the supermarket.

Spending in the shops will suffer, profits in consumer businesses will slump and jobs will get cut. Meanwhile, the housing market will get much worse as mortgage problems mount. The Council of Mortgage Lenders now sees house prices dropping 7% this year, with transactions down by over a third on last year.

And banks will become less and less willing to lend money to all those people who’ll need it more and more. Don’t believe we can’t have a recession at this level of interest rates. If the banks close the loan shutters, we can.

Why the Bank of England is a lot gloomier than the Government

It seems the Bank of England is finally catching on, too. Today’s FT reports that the Threadneedle Street thinkers are now a lot more gloomy than official Government forecasts. Indeed, the Bank now believes that “a long period of weakness” is needed to bring inflation under the thumb, as I talk about below.

What’s more, the Government, i.e. taxpayers like you and me, won’t be able to do much about helping out, now that Gordon Brown has broken his Golden Rule by reeling in Northern Wreck.

UK public debts have now smashed through the government's official ceiling of 40%, preliminary figures suggest, reaching 43.1% of gross domestic product (GDP) in March. And although Chancellor Alistair Darling has said that any impact on the public finances by nationalising Northern Rock would be 'temporary and exceptional', just remember Milton Friedman’s comment that “there’s nothing so permanent as a temporary government programme.”

Historically, governments have been able to use our cash to boost the economy. But Howard Archer, chief UK economist at Global Insight, said the government's aim to keep borrowing down to £43 billion in the current financial year is 'wishful thinking' should the economy slow sharply.

And because of inflation, the Bank of England won’t be able to help either. The hands of the rate setters on the Bank’s Monetary Policy Committee (MPC) are well and truly tied by the CPI (consumer price index) hitting 3% and looking like it’s going some way higher, rather than lower.

In short, there should be no more interest rate cuts on the MPC’s agenda for the moment. Not that they were doing much good anyway. What matters most to the majority of homeowners is the level of mortgage rates. These are priced off so-called swap rates, in turn based on LIBOR – the interbank rate at which lenders lend to each other. Libor rates have stayed stubbornly high, the best part of 1% above base rates, despite the MPC’s earlier antics.


This may all sound like a technicality, but it isn’t. What it’s saying is that there’s still a lot of nervousness left in the banking system. Mortgage variable rates won’t fall until the markets regain confidence in the Bank’s bank rate.

So the picture’s looking bleak on all fronts. Recession looms, consumer prices soar, public debt climbs. Not nice at all.

Turning to the wider markets:

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London shares started the day on firmer ground, but the rally fizzled out and the FTSE 100 ended up just 0.1% at 6198. With the oil price heading ever higher, oil stocks were in demand, with Premier proving the best performer with a 6% spurt. Royal Dutch put on almost 5% and BG 5.5%, while BP gushed up 3.5% as analysts upgraded profit forecasts. In contrast, bank stocks dropped again, led by Bradford & Bingley whose impending rights issue looks like landing underwriters with plenty of stock.

RBS slid 5% and HBOS 4% on housing market concerns.

In Europe, despite better-than-expected German business confidence indicators, the Xetra Dax shed 1% while the French CAC index lost 0.5%.

Wall Street suffered its second successive large decline, with the Dow Jones Industrial Average losing 227 points, its biggest drop in a month, to close 1.8% down at 12602. Signs that the US Federal Reserve was cutting economic growth forecasts and raising inflation projections worried traders. The broader S&P 500 lost 1.6% while the Nasdaq fell 1.8%.

Overnight the Japanese market ignored the States, with the Nikkei 225 advancing 0.4% to close at 13978, though in Hong Kong, the Hang Seng declined 1.6% to 25043.

Brent spot was surging ever higher, trading this morning at $133.47, while spot gold rose to $928. Silver was trading at $18.01 and Platinum was at $2193.

Turning to forex, this morning sterling was again slightly firmer at 1.9725 against the US dollar, but similar against the euro at 1.2515. The dollar was last trading at 0.6345 against the euro and 103.29 against the Japanese yen.

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