15 September 2008
Vanessa Rossi
(Former Chatham House Expert)


The end of the summer break has seen the order of priorities for policymakers change markedly - gone are the worries over soaring oil prices and inflation risks, in comes the stark threat of being engulfed in a global recession and the next stage of the global financial sector meltdown. And, unfortunately, the realisation that this will not just be a UK thing cannot be seen as good news. The IMF has pencilled in an OECD slowdown that looks like the last recession in 2001-2002 or that of 1993 - but it could turn out to be as bad as the early 1980s.

The US is looking at a bleak second half for the year as unemployment is sharply up and yet more banks are teetering on the abyss - in spite of the Treasury's massive bail out of the mortgage system (Freddie and Fannie). The consumer has spent the tax rebates and has little left in its purse for the end of the year. By now, the surprisingly strong blip up in Q2 growth looks like a last fling rather than a new uptrend - indeed it is quite typical for the US economy to rock around on its way into recessions. Even with the administration hell bent on warding off recession, or at least limiting its scale, the US looks unlikely to show a sustained pick up before the middle of next year. But at least they are trying. And the markets still see the US as most likely to be first out of recession - although the date for this happy event has undoubtedly been postponed.

News from Europe has only confirmed the suspicions that we voiced in a previous World Today article: the UK's immediate neighbours are actually faring even worse in the economic downturn. The Eurozone economy started contracting in Q2 and the consumer slump is far worse than that in either the UK or US. So much for this supposed zone of stability. And there seems little chance of policy easing as there is little scope for flexibility in fiscal policy and the ECB continues to fret over inflation risks - egged on by higher pay demands from German unions. Great timing.

Finally, even China, so far the mainstay of emerging markets and the global economy, is looking vulnerable - although it is not because of weaker export growth but due to cracks appearing in its domestic economy. The stock market has visibly plunged, damaging confidence, while, less visibly, the property sector is also hurting and residential construction investment (about 20% of total investment and over 10% of GDP) could see a sharp contraction in the months ahead. The government is rattled enough to be talking of fiscal boosters.

Against this global background, and with its own woes to attend to, the UK outlook for 2009 is bleak. A weak pound cannot help much if no one is buying and deteriorating economic growth will create yet more knock on effects in the banking and property sectors - collapsing travel companies may be just the tip of the iceberg, especially in sectors already suffering from the pincer of both inflation in costs but deflation in consumer prices. The house builders look as if they have shored themselves up but can the same be said of all the retailers already struggling to cope?

As the flush of commodity price inflation fades, consumer price inflation will fall sharply. As we warned previously, there could be an emerging threat of deflation by next year. It is already visible in the housing market and much of retailing - and will probably spread. Some of the UK's monetary policy committee members are now talking about the deflation risk. And the UK's base rate will be heading down soon. What else the government can do to improve the outlook is much less certain.

Also read Another Wall Street Collapse: Are We Surprised? by Dr Paola Subacchi, Research Director, International Economics at Chatham House.