UK Growth to Falter in 08 As Credit Squeeze Tightens

23 October 2007

LONDON: There's good financial news and bad for 2008, according to the Ernst & Young Item Club, a closely watched quarterly reading of the UK economy based on the Treasury's own economic model (hence ITEM, an acronym for 'Independent Treasury Economic Model').

The Club's autumn forecast has downgraded its earlier 2008 growth prediction from 2.5% to 2.1%, a fall equivalent to nineteen percentage points.

Bad news? Not necessarily says the Club's Peter Spencer.

Referring to certain roughneck elements within the financial services industry [not Spencer's words], he opines: "This is a very timely tightening, targeting parts of the financial sector that were growing too fast and were too dependent on cheap credit. Having to reverse gear may not be such a bad thing."

Among the most susceptible groups cited in the report are over-exposed hedge funds, private equity firms and property buyers who have borrowed a very high proportion of the value of their properties.

The report also points out that the Treasury will be hit by falling tax revenues from the City.

The tighter monetary conditions and lower inflation should enable the Bank of England to reduce its base rate in the coming months, once the growth of GDP and of M4 money supply have slowed.

But a base rate cut is unlikely to revitalise demand, nor will it mean lower credit or mortgage costs for many borrowers as, in the meantime, other interest rates are likely to rise.

In overall perspective, the bulk of the UK economy has continued to grow strongly, while CPI inflation has fallen to just below the 2% target, and this momentum should result in GDP growth of 3.1% over 2007.

But now that the credit boom - which has fed much of the expansion over the last few years - has somersaulted into a credit squeeze, this will restrain investment and spending across all sectors, and economic growth will be subdued. Thus ITEM foresees growth of only 2.1% over 2008.

A detailed summary of the report can be viewed by clicking here.

Data sourced from BBC Online (UK); additional content by WARC staff