With current UK growth forecasts 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.
Recession in UK could occur
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. Potential for House Prices to fall.
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 inflation is forecast to rise. Therefore to keep inflation close to the government’s 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.
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 don’t have to cause a recession.
In 1989 the economic situation was different. The UK had an inflationary boom and also joined the ERM. Joining the ERM require interest rates to be much higher.
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.