The UK economy will struggle to avoid recession in 2009 and the economy is expected to grow at a slower pace as the 'toxic mixture' of a moribund credit market and volatile oil price makes the future gloomier, the Ernst & Young ITEM Club said in its summer forecast on Monday.
The think-tank also forecasted inflation to remain above the target range of 1%-3% for the next 12 months, while unemployment is anticipated to increase considerably. On July 15, data from the Office for National Statistics showed that annual inflation in the UK accelerated to 3.8% in June from 3.3% due to higher prices of food and non-alcoholic beverages.
While stating that the increase in the numbers of unemployed will be modest, compared to previous downturns, ITEM said a major contributory factor is that poorer UK employment and economic prospects as well as a weaker exchange rate are already causing reversals in migration flows. According to the summer forecast, unemployment is set to increase from the low point of 1.6 million recorded at the end of last year to top the 2 million mark by 2010.
With consumer spending falling off sharply, the think-tank expects a slowdown in the high street to pave the way for an interest rate cut, possibly as early as November. Ernst & Young ITEM Club Chief Economist Peter Spencer said, "The weakening economy should allow the MPC to cut base rates this winter without running the risk of inflationary second-round effects."
The economist said ITEM expects base rates to fall to 4% by the end of 2009 and this will help to put a cushion under the level of demand in the economy and set the scene for a recovery in 2010. On July 10, the Bank of England's Monetary Policy Committee had voted to maintain the official Bank Rate at 5%. The central bank held the base rate unchanged for the third month in a row after a 25 basis point cut in April, the third since December 2007.
The think-tank sees consumer spending to grow only 0.2% in the coming year as consumers struggle with rising inflation, limited availability of credit and sharp reversals in the housing and equity markets.
In light of the deteriorating economic environment, ITEM expects house prices to register significant decreases in the coming months. The think-tank sees prices to drop by about 10% through 2008 and a further 6% through 2009. According to data released by property website Rightmove on Monday, asking prices for homes in the Great Britain fell 2% year-on-year in July.
Spencer cautioned that both on the high street and in the housing market it is going to get a great deal worse before it gets better. The economist also expressed concern that without the usual medication from the Bank of England, which would have nasty inflationary side effects in this environment, the consumer will follow suit, moving from their current state of denial into a state of despair.
Further, the ITEM noted that oil prices are expected to peak at $150 a barrel this summer, before easing back towards $100 over the next two years. According to Spencer, this will prompt consumers to cut back on non-essential spending in the face of the impact of rising food and energy prices on their discretionary incomes. Many parts of the leisure sector will be particularly hard hit.
Considering all these facts, ITEM urged the government to stand firm on excessive public sector pay demands, which could put severe pressure on any attempts to dampen down inflation and potentially blow any hopes of a medium term recovery out of the water.
The UK economy is facing a growing number of recession warnings. The Quarterly Economic Survey conducted by the British Chambers of Commerce, or BCC had also warned of a serious risk of recession in the UK, with some survey results reaching their historical low in both manufacturing and service sectors.
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