Why the Bank of England can’t save Britain from recession

The OECD says Britain is 'uniquely at risk' of recession. The government squandered public money in the boom years, and no amount of tinkering with interest rates can save us now.

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Uh-oh. We must really be in trouble.

The Organisation for Economic Co-operation and Development (OECD) has singled out Britain's economy for especially gloomy treatment in its latest six-monthly take on the world economy.

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Britain is "uniquely at risk", mainly because the Government has spent too much during the good times. The country faces house price falls of as much as 10%; while unemployment will rise to a ten-year high, with 200,000 people losing their jobs over the next 18 months.

Nice to see the world's economic institutions are catching up to reality. But the OECD is still too optimistic

The OECD has warned that the UK is in big trouble. It reckons the Bank of England needs to cut interest rates to 4.25%, but says it must hold off until next year because of inflation risks. The Bank will be announcing its decision on interest rates later today, and is widely expected to keep them on hold at 5%.

Why the government should be spending more right now but can't

It also says that the Government probably shouldn't be pulling in the reins in terms of public spending. The idea is that when times get hard, the Government spends a bit more to keep the economy ticking over until the private sector gets back on its feet.

But of course, this isn't really possible, because the Government has bled the country dry during the good times. Gordon Brown has taken money that would once have gone into private sector pensions (which would have enabled more of our citizens to take care of themselves in the future, rather than relying on the state), borrowed a whole load more, and then sprayed it all over the public sector to almost no apparent effect at all (if you still have trouble believing this, read Squandered by David Craig - do remember to take your blood pressure pills first though).

As the OECD puts it, a little less bluntly: "The Government's options have been limited by excessively loose fiscal policy in past years when economic growth was strong."

It's unusually tough talking from this type of body. Of course, the Treasury said the OECD was wrong. "The UK economy remains strong, and is well-placed to get through these global problems." All I can say is, it's little wonder that British consumer confidence is at a record-low ebb.

Those in power both in the public and private sectors of our key economic institutions seem to have one reaction to the credit bubble popping. That's to stick their fingers in their ears and sing "la-la-la, I can't hear you." If it's not Alistair Darling blethering about the UK being "well-placed", then it's any number of banking chief executives effectively saying: "Everything's fine, our lending book is top notch, and even though the housing market is in meltdown, we will somehow be the one bank that can get through it unscathed. By the way, can any of you shareholders spare another few billion? No, don't form a queue, people might get the wrong idea"

A 10% fall in house prices? We should be so lucky

The unfortunate truth is that in fact, the OECD's predictions that house prices could fall by as much as 10%, and that unemployment will rise by just 200,000, still seem quite tame.

Plenty of mainstream forecasters are now predicting falls of at least 10%. And during the 1990s recession, unemployment actually rose by closer to one million. And despite the increasingly desperate claims of the optimists, it is looking more and more as though this downturn could be much worse than the one in the 1990s.

One of the reasons behind yesterday's 87-point drop in the FTSE 100 was a particularly worrying piece of economic data. The Chartered Institute for Purchasing and Supply released its services sector survey for May. The data showed that the sector shrunk for the first time in more than five years.

This is bad news. The service sector accounts for about three-quarters of Britain's economic growth. But even worse was the news that employment saw its biggest contraction since records began in 1996, "with hotels and restaurant staff bearing the biggest brunt," reports Edmund Conway in The Telegraph. And yet prices charged continue to rise. Companies are also more pessimistic than at any time since records began.

And all of this is already happening when we're still at the start of the fall-out from the housing crisis as the Halifax reported this morning (see below), prices are now down 3.8% year-on-year. The number of people in negative equity is creeping higher by the day.

It doesn't matter what the Bank does today, or how many warnings the OECD gives out. The British economy is headed for recession. The only question is how bad will it get?

Turning to the wider markets

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The FTSE 100 fell 87 points to 5,970. Mining shares and oil companies fell back as metals and oil prices fell as the dollar strengthened. For a full market report, see: London market close

European markets were also lower. The German Xetra Dax fell 53 points to close at 6,965 and the French CAC 40 fell 68 points to 4,915.

US stocks were mixed, with warnings that Moody's may downgrade two major bond insurers (Ambac and MBIA) hanging over the market. The Dow Jones Industrial Average fell 12 points to 12,390. The wider S&P 500 was flat at 1,377, while the tech-heavy Nasdaq Composite gained 22 points to 2,503.

In Asia, the Nikkei 225 fell 0.7% to close at 14,328, as falling crude oil prices hit commodity trading groups. In Hong Kong, the Hang Seng climbed 0.2% to 24,161.

Brent spot was lower again this morning, trading at $121.02, with crude in New York trading at $122.25. Spot gold was at $875 an ounce. Silver was trading at $16.67 and Platinum was at $1,987.

Turning to forex, sterling was trading at 1.9515 against the dollar, and at 1.2636 against the euro. The dollar was last trading at 0.6478 against the euro and 105.87 against the Japanese yen.

And this morning, the Halifax reports that house prices fell by 3.8% in May compared to the same month last year. That's the biggest annual drop since April 1993, when prices fell 2.4%.

Take a chance on this turbulent sector

The airline industry is not for the faint-hearted. It has a terrible image problem and rising fuel prices are hitting it hard. But pick your stocks wisely and there could still be money to be made.

Why it pays to hang on to gold

It's tough tipping investments just now. Recession is the air and Western equities are not a good bet. But there is one thing you can count on in a full-blown financial crisis, says Merryn Somerset Webb.

John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.