Why the UK can’t avoid falling into recession

published 6 March 2008

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Sterling and the dollar both took a pounding against the euro yesterday.

A currency is often described as being roughly equivalent to the share price of a country. And the stock of both the USand the UKhave rarely been lower. Both hit all-time lows against the eurozone's paper money. A euro will now buy you roughly $1.53 or 77p.

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Economic data on both sides of the Atlanticlooks grim. Mind you, investors are clearly worried that the weaker eurozone countries are headed for trouble too. The gap between the yield on Italy's bonds and Germany's hasn't been this high since before the euro came into being.

Yet they'd still rather buy up a wobbly Frankenstein' currency that has only existed for a few years rather than risk their wealth in the banknotes printed by the UKand the US.

That's not exactly encouraging

So why the vote of no confidence in Britainand the US? The simple truth is that as each new piece of economic data comes out, the reality of the recession ahead becomes clearer.

In the US, the services sector which accounts for about 60% of its economy shrunk for the second month in a row. Factories have also seen demand for their goods fall. Meanwhile, in the UK, Nationwide reported that consumer confidence had hit its lowest level since its confidence survey was introduced four years ago.

That's not great news the survey might be fairly young, but falling consumer confidence usually means that people spend less because they feel worried about how much money they have to play with. Consumers are actually in very dire straits, and they're just beginning to realise it.

We've got less money coming in...

There are only two things to worry about as a consumer. The money that comes in; and the money that goes out. The easy availability of credit in recent years has meant that consumers have come to see a credit line as being pretty much indistinguishable from earned income, or investment income.

This confusion between debt and income has partly arisen because much of the credit has either been based on rising house prices (so it's not really credit, it's money consumers have earned' on their homes) or because it's been put on interest-free credit cards and then rotated between different lenders, without the original capital sum ever being repaid (so it's free' money).

If you find this hard to believe, then ask yourself why pay deals have been so restrained over the past 10 years, even as company profits have hit a record high. Workers haven't been demanding more money from their employers, because they've been able to get it from the bank. Your boss might give you more money if you ask, but he or she will do it with a grimace and might even expect you to do more work in return. On the other hand, your bank manager will eagerly extend your credit line with a big smile and no questions asked.

Well, up until the middle of last year that is. Now the credit crunch means that lending of all stripes is being slashed. Credit card limits are being arbitrarily dropped; mortgage lending has dried up, even to the low-risk' buy-to-let sector. In fact, the Royal Institution of Chartered Surveyors has just reported that, for the first time since it started its monthly survey in 1998, "more surveyors reported a fall in new landlord instructions than a rise." This is hot on the heels of news that the number of landlords struggling to pay mortgages rose by a quarter in the last three months of 2007.

...and more going on necessities

All of this adds up to one thing: the amount of money available to consumers on the income side of the equation is falling. So what about the other side? Well, the news on spending is bad too. Energy bills are rising. Mortgage bills are getting more expensive, despite the falling base interest rate. Food prices are shooting up - the British Retail Consortium reported that shop prices rose at their fastest annual rate since their price survey began. And you can bet that taxes will just keep going up to pay for the government's ongoing profligacy.

So consumers are getting shorter of income, while their spending on necessities is rising rapidly. No wonder they're not feeling confident.

All of this points to recession (Halifax has also just reported house prices falling in February). It's little wonder that investors are favouring the euro over sterling. But an even better bet is our old favourite, gold. It's risen very close to $1,000 an ounce, well above its nominal high of 1980. But if you adjust for inflation, it would have to hit $2,500 an ounce to truly breach that high.

That gives us plenty of room to go. You can read Bill Bonner's take on the case for investing in gold in this week's issue of MoneyWeek, out tomorrow. If you are not yet a subscriber, you can get your first three issues free by clicking here: 3-week free trial.

Turning to the wider markets

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Property stocks lead FTSE gains

In London, merger talk saw Liberty International lead the blue chips with gains of over 9% and give fellow property stocks a lift yesterday. The FTSE 100 index added 85 points to end the day at 5,853, and the broader indices were also higher. For a full market report, see: London market close

On the Continent, the Paris CAC-40 gained 80 points to close at 4,756, and the DAX-30 was 138 points firmer, at 6,683, in Frankfurt.

On Wall Street, stocks dipped into the red in afternoon trade on news that troubled bond insurer Ambac is to sell $1.5bn in stocks and equity, but a late rally saw the Dow Jones close in positive territory for the first time in five days. The industrials index added 41 points to close at 12,254. The Nasdaq was 12 points higher, at 2,272. And the broader S&P 500 was up 6 points, at 1,333.

Rising oil and metals prices saw Asian markets make good gains overnight. The Japanese Nikkei added 243 points to end the session at 13,215. And in Hong Kong, the Hang Seng was up 228 points, at 23,342.

Property stocks lead FTSE gains

On the Continent, the Paris CAC-40 gained 80 points to close at 4,756, and the DAX-30 was 138 points firmer, at 6,683, in Frankfurt.

Oil above $104, gold just under $1,000

Crude oil futures had fallen back from yesterday's record close of $104.52 a barrel last night in New York, and were last trading at $104.32. In London, Brent spot had fallen to $101.35.

Spot gold was at $991.90 this morning, just below yesterday's record high of $995.20. And silver hit a new 27-year high of $21.18.

In the currency markets, the pound was last trading at 1.9956 against the dollar and 1.3011 against the euro. And the dollar was at 0.6518 against the euro and 103.48 against the Japanese yen.

And in Londonthis morning, HBOS announced that the average price of a home in the UKfell 0.3% to £196,649 in February. Chief Economist Martin Ellis is still, however, predicting that house prices will remain flat in 2008.

And in Londonat noon, the Bank of England will announce the outcome of its latest rate-setting meeting. Be sure to visit MoneyWeek.com at lunchtime to discover the outcome.

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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.