LONDON, Dec. 26 (UPI) -- Despite surprisingly strong consumer spending on Christmas shopping, the British economy -- like the British government -- is facing the coming new year with trepidation.
The pound has already dropped to a record low against the euro, has slipped below the $2 mark against the greenback, and is heading down to around $1.76 according to forecasts from the HSFC bank.
"Sterling's outlook for 2008 is about to take a significant turn for the worse. Trade data shows that the UK is becoming increasingly uncompetitive in the international arena," said David Bloom, the bank's chief currency strategist.
Just before Christmas a series of grim economic figures rocked the British Treasury. The latest balance-of-payments data showed that the current account was in deficit by a huge $40 billion in the third quarter, the highest figure since records began in 1955. This, representing almost 6 percent of national income, had surged from $27 billion in the previous quarter, and as a proportion of GDP this left Britain's balance of payments as deep in the red as that of the United States.
In the past British trade deficits were balanced by strong earnings in the financial sector and large profits from the oil sector. But with North Sea oil drying up and the financial sector slipping into recession, analysts are talking ominously of a "perfect storm" next year as the housing bubble pops, the Bank of England is forced to slash interest rates, and the declining financial sector reels under the credit crunch.
The health of the pound sterling has come increasingly to depend on attracting "hot money" from overseas, cash that could flee the pound swiftly when the Bank of England cuts interest rates. Foreign accounts also now hold a record 32 percent of British gilt-edged stock, worth almost $300 billion, and foreign holdings have almost doubled in the past four years. If that money leaves quickly, the pound could start heading into freefall.
"The latest flurry of UK data painted a distinctly ugly picture of a dangerously unbalanced economy, supporting our view that the coming slowdown will be a prolonged and potentially painful period of adjustment," commented Jonathan Loynes of Capital Economics.
This rash of pre-Christmas bad news came as signs that government tax receipts were below expectation while government borrowing seemed likely to surge well above $80 billion for the present financial year, against a $75 billion Treasury forecast, and reach annual totals of more than $100 billion in future years. Public borrowing rose in November by a record 11.2 billion pounds, 20 percent more than the previous year, and analysts now expect a government spending freeze or even budget cuts.
Government finance chief Alistair Darling (his formal title is Chancellor of the Exchequer) will be unwilling to cut spending with the government lagging in the opinion polls, and a new general election must be held within the next 28 months. Darling's credibility in the markets had been damaged by his fumbling of the crisis over the bailout of the Northern Rock bank, which has left the British taxpayer liable for up to $60 billion in guarantees. But financial analysts say he will have little choice.
"The Chancellor is likely to be playing Scrooge for some years in order to get this uncomfortably high budget deficit back under control," suggested John Hawksworth of PricewaterhouseCoopers.
As in the United States, the underlying economy seems reasonably healthy, with GDP growth in the 3rd quarter running at 3.3 percent, driven by consumers dipping into their savings. The savings ratio, which measures how much of Britain's employed workforce is putting aside from wages and salaries, fell from 4 percent to 3.4 percent in the quarter.
The overall economic mood in Britain, which has been upbeat for the last 15 years of continuous growth, is fast turning sour as the City of London braces for the full impact in the new year of the credit crunch and liquidity crisis. Some highly respected forecasters are sounding almost apocalyptic as they try to assess the prospects in the year ahead and the impact of the extraordinary $500 billion flood of liquidity pumped into the market by the European central bank in the days before Christmas.
One of the gloomiest is Peter Spencer, professor of economics and finance at the University of York and an economic adviser to the Ernst & Young ITEM Forecasting Club, which runs a regular alternative analysis based on the U.K. Treasury's own computer model, which Spencer helped develop 20 years ago. As a former chief economist at Dresdner Kleinwort Benson, he has strong private-sector credentials and caused a stir Christmas Eve by warning that the world's financial authorities have only a few weeks to stave off disaster.
"The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard," he warned.
"They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don't think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park."
It may be overblown or misjudged, and even condemned as close to a self-fulfilling prophecy, but that is the kind of forecast that commands attention -- although in reality it may reflect this particular moment of British gloom more than it reflects the global reality.
