Outlook Grim for the U.K. Economy

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Gordon Brown continues to compete for title of the unluckiest prime minister in modern British history. Political views aside, he waited fairly patiently in the shadow of Blair for much the past twelve prosperous, albeit debt fuelled years, biding his time hoping that one day fate would be kind and hand him the key to 10 Downing Street. Even if Brown is at least partly responsible for the mess the UK economy is in, it’s hard not to feel sympathy for the man. Not everything wrong within UK Plc is his fault, surely?

So after getting beaten up by journalists for 14 days in relation to inappropriate expense claims by members of parliament he must have thought it really couldn’t get any worse? Wrong. It can always get worse. His only remaining trump card, the suggestion he was the inspirational leader and international co-ordinator in the fight-back against the global recession fell flat on its face this week when Standard & Poors placed the British economy on “outlook negative” citing rising government debt as the primary cause. Expensive bank bail-outs, rising unemployment, weakening tax receipts and a long-term budget deficit, S&P claimed, gave them no choice but to place the UK economy under closer scrutiny with the possibility of a humiliating downgrade now looming for some years hence. S&P also threw oil on the political fire suggesting it would look closely at the policies of the leading political parties in the run up to the next general election to clarify if plans were in place to fix public finances. Such is the power of S&P, the leading rating agency, their statement immediately prompted sharp volatility in currency and debt markets with Sterling falling sharply across the board before recovering, primarily against the Dollar, for reasons discussed in the previous ‘Global’ section.

It may also be appropriate to analyse the timing of the S&P announcement. The Northern Rock debacle was over a year ago. The near collapse of the global banking sector was 6 months ago. It was known UK government borrowing would break post-war records late in 2008. Even the farcical 2009 budget was weeks ago. Every man and women who lives outside of a remote Alaskan log cabin knows in great detail the economic and monetary problems the UK and the rest of the world is facing. In fact the S&P announcement is so late it’s almost sarcastic. And in this instance late is not better than never. But S&P likes to dwell thoughtfully on the obvious. A quick review of their banking sector analysis confirms as such, with downgrades to US banks coming thick and fast…. after the Lehman Brothers collapse.

Looking forward, if the UK is formally downgraded, the cost of government borrowing will increase as it will have to offer a higher rate of return to purchasers of its debt. Also, many investment managers that specialise in the purchase of government debt may have to sell their holdings of UK gilts, further pushing lower the price (and therefore the yield higher) if their fund investment objectives state they can only invest in top tier “AAA” rated debt.

There was further bad news. The UK economy contracted at its fastest pace since 1979, during Q1 2009, whilst consumers cut personal spending at the sharpest rate since 1980. The data was in line with expectations with the GDP data unchanged from the previous estimate. Market sentiment still suggests Q1 represents the trough of the UK economic cycle despite continued pessimism amongst consumers, due to the rising jobless number, weak house prices and the inability of many to secure credit. Admittedly, it’s only members of parliament that seem to need 3 house moves each year, moats and bi-annual home refurbishments but normal people, allegedly, still have important household expenditures too, like feeding the family and paying mortgages so not to be made homeless by unsympathetic banks, many of which would themselves be ‘bankrupt’ were it not for tax-payer bail-outs.

Of course the current interest rate of 0.5%, a record low, is helping homeowners lucky enough to be on a variable mortgage deal. However, concerns remain that prices will rebound before employment recovers. Such a scenario will place the Bank of England Monetary Policy Committee in the unenviable position of having to focus on its narrow, fighting inflation, remit instead of supporting the economic recovery with another 18 months of unchanged rates, which is probably required to fix the structural problems on corporate and consumer balance sheets. Then, perhaps, we can all pay for our moats to be cleaned, without having to claim the expense back from our employers.

Disclosure: The writer holds no interest, direct or indirect, in any instrument that has exposure to any stock mentioned in the above article.