Forecasts on UK economy point to further downturn

Report predicts sharp increase in insolvencies in north-east of England and Wales, and rise in write-offs on corporate loans

Banks and insurers face a rocky 2012 as insolvencies rocket to levels not seen since the 1990s, according to a report by the Ernst & Young Item Club.

The economic slowdown will also hamper corporate lending by the banks, the report said, which came after recession became official last week with figures showing the economy contracted 0.2% in the first quarter of the year. Lending to businesses is unlikely to recover to its 2008 peak before 2016, the report predicts.

In a separate study, the accountancy firm Deloitte's consumer tracker found 51% of people were downbeat about their household's disposable income, up two percentage points from 49% in the previous quarter.

After six weeks of bad news for the chancellor, George Osborne, starting with his ill-received budget, reports that the current borrowing squeeze will continue for several years will be disappointing. Britain joined many other EU nations in recession, including Belgium, the Netherlands and Spain, following a sharp fall in construction and poor figures from the financial and business services industries.

The Item Club said financial services faced a "worsening outlook as the real effect of sluggish growth continues to impact creditor and consumer behaviour". It said write-offs on corporate loans will increase to 1.9% of loans in the corporate sector, from 1.6% in 2011. "Insolvencies are likely to rise more sharply in the north-east of England and Wales, where economic output is set to contract by 0.1% and 0.3% respectively," it said.

Neil Blake, senior economic adviser to the club, said: "Although 1.9% doesn't sound big, this will be the highest annual rate of write-offs since the mid-90s, and the more loans banks have to write off the less money they will have to lend. Consumer-led sectors such as retail are likely to be hit disproportionately hard as discretionary household spending is cut back amidst difficult labour-market conditions, especially in regions hit hard by government spending cuts."

Blake said the rise in write-offs and lacklustre outlook for business investment and economic growth was the main reason he believed lending to corporates has worsened considerably since the last quarter.

The forecast is now for a contraction of 6.8% this year rather than the previous estimate of 5.7%. Corporate sector loans are not predicted to return to their pre-crisis peak of £575bn until 2016.

Blake said: "The contraction expected in 2012 is more acute than the 6.1% contraction last year, and means that the funding squeeze that corporates and SMES have been experiencing is only set to get worse.

The downbeat assessment of the economy was echoed by Ian Stewart, chief economist at Deloitte, who said the only positive note from its study were the signs that the slump in consumer sentiment may be bottoming out.

He said: "For consumers to spend more, disposable incomes need to improve. Wages are unlikely to see much growth this year, so the big hope is that sharply lower inflation will support consumer spendingpower. He added: "If inflation drops in the second half of this year, the UK consumer should see some modest growth. Yet the UK consumer remains vulnerable to events, particularly an intensification of the euro crisis or further rises in oil and energy prices."

A rise in oil prices is often cited as a potential barrier to growth. Britain is particularly vulnerable to higher prices for oil and gas following a drop in the value of the pound and a dramatic fall over the last decade in North Sea output.

Concerns that the situation was already set to worsen came after a speech from a senior Bank of England official who said inflation was likely to stay higher than predicted. Deputy governor Paul Tucker warned that recent falls in inflation may come to a halt and stay above the bank's target level of 2%. Wages are currently increasing at 1.1%, leaving a 2.4% shortfall in light of the 3.5% rate of inflation.

http://www.guardian.co.uk/business/2012/apr/30/uk-economy-forecasts-further-downturn






RESPONSE


As it stated that the economic slowdown will hamper corporate lending, that means that business investment will go down: rather than fund future projects or buildings, the businesses will have to use their money to pay for immediate occurrences. However, the article also states that by 2016 lending to businesses is likely to recover, so in the long-run, investment should increase.


The article further states that 51% of people were downbeat about their household’s disposable income, thus suggesting that consumption would also decrease as there is less money to spend on non-necessity consumer goods. Additionally, the article notes that corporate loans will increase as companies use write-offs. However, this increase in corporate loans will result in less lending money. Therefore, consumer-led sectors will suffer even more from the lack of disposable income as consumers and these sectors will be unable to borrow large sums of money. 


In the short run then, the equation for national income will look like:


GDP (decrease) = C (decrease) + I (decrease) +G + E -I.


However, the article states that the UK will try to increase consumer spending by lowering inflation. So if the UK can do this, in the long run Consumption should increase. Yet, there are also the potential barriers of high oil and gas prices as well as the intensification of the euro.