The recession: the present and the future

15 February 2010

The recession has exerted enormous pressure on both businesses and consumers. Businesses have struggled to obtain credit; consumers have tightened belts. Here we look at some of the consequences of the worst economic downturn in generations.

Public finances

One of the major problems facing the UK economy is the vast scale of public borrowing; money borrowed in order to bolster failing banks, to ensure the continuing lubrication of the wheels of the economy (through the Bank of England’s quantitative easing programme) and to support public sector employment. As of November 2009, the government was borrowing to the tune of £830 billion, or 59.2 per cent of GDP; the planned budget deficit for the year was £178 billion. It is a debt, however essential its role in the short term, that will have to paid down through increased taxation – some, the upcoming 1 per cent rise in national insurance contributions for example, aimed at businesses – and through public spending cuts in the medium and long term. Those cuts may shave as much as 2 per cent off the economy.

Consumer spending

The Chancellor’s decision to reduce the standard rate of VAT from 17.5 per cent to 15 per cent for 2009 helped, but consumer spending on large items such as furniture and white goods plummeted. That measure of the vitality of the economy – sales of new cars – registered such dismal figures that the Chancellor also introduced the scrappage scheme: a £2,000 discount for those who traded in old cars for new ones. But spending habits showed a distinct change across the board. Cut-price supermarkets enjoyed a boom of 18 per cent in business.

Saving

What the economics of a recession demand is that people keep spending; what the human psychology of a recession demands is that people stop spending and start saving, or at least start paying off debts. Such has been the case.

The number of households that are using their money to pay down debts or to boost their savings is on the increase. Worries over prospects for the UK economy and the effects of the forthcoming rises in taxes have encouraged more people than ever to save rather than to spend, official figures suggest.

The level of earnings that is being saved in banks and building societies is at its highest for almost a decade. In the third quarter of 2009 consumers repaid £5 billion more than they borrowed, according to the Office for National Statistics (ONS).

While consumer spending edged up by just 0.1 per cent in the same period, the gap between household income and the average amount that households spent rose to 8.6 per cent. Much of that money will have been used to cancel debts or bulk up savings accounts.

Inflation

Those savers, though, have found themselves penalised by historically low official interest rates and by rising inflation.

According to the Office for National Statistics, the Consumer Price Index for January stood at a rate of 3.5 per cent, its fastest annual pace of increase in 14 months, up from 2.9 per cent in December and up from 1.9 per cent in November. The main reason for the hike is the distorting interventions of a surge in oil prices and the return of the VAT rate to 17.5 per cent.

The Bank of England had been anticipating such a rate of increase. In its latest inflation report, it forecast a rise to 3.5 per cent this year, but also predicted that the CPI index would fall back to 1.8 per cent towards the end of 2010 as the economy recovers from the recession and as the underlying pressure on prices – not necessarily good news for businesses – is counterbalanced by excess capacity, modest wage increases and competitive discounting among retailers still struggling to attract customers.

Given its expectations that inflationary pressures will subdue later in the year, dampened by the continuing weakness of the economy, analysts predict that the Bank will resist the urge to increase interest rates, currently at 0.5 per cent, in the short term for fear of choking off the still fragile recovery. However, the sharp rise in inflation may also have accounted for the Bank’s decision not to press ahead with any further quantitative easing on top of the £200 billion that has already been used to buy up bonds and debts in an effort to boost commercial lending by the banks.

As a result, for basic-rate taxpayers with an average instant access savings account the yield on their funds could fall by as much as 2.92 per cent. For higher-rate taxpayers, the decline could be 3.06 per cent. The January rise in inflation, combined with the tax paid on savings, means that a basic-rate taxpayer will require an account that delivers 4.38 per cent gross in order to secure a return. For a higher-rate taxpayer, that interest rate is 5.83 per cent. However, moneyfacts.co.uk, the financial information organisation, said that just two from a total of 1,101 accounts offer guarantees of such rates of return and they are limited to regular savers rather than those with a lump sum to invest.

For savers with mortgages, any hope of meeting the rise in the Retail Prices Index, which was up from 2.4 per cent to 3.7 per cent in January, demands an account with an interest rate of at least 4.62 per cent for basic-rate taxpayers and 6.17 per cent for higher-rate taxpayers.

Interest rates

Given the Bank of England's anticipation of a rise then fall in inflation, many analysts are forecasting that official interest rates, locked at 0.5 per cent since last March, will remain moored at that level or very close to it for the remainder of 2010. The threat of further inflationary pressures may, however, see a rise in 2011.

Future growth

In the same inflation report, the Bank of England chose to revise its predictions for the growth rates that the UK economy can look forward to. In its previous estimates, the Bank anticipated 4 per cent expansion by the second quarter of 2011. That has been revised down to 3.2 per cent.

The dangers of recovery

If we are indeed crawling our way along the long and bumpy road to recovery, it may not be good news for a number of firms. The recessions of the 1980s and 1990s taught us that a return to growth in the economy also heralded the end for some businesses. Known as the insolvency lag, firms that have been getting by on the goodwill of lenders and the government suddenly discover that the leeway they had been granted is withdrawn.

Research by the Association of Business Recovery Professionals has revealed that, in the 1990s, the peak in corporate liquidations arrived a full five quarters following the first quarter of recovery. Why? Because it requires time for the recovery – increased orders and customer expenditure – to feed its way not just into the economy but also into the systems of individual businesses. And because creditors and government policy-makers mistake the general signals of recovery for the health of individual businesses, and begin the process of reclaiming loans and cutting measures designed to support them.

Planning for recovery

Planning, for every business and individual, is important at the best of times; in our uncertain times, it is imperative. It is imperative because only with careful, intelligent planning can you or your business take advantage of the recovery – whatever its nature.

There are a number of areas where we can help you plan. These include: cash flow management; profit enhancement; capital expenditure; debt management; and investment portfolios. Please don’t hesitate to contact us for expert, professional advice and guidance.