Country Report United Kingdom January 2009

Outlook for 2009-10

• The scale of the global financial crisis and its effects increase the risks attached to the Economist Intelligence Unit's political, policy and economic forecasts. A deeper recession, more radical policy moves and social instability are possible.
• The recent bounce in support for the governing Labour Party and for the prime minister, Gordon Brown, is expected to reverse in the coming months, as the economic recession deepens and unemployment continues to rise.
• A snap general election this year cannot be ruled out, although it appears increasingly unlikely that voters would respond positively to such a move.
• We expect the opposition Conservative Party to defeat Labour at the next election (due by May 2010) and achieve a modest overall parliamentary majority, but a hung parliament cannot be discounted.
• The government's response to the financial crisis has huge policy implications for years to come, in terms of the state's mounting financial commitments and its expanding role in the economy. Further state intervention is inevitable.
• Economic prospects at home and abroad have continued to deteriorate at an alarming rate as the impact of the financial crisis spreads to the real economy. We now expect real GDP to contract by 3.2% in 2009 and by 1.1% in 2010.
• We do not expect a sustained recovery in bank lending until 2011-12, reflecting a prolonged period of private-sector balance-sheet adjustment. As interest rates fall towards zero, policymakers will increasingly engage in quantitative easing.
• The public finances will deteriorate sharply. As pressure on the state balance sheet increases, so will concerns over the UK meeting its debt obligations.

Monthly review

• The bounce in support enjoyed by the Labour government in October and November 2008 appeared to have come to an end by early January.
• The Bank of England (the central bank) cut official interest rates to 1.5% on January 8th. The base rate is now at its lowest level in the Bank's 315-year history, having been reduced by 350 basis points in the past four months.
• Lower rates matters little if banks are refusing to make new credit available at any price, as is the case at present. Credit conditions tightened further during December, as banks hoarded cash as an insurance against future loan losses.
• The public finances deteriorated further, as declining activity depressed tax revenue. Long-term government bond yields fell to surprisingly low levels.
• Business surveys pointed to a further contraction in economic activity, with no sign of a turnaround. Unemployment rose to 6%, with a spate of additional job losses announced throughout December and early January.

Source: Country Report