Will the UK enter into Recession in 2006?
A recession is a period of negative economic growth for 2
consecutive economic quarters. In the post war period UK
economic growth has been characterized by the boom and bust
economic cycles. A period of growth is followed by high
inflationary growth and then a downturn in the economy. However
since 1992 the UK has experienced a long period of economic
growth, the longest period of uninterrupted growth this century.
It appears the UK has temporarily avoided the threat of
recession, but although forecasts remain positive there are many
factors that could push the UK into recession.
Possible causes of a recession could include:
1. Fall in house prices. The UK economy has a strong dependency
on the housing market. Most people own a house, renting is not
common like on the continent. Borrowing costs are a high % of
income because people take out large mortgages.
If house prices were to fall there would be a negative wealth
effect which would adversely affect consumer spending and cause
a fall in AD. Some people say house prices are overvalued
because of speculation. However others argue the UK market
remains strong because of shortage of supply and constant
demand. However the housing market is very susceptible to even a
small rise in interest rates. If interest rates rise it would
increase mortgage costs and there would be a big fall in demand
and therefore consumer spending.
2. In addition record levels of consumer borrowing means the
economy is likely to be significantly affected by any rise in
interest rates. The savings ratio is at an all time low. If
interest rates were to rise then it would cause great pain to
consumers.
3. Decline in Manufacturing sector. For a long time the UK
manufacturing sector has becoming morey uncompetitive with the
rest of the world. Mainly because of competition from Asian
countries with lower labour costs. In this sector the UK is
experiencing rising unemployment, causing unemployment to go
back above 5% (ILO Labour Force Survey)
4. Government borrowing is high. To meet the shortfall the Govt
may have to increase taxes. This would have the effect of
reducing consumer spending.
5. Global downturn. If the world economy slows down there will
be less demand for British exports and also reduced economic
confidence. This is very significant with increased
globalisation of the world economy.
6. It is argued interest rates are being kept artificially low
by the demand by China and other Asian countries to buy UK and
especially US debt. If for whatever reason this was to end.
Interest rates would rise to try and combat the imbalances in
the current account and domestic levels of savings.
7. Rising price of oil. In the past 2 years the price of oil has
surged ahead in the past this was often sufficient to cause a
recession. This time has been different because the rising price
has been caused by high demand rather than supply shocks.
However if the price of oil was to continue to rise (as is
predicted by many oil analysts) this would put pressure on
business costs, causing inflation. To maintain the governments
inflation target the MPC may increase interest rates. Thus
triggering a fall in AD
However growth in the UK is forecast to be 3% for next year.
This is because consumer spending is forecast to remain steady
against a backdrop of low interest rates and low inflation.
However if there was to be a moderate rise in interest rates the
growth rates could prove to be over optimistic (as they were
last year). This could be sufficient to reduce consumer and
business confidence. Thus starting a recession.