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December 23, 2007    

Threats for the UK economy in 2008

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by Brian Turner

The Credit Crunch has dominated financial news over the second-half of 2007.

As we prepare to start a new year, a number of adverse indicators continue to threaten the UK economy for 2008.

1. Property

The UK property market across all sectors has shown itself to be a core factor in the economic health of the nation - but by all accounts, every sector is heading for a downturn.

Residential Property:
The UK property market has been regarded as something of a bubble, with a raft of high-profile economic bodies rating the UK property market as over-priced in the region of 10%-30%. So far we’re already seeing what lenders describe as a “slowdown” in the residential market, with prices falling over four consecutive months, with no one optimistic of signficant house price growth nationally until 2012.

Commercial Property
Commercial property has already been hit by a slump and faces continued declines. And with expectations of a fall of 25% in commercial property values, some investment funds are already taking drastic action to prevent investors stampeding their assets out.

Buy To Let
The Buy To Let market has seen an incredible growth in popularity over the last ten years, and so far landlords have sought to ignore warnings on a possible downturn. However, with the fall of Paragon, the collapse of the sub-prime buy to let market, and a fall in tenant demands for flats, the short-term outlook looks very unfavourable for many property investors.

2. Inflation

Inflationary pressures remain strong, continuing to put pressure on the Bank of England. While they rode out above-target inflation for almost a year over 2006-2007, we may find the bank in a similar predicament over 2008.

It goes without saying that oil prices continue to breach records and remain extraordinarily high, almost breaching $100/barrel in November. The impact of this continues to increase manufacturing and production costs, while translates into increasing cost of consumer goods which can adversely impact consumer spending, the big engine of the economy.

As we warned in August, food prices have also seen a dramatic rise in price over this year, and the situation hasn’t improved as the movement from agricultural production for food gives way to agricultural production for biofuels. Rising food costs means less consumer spending in other areas, which has a knock on effect on retail sales, reducing company profits, and therefore pushing share prices downwards in key areas.

Exchange Rate
Recent moves by the Bank of England to cut rates to stimulate the financial markets has an ugly inflationary effect. Cutting the lending rate helps devalue the pound, and reduction in the value of the pound to the dollar increases the price of commodities in real terms, further compounding inflationary issues.

3. Debt

Personal Debt
Britain continues to hold the highest amount of personal debt of any European country, accounting for as much as one third of all European debt. With nearly 2 million households are currently moving from low interest fixed-term mortgages and are now being hit by higher variable mortgage rates, it leaves consumer spending and debt issues very sensitive to further adverse changes in economic conditions,.

National Debt
Over the course of the economic boom we’ve enjoyed over the past 10 years, rather than save, the UK government has accrued increasing national debt. The figure now stands at a £20 billion deficit, almost 5% of GPD. One can only fear what will happen as adverse economic conditions impact, and the cuts the government will need to apply to stop this debt spiralling out of control.

Of course, it also needs remembering that the UK government is currently funding Northern Rock to the tune of nearly £30 billion as well…

4. Credit Crunch
The Credit Crunch has rocked financial markets, but we’ve only seen the opening salvo on what continues to be seen as an unparalleled event in financial history.

The main impact has been a tightening on lending, with mortgage lending already in decline. Products in the mortgage and loans market associated with increased risk are being offered on a far more restrictive basis.

Until all balance sheets clearly demonstrate where the bad debt rom the US mortgage crises is held, investor uncertainly will remain. Estimates suggest as much as $300 billion in mortgage defaults will hit the credit markets. The serious problem is that as much of this was used to leverage larger investment, so $300 billion could have been used to secure as much as 100 times that amount. This is why the mind-boggling scale of the problem cannot be over-stated we’ve not seen any comparable economic situation since the 19th century.

Overall Economic Conditions

In the face of the above, it’s obviously that the economic wheel is turning full cycle, and that potentially very adverse conditions face us, not just through 2007, but also in the years that follow.

Recession is a potential reality, but even worse is that is the possibility of Stagflation, which would see the economic wheel stall.

The problem is that each of the above covered conditions invites further economic woe, helping to feed further corrective economic processes that will bite hard.

It’s easy to take a “gloom and doom” approach to financial forecasting, but so far various other economic factors have helped provide a robustness and stability to the overall situation - but those factors will increasingly erode.

The simple fact is that economic cycles are entirely natural and healthy aspects of growing economies. However, the seriousness of the current situation is underlined by the extended boom period, and serious flaws at the very foundations of the international financial markets.

While these issues may be beyond the control of the ordinary person, the one thing we can all do now is take proper responsibility for our own micro-economic situation within a worsening macro-economic situation.

If ever there was a time for proper management of personal finances it is now - because the summer of plenty is ending, and the cold winds of an economic winter of discontent are blowing. If so far you have lived like a grasshopper, now is the time to become an ant.

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