British economy faces rocky ride

A leading economic forecasting group has warned that the British Economy will shrink by 0.25% during 2009, the first full-year contraction since 1991.

Capital Economics, which is well-known for having a hawkish outlook, says it is extremely worried about the outlook for the British economy. Its warning comes a week after the Office for National Statistics revealed that in the second quarter of 2008 the economy effectively ground to a halt with 0% growth during the period.

Economists expect negative growth in the third and fourth quarter, pushing the UK into a technical recession. And, according to Capital Economics, the recession will last well beyond 2008 with a full-year of negative growth in 2009.

It also believes that the amount of money banks are willing to lend to households will continue to contract going forward. In a Capital Economics report, it states: “Banks will struggle to raise enough capital to restore their capital ratios after the damage inflicted by the credit crunch and housing downturn. Accordingly, they will be forced to rein in their lending, with serious adverse effects on economic activity.”

On the plus side, Capital Economics expects a “significant” fall in inflation over the next 12 months, with households finally experiencing some let-up in the impact of higher food and fuel prices. Although this won’t stop a recession, it should help the thousands of people struggling to cope with the rising cost of living.

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And interest rates are likely to fall “much further” than expected, it predicts, potentially to as low as 3.5% next year.

Vicky Redwood, an economist at Capital Economics, says the economy could escape such a hefty blow to growth if banks are able to attract more money to fund lending. But she isn’t hopeful: “It is looking unlikely that banks will raise all the capital they need… as a result they will have to rein in their lending.”

She adds that lower rates of lending could have “dire implications” including a house price crash.

Shadow chancellor George Osborne says the “gloomy” report is a sign that Britain has returned to the trend “boom and bust”, more commonly associated with the Conservative Party.

"Another day brings another gloomy prediction about the British economy,” he adds. “The Brown bubble has burst and, thanks to Labour’s economic incompetence, nothing was put aside for a rainy day to help British families cope."

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