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Viewing cable 08LONDON1917, SQUEEZED IN THE JAWS OF THE CREDIT CRUNCH -- UK ECONOMY

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Reference ID Created Released Classification Origin
08LONDON1917 2008-07-23 12:30 2011-08-25 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy London
VZCZCXRO4253
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHLO #1917/01 2051230
ZNR UUUUU ZZH
P 231230Z JUL 08 ZFR ZFR ZFR
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 9259
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBL/AMCONSUL BELFAST PRIORITY 1085
RUEHED/AMCONSUL EDINBURGH PRIORITY 0950
UNCLAS SECTION 01 OF 04 LONDON 001917 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD UK EINV
SUBJECT: SQUEEZED IN THE JAWS OF THE CREDIT CRUNCH -- UK ECONOMY 
 
LONDON 00001917  001.6 OF 004 
 
////////////ZFR CANCEL THIS MESSAGE.  NEW MESSAGE SENT OUT 
UNDER MRN 
QUARTERLY UPDATE 
 
LONDON 00001917  002.4 OF 004 
 
/////ZFR CANCEL THIS MESSAGE. NEW MESSAGE SENT OUT 
UNER MRN 1921 
 
QUARTERLY UPDATE 
 
 
5. (U) ITEM expects CPI to remain above the Bank of England's target 
 
range of 1-3 percent for the next 12 months.  It predicts that 
inflation 
will average 3.5 percent in 2008, coming down to 3 percent in 2009 
and 2 
percent by 2010.  It notes that this forecast assumes that wage and 
 
domestic cost inflation remain subdued.  In the UK there is 
currently a 
significant push for higher wages to offset price increases.  This 
pressure is particularly acute in the public sector where pay 
increases 
have been held below those in the private sector and below the cost 
of 
living for two years.  Chancellor Darling has called for pay 
constraint 
but unions are threatening a season of industrial action if pay 
deals 
are not reopened.  ITEM urged the government not to accept any 
excessive 
public sector pay demands which could put severe pressure on any 
attempts to dampen inflation and potentially destroy any hopes of a 
 
medium term recovery. 
 
6. (U) During the first quarter of 2008, the largest upward pressure 
on 
inflation came from food, mainly meat, vegetables, and non-alcoholic 
 
beverages, and fuel, particularly heating oil.  Despite growth in 
the 
CPI, however, the UK inflation rate is below the provisional figure 
of 4 
percent for the European Union as a whole.  The main factors 
affecting 
the CPI also affected the RPI.  However, the Retail Price Index 
experienced a downward contribution from housing.  This came mainly 
from 
mortgage interest payments as lenders passed on April's quarter 
point 
decrease in the bank rate to customers, in addition to house price 
depreciation. 
 
(Annual inflation rates - 12 month percentage change) 
 
----------------------------------------- 
 Jan08 Feb08 Mar08 Apr08 May08 Jun08 
 
CPI 2.2 2.5 2.5 3.0 3.3 3.8 
 
RPI 4.1 4.1 3.8 4.0 4.3 4.6 
 
----------------------------------------- 
 
Employment Stable 
----------------- 
 
7. (U) Overall employment and unemployment figures have remained 
fairly 
stable, despite volatility in the economy.  The total number of 
people 
in work rose in the three months to May to an all time high of 29.59 
 
million.  However, the number of people in the UK claiming 
unemployment 
benefit saw the biggest jump in 16 years.  The claimant count has 
risen 
by 45,000 since the end of January 2007, to 2.6 percent of the 
working 
age population.  Job losses are most prominent in the building and 
financial sectors. 
 
8. (U) Professor David Blanchflower, a member of the Bank of 
England's 
Monetary Policy Committee who has voted for interest rate cuts for 
the 
last nine months, has predicted that the UK is heading for a 
recession 
which could cost hundreds of thousands of jobs.  He expects 
unemployment 
to rise from 5.2 percent to more than 7 percent.  While ITEM is 
forecasting a rise in the overall numbers of unemployed, it remains 
 
hopeful that it will only be a modest jump, particularly in 
comparison 
 
LONDON 00001917  003.4 OF 004 
 
 
ZFR CANCEL THIS MESSAGE NEW MESSAGE SENT OUT UNDER MRN 1921 
 
with previous downturns.  A major contributory factor to the limited 
 
nature of this increase is that poorer UK employment and economic 
prospects, combined with a weaker exchange rate, is causing a 
reversal 
in migration flows.  However, it still anticipates that unemployment 
 
will rise from 1.6 million at the end of 2007 to the 2 million mark 
by 
2010. 
 
 
Seasonally Adjusted (Percentage) 
 
--------------------------------------------- -- 
   Q107 Q207 Q307 Q407 Q108 
 
Employment  74.3 74.4 74.4 74.7 74.9 
 
Unemployment  5.5 5.4 5.4 5.2 5.2 
--------------------------------------------- -- 
 
Interest Rate, Pulled Both Ways, Doesn't Move 
--------------------------------------------- 
 
9. (U) The Bank of England's Monetary Policy Committee (MPC) has 
resisted calls to cut the interest rate as the economy continues to 
 
falter.  With inflationary expectations rising in line with headline 
 
inflation figures, the MPC has felt unable to offer relief from a 
lower 
base rate.  However, ITEM expects a slowdown in consumer spending to 
 
pave the way for a rate cut this winter, perhaps as early as 
November. 
Beyond that, interest rate decisions will likely be determined by 
the 
behavior of commodity prices.  If crude oil prices follow the 
expectations of the futures market and peak at $150 a barrel this 
fall, 
before easing back, ITEM expects interest rates to fall back to 4 
percent by the end of 2009.  This will help to put a cushion under 
the 
level of demand in the economy and set the scene for recovery in 
2010. 
 
--------------------------------------------- -- 
  Jan08 Feb08 Mar08 Apr08 May08 Jun08 
 
Bank Rate 5.50 5.25 5.25 5.00 5.00 5.00 
--------------------------------------------- -- 
 
Public Finances Breaking the Rules 
---------------------------------- 
 
10. (U) HMG's current budget deficit in May, at GBP 9.1 billion, was 
the 
worst May figure since monthly records began in 1993, and the second 
 
worst figure on record.  Tax receipts in the first two months of the 
 
fiscal year (which begins in April) were up only 3.6 percent year on 
 
year, worse than the 4.8 percent forecast by the Chancellor in his 
March 
Budget.  The Chancellor has predicted public sector net borrowing to 
 
reach GBP 43 billion at the end of the financial year, but analysts 
 
believe he will exceed this target by a substantial margin. 
 
11. (U) There has been media speculation, widely regarded as 
accurate, 
that Treasury officials have begun working privately on plans to 
rework 
the fiscal rule, established by Gordon Brown as Chancellor, that 
limits 
public sector debt to 40 percent of national income.  Following the 
rule 
changes, it is likely that public sector debt could rise to 42-45 
percent of GDP.  At a Downing Street press briefing, the Prime 
Minister's spokesman noted that according to the IMF's latest 
estimates 
for 2008, the UK is in a stronger position than most countries.  Net 
 
debt in the Euro area as a percentage of GDP is currently 55.9 
 
LONDON 00001917  004.4 OF 004 
 
SUBJECT: ///ZFR CANCEL THIS MESSAGE.  NEW MESSAGE SENT OUT 
UNDER MRN 1921 
 
SQUEEZED IN THE JAWS OF THE CREDIT CRUNCH -- UK ECONOMY 
QUARTERLY UPDATE 
 
percent 
and in the U.S. is 47.9 percent. 
 
------------------------ ---------------------------------- 
    Apr08 May08 Jun08 
 
Current Budget (Billions) 0.6 (9.1) (7.6) 
(Deficit in brackets) 
 
Public Sector Net Lending 0.5 (11.0)  (9.2) 
(Billions-Borrowing in brackets) 
 
Public Sector Net Debt  36.5  37.2    38.3 
(Percentage of GDP) 
----------------------- ----------------------------------- 
 
 
Chancellor to Pay the Price? 
---------------------------- 
 
12. (SBU) Darling threatened to resign twice prior to publishing the 
 
2008 HMT budget report, according to recent reports in the media. 
One 
influential MP told us that a shake-up of Brown's cabinet is very 
likely 
in the fall, confirming press reports. Darling could likely lose the 
 
Chancellorship in any government re-shuffle, given Brown's need to 
demonstrate a response to the growing public perception of economic 
 
malaise in the UK. Darling has also been the point person in 
multiple 
unpopular tax proposals that were later revised or scrapped, 
including 
the non-dom tax changes, car taxes, and most recently a tax on 
passive 
income for multinational firms. The constant reversals have battered 
 
Darling's and the government's reputations as responsible guardians 
of 
the British economy. 
 
TUTTLE