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Viewing cable 08LONDON2217, UK SLIDING TOWARDS RECESSION

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Reference ID Created Released Classification Origin
08LONDON2217 2008-08-29 12:25 2011-08-25 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy London
VZCZCXRO1675
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHLO #2217/01 2421225
ZNR UUUUU ZZH
P 291225Z AUG 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 9613
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUEHOT/AMEMBASSY OTTAWA PRIORITY 1165
RUEHKO/AMEMBASSY TOKYO PRIORITY 1166
RUEHBL/AMCONSUL BELFAST PRIORITY 1098
RUEHED/AMCONSUL EDINBURGH PRIORITY 0966
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
UNCLAS SECTION 01 OF 04 LONDON 002217 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV UK
SUBJECT: UK SLIDING TOWARDS RECESSION 
 
LONDON 00002217  001.2 OF 004 
 
 
1. (SBU) Summary: The economic news is not good for Great 
Britain or its Prime Minister. GDP growth was 0.0 per cent in 
the second quarter of 2008, the worst quarter in 16 years. 
Inflation hit 4.4% in July, and the Bank of England predicts 
it will rise to 5% by the end of the year. Employment numbers 
remain relatively stable, but unemployment is beginning to 
tick upwards. The Bank of England is faced with the tough 
choice of combating inflation or attempting to spur economic 
growth. The public increasingly blames PM Brown for the 
country,s economic woes, and he has hinted he will propose 
an economic stimulus package in September. However, HMG,s 
self-imposed fiscal rule that public debt cannot exceed 40 
percent of GDP makes any large recovery package unlikely. End 
summary. 
 
Recession Expected as Growth Stalls 
---------------------- ------------ 
 
2. (SBU) The UK economy stalled in the second quarter of 2008 
with zero percent GDP growth.  The Office of National 
Statistics revised downward its initial estimate that the 
economy grew by 0.2 percent in the three months leading to 
June 2008. A U.S. investment bank representative told us that 
zero percent growth was not totally unexpected and that there 
is currently no light at the end of the tunnel.  Chris Kelly, 
Senior Economic Advisor at HM Treasury told us there has been 
very little good news for the UK economy the last few months. 
The financial markets are still in turmoil, both the U.S. and 
UK housing markets are weak, and the Euro zone is an 
especially large drag on the British economy. Kelly said the 
one bright spot has been recent lower oil prices. The IMF 
recently downgraded its 2008 growth forecast for the UK to 
1.4 percent from the 1.7 percent it predicted in the spring 
and below the Chancellor,s projection for growth of 1.75 
percent.  It predicts that growth next year will only reach 
1.1 percent, compared with the Chancellor,s current forecast 
of 2.25 percent.  The IMF noted the outlook for the labor 
market and consumer demand is steadily declining, adding 
pressure to housing and financial markets.  The IMF warned 
that soaring UK inflation rates leave the Bank of England 
&little scope8 to cut interest rates to encourage growth. 
 
3. (U) The British Chambers of Commerce (BCC) has predicted a 
technical recession (when GDP declines over two successive 
quarters),  expecting two or three quarters of slightly 
negative or zero growth followed by a shallow recovery.  BCC 
predicts a prolonged period of weak, below-trend growth 
lasting through 2009 into early 2010.  This forecast was 
largely echoed by Mervyn King, Governor of the Bank of 
England.  In a press conference for the release of the 
Bank,s August Inflation Report, King said the Bank,s 
central GDP projection is for output to be broadly flat over 
the next year, so four quarter growth will slow sharply in 
the near term.  He added there was &bound to be a quarter or 
two8 of economic contraction. 
 
Figures show real quarterly growth and are seasonally adjusted 
 
------------------------------------- 
      Q207  Q307  Q407  Q108  Q208 
 
GDP   0.9   0.6   0.6   0.3   0.0 
------------------------------------- 
 
Inflation Increases 
------------------- 
 
4. (U) To add to the misery of low growth, the UK is 
suffering from increasing inflation. The Consumer Price Index 
(CPI), HMG,s target measure of inflation, increased to 4.4 
percent in July, up from 3.8 percent in June and 2.4 percent 
above the Bank of England,s target rate.  It is important to 
note, however, that while unemployment has increased and 
vacancies are falling, wage growth remains contained.  The 
Retail Price Index rose to 5 percent in July, up from 4.6 
percent in June.  High inflation may also negate any positive 
effects that a weakening Pound may have on British exports 
according to HM Treasury,s Chris Kelly. Higher imported 
input component costs will cancel out exchange rate cost 
benefits for foreign consumers. 
 
5. (U) The Bank of England,s August Inflation Report 
suggests that higher energy, food and import prices will push 
inflation to 5 percent in the coming months.  The Bank then 
expects inflation to fall back sharply to a little below the 
 
LONDON 00002217  002.2 OF 004 
 
 
2 percent target in the medium term but acknowledges the 
inflation outlook is unusually uncertain. Kelly said that 
although evidence suggests inflation will increase in the 
short term, no evidence yet suggests it will remain high in 
the medium or long terms. The IMF forecast also shows CPI 
peaking at 5 percent in the short term, averaging 3.8 percent 
in 2008, and returning to the Bank,s 2 percent target in 
2010.  Consumers, inflation expectations, however, do not 
match these forecasts.  According to a survey conducted by 
Barclays Capital, consumers believe inflation will rise to 
4.7 percent over the next year, and remain close to that 
level for two years.  When asked about expectations for 
inflation in five years, time, respondents expected an 
average rate of 4.8 percent.  These results reflect public 
concern over inflation, which could lead to upward pressure 
on wages and a further drag on growth from depressed consumer 
expectations for the economy. 
 
(Annual inflation rates ) 12 month percentage change) 
 
----------------------------- 
      Apr08 May08 Jun08 Jul08 
 
CPI   3.0   3.3   3.8   4.4 
 
RPI   4.0   4.3   4.6   5.0 
---------------------------- 
 
Unemployment Predicted to Rise 
------------------------------ 
 
6. (U) Decreasing growth and increasing inflation put 
pressure on companies to reduce labor costs. The unemployment 
rate was 5.4 percent for the three months to June, up 0.2 
percent over the previous quarter (but unchanged over the 
year).  In July, the number of people claiming unemployment 
benefits increased at the fastest rate for almost 16 years as 
the job market came under intensifying pressure.  The number 
of people unemployed increased by 60,000 over the quarter and 
by 15,000 over the year, to reach 1.67 million. Howard 
Archer, Chief UK and European economist at Global Insight, 
said: &It seems inevitable that extended very weak economic 
activity and deteriorating business confidence will exact an 
increasing toll on the labor market over the coming months.8 
 Large numbers of lay-offs have meant morale is particularly 
low in the City (The London banking district), according to a 
U.S. investment bank representative.  Further lay-offs can be 
expected as financial firms face a particularly challenging 
business environment.  The BCC predicts UK unemployment will 
increase by 250,000-300,000 over the next two to three years, 
pushing the number of people out of work close to 2 million. 
IMF projections put unemployment at 5.5 percent in 2008 and 
5.7 percent in 2009. 
 
Seasonally Adjusted (Percentage) 
 
------------------------------------------ 
             Q207  Q307  Q407  Q108  Q208 
 
Employment   74.4  74.4  74.7  74.9  74.8 
 
Unemployment 5.4   5.4  5.2   5.2   5.4 
----------------------------------------- 
 
Bank of England Resists Pressure to Cut Interest Rate 
--------------------------------------------- -------- 
 
7. (U) Despite all the negative signs, the Bank of England,s 
Monetary Policy Committee (MPC) continues to resist calls to 
cut the Bank Rate.  The minutes of the Committee,s meeting 
in August reflect its dilemma: raising the interest rate 
would send a strong signal to wage and price setters that the 
Bank would not allow above-target inflation to persist but 
could adversely affect business and consumer confidence; 
cutting the rate would help to ameliorate the worst of the 
downturn in activity but could cause wage and price setters 
to conclude that the Committee was more concerned about 
sustaining output growth than about returning to target 
inflation.  Seven MPC members voted to keep the interest rate 
at 5 percent, while one member preferred an increase of 25 
basis points and another preferred a reduction of 25 basis 
points. 
 
8. (U) Industry groups are divided over what the MPC should 
do next.  The British Chambers of Commerce stresses that a 
 
LONDON 00002217  003.2 OF 004 
 
 
major recession can be avoided if the MPC resists calls to 
increase the Bank Rate and considers an early cut.  It argues 
that weak demand combined with a squeeze on disposable 
incomes will constrain inflation and immediate threats to 
growth are more alarming than dangers of high inflation. 
However, the Confederation of British Industry (CBI) believes 
current inflation levels leave little scope for interest rate 
cuts in the immediate future.  In a press release the CBI,s 
influential Director-General, Richard Lambert, said the Bank 
was right to leave rates on hold. 
 
------------------------------------------ 
          Apr08  May08  Jun08 Jul08 Aug08 
 
Bank Rate 5.00   5.00   5.00  5.00  5.00 
------------------------------------------ 
 
Chancellor has Little Room to Maneuver on Public Finances 
--------------- ----------------- ----------------------- 
 
9. (U) So what can the government do? The IMF expects HMG,s 
sustainable investment rule (which requires public debt as a 
percentage of GDP be held at a stable and prudent level of 40 
percent) to be exceeded for a protracted period.  It believes 
the fiscal deficit will hover around 3.5 percent of GDP in 
2008 and 2009.  The IMF stressed that any revision of the 
fiscal rules (which has been widely speculated) should 
emphasize accountability over flexibility. It recommends the 
40 percent net debt ceiling be retained through adoption of a 
clear and short horizon to bring debt back under the ceiling 
following a breach. 
 
10. (U) The Institute for Fiscal Studies (IFS) notes the 
Chancellor has virtually no room left to maneuver.  The 
forecasts from his 2008 Budget, combined with his May 13 
&mini-Budget8 announcement of a GBP 2.7 billion giveaway to 
basic-rate income tax payers and his September 16, 2007 
announcement of a postponement in the increase in fuel duties 
planned for October 1 have left him short of fiscal levers. 
The IFS also notes that overall receipts of corporation tax 
in the first four months of this financial year (which began 
in April) were only 3.2 percent higher than the same four 
months in 2007.  Meeting the Chancellor,s Budget forecast 
would require annual growth of 10.6 percent.  July receipts 
from North Sea oil companies more than doubled from July 
2007, bringing in an extra GBP 2 billion to the Treasury. 
But receipts of corporation tax from other companies fell by 
a quarter, costing the Treasury GBP 2 billion.  The IFS is 
also concerned that spending by central government has been 
growing more quickly over the last quarter than that forecast 
in the Budget for the year as a whole. 
 
------------------------ ---------------------------- 
                              Apr08 May08 Jun08 Jul08 
 
Current Budget (Billions)     0.6   (9.1) (7.6) 6.6 
(Deficit in brackets) 
 
Public Sector Net Lending     0.5   (11.0)(9.2) 4.8 
(Billions-Borrowing in brackets) 
 
Public Sector Net Debt        36.5   37.2  38.3 37.3 
(Percentage of GDP) 
----------------------- ----------------------------- 
 
Public Blames Brown 
------------------- 
 
11. (U) All of this adds up to political problems for an 
already beleaguered PM Brown. More than three-quarters of 
respondents to an FT/Harris poll on August 26 said the 
government bore at least some of the blame for the economic 
downturn and its consequences, with 56% believing Ministers 
had most or complete responsibility.  Only 3% of respondents 
rated the handling of the downturn and its consequences as 
good, while 63% said that it had been bad or terrible.  The 
results suggest Gordon Brown,s continued emphasis on the 
global nature of the slowdown has failed to convince the 
public. 
 
12. (SBU) PM Brown has hinted publicly that next month he 
will outline measures designed to ease pressures on living 
costs and the housing market. Although 10 Downing Street has 
not yet released any official details, there has been much 
speculation about his plans. One theory is that he may 
 
LONDON 00002217  004.2 OF 004 
 
 
suspend the stamp duty, the tax paid when buying a home, in 
an attempt to spur the sagging housing market. However, these 
rumors have so far had the opposite effect. Many would-be 
home buyers are postponing their purchase in anticipation of 
the suspension of this tax. Another theory is that PM Brown 
may distribute a one-time handout of 150 GBP ($285 USD) to 
parents. The nominal purpose of the handout would be to help 
families cope with energy price inflation, but the impact of 
such a relatively small sum on economic growth is debatable. 
 
HMG,s Hands are Tied, Expect Inaction 
-------------------- ---------------- 
 
13. (SBU) Comment: Few options for jump-starting the economy 
remain open to HMG, because of its self-imposed limitations 
and rules. The independent Bank of England is unlikely to 
lower interest rates in the next few months, despite likely 
pressure from Chancellor Darling. The Bank,s remit is to 
keep inflation under a specific target of two per cent. With 
inflation more than double that amount, the Bank will likely 
take a &wait and see8 attitude. Bank of England Governor 
Mervyn King has publicly resisted calls to lower interest 
rates. In meetings earlier this summer, Bank of England 
Deputy Governor John Gieve and MPC member Paul Tucker both 
told us that inflation is their primary concern. It will most 
likely take an actual recession to prompt the Bank of England 
to lower interest rates. During his years as Chancellor of 
the Exchequer, PM Brown imposed strict limitations on 
borrowing in order to limit public debt. The opposition 
Conservatives would showcase any reversal of his rules as 
more evidence he is unfit to steer the country away from a 
recession. These limitations effectively prevent the current 
Chancellor from making any large increases in public spending 
or significantly lowering taxes. The Pre-Budget Report this 
fall will likely contain a few largely superficial proposals 
for re-starting the economy, but nothing drastic. Only a 
change in Labour party leadership or an election may prompt 
radical economic action. A new Labour Party leader or a 
Conservative government would not be constrained by Brown,s 
fiscal rule limiting public debt and would have more 
flexibility to respond to a weakening economy. End Comment 
 
Visit London's Classified Website: 
http://www.intelink.sgov.gov/wiki/Portal:Unit ed_Kingdom 
 
LEBARON