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Viewing cable 08LONDON2683, HMG ACKNOWLEDGES UK ECONOMY ENTERING RECESSION

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Reference ID Created Released Classification Origin
08LONDON2683 2008-10-24 09:40 2011-08-25 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy London
VZCZCXRO3176
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHLO #2683/01 2980940
ZNR UUUUU ZZH
P 240940Z OCT 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 0191
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBL/AMCONSUL BELFAST PRIORITY 1147
RUEHED/AMCONSUL EDINBURGH PRIORITY 1005
UNCLAS SECTION 01 OF 02 LONDON 002683 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV UK
SUBJECT: HMG ACKNOWLEDGES UK ECONOMY ENTERING RECESSION 
 
LONDON 00002683  001.2 OF 002 
 
 
1.  (SBU) Summary:  This week, officials publicly acknowledged that 
the UK is likely to be entering a recession.  For months, prominent 
public figures refused to mention the 'R' word, in favor of talking 
up the underlying strength of the UK's economic position.  However, 
Mervyn King, Governor of the Bank of England, broke the silence and 
explicitly acknowledged that the UK is likely to enter a recession. 
His comment was soon echoed by PM Brown and supported by independent 
forecasts.  Such a bleak horizon has pushed sterling to a five-year 
low against the dollar while equity prices continue to fall. 
Despite a record public deficit, HMG has announced that it will 
borrow more to invest in projects that will help stimulate the 
economy.  The opposition has accused PM Brown of presiding over a 
decade of heavy borrowing and lax regulation which has aggravated 
the impact of the credit crunch.  End Summary. 
 
Governor King Uses The 'R' Word As GDP Growth Turns Negative 
---------------------------- ---------------------- 
 
2.  (SBU) The UK economy is likely to be entering a recession, 
according to Mervyn King, Governor of the Bank of England, in his 
gloomiest assessment of the UK outlook since becoming Governor in 
2003.  His comments were supported by confirmation that GDP growth 
was negative 0.5 percent in the third quarter.  King told business 
executives that the credit crunch, combined with a fall in real 
disposable incomes, poses the risk of a prolonged slowdown in 
domestic demand.  Additionally, the trauma of the banking crisis is 
likely to damage business and consumer confidence.  His comments 
were echoed by the Prime Minister who said Britain's economic 
downturn is likely to cause a recession.  Lord Mandelson, the new 
Business Secretary, acknowledged that it is now 'unavoidable' that 
the UK economy will contract and added that many small and 
medium-sized businesses might go bankrupt. 
 
3.  (SBU) Ernst & Young's ITEM Club agrees with recession 
predictions.  In its quarterly macroeconomic forecast, the Club says 
it expects UK GDP to shrink by 1 percent next year, followed by a 
modest recovery in 2010 with GDP growth of 1 percent.  If the Club 
is correct, 2009 will be the first full year of shrinking output 
since the last recession in 1991, when output fell by 1.4 percent 
over the year prior.  The report also says that the credit crunch 
will hit the economy hard even if wholesale markets reopen and 
equity markets stabilize.  It suggests that the downward momentum in 
the housing market will be difficult to arrest and that it is 
spreading to other sectors.  While the recent government rescue 
package may have pulled the economy back from a depression, the 
report says the financial system remains in an enfeebled state. 
(Note: The financial sector accounts for approximately 10 percent of 
UK GDP and nearly 20 percent of tax receipts.  End note.) 
 
4.  (SBU) NIESR, an influential UK think tank, agrees that the 
country is on the brink of recession.  It forecasts that the British 
economy will suffer more than any other G7 country in 2009, with the 
economy shrinking by 0.9 percent, consumer spending falling by 3.4 
percent, business investment down 3.8 percent and private housing 
investment 17.1 percent lower.  Its forecast assumes that the Bank 
of England will cut the Bank Rate to 4 percent in early 2009.  NIESR 
thinks that if the government's banking bail-out does not succeed, 
the recession will be deeper and longer than currently anticipated. 
The NIESR report also predicts that trend growth is now only 2.2-2.3 
percent and said that this will have serious implications for HM 
Treasury revenue forecasts in the Pre-Budget Report that is expected 
in November. 
 
Sterling At Five-Year Low On Recession Warnings 
------------------------ ---------------------- 
 
5.  (SBU) Following Mervyn King's statement, the pound fell to a 
five-year low against the U.S. dollar.  On October 22 sterling fell 
five cents or 3 percent against the dollar and also declined versus 
the euro, the lowest level since 2003.  This was the steepest one 
day decline in 16 years.  Simon Derrick, Chief Currency Strategist 
in London at Bank of New York Mellon Corp said "These are...moves 
that come along once in a decade...King certainly acted as a 
catalyst, but in fairness, risk aversion had been kicking around 
long before that." 
 
Public Finances To Support Economy 
---------------------------------- 
 
6.  (SBU) PM Brown told the House of Commons on October 20 that HMG 
will increase borrowing to support the economy.  Despite public 
finances reaching a record deficit in the first six months of the 
financial year (which begins in April), Brown said increased 
borrowing is a viable option because of the strength of the UK's 
economic indicators.  HMG will support mortgage holders, small firms 
and employees through "carefully targeted, rigorously worked through 
investments."  HMG will also bring forward construction projects on 
schools and hospitals, the Chancellor told the Sunday Telegraph. 
 
LONDON 00002683  002.2 OF 002 
 
 
 
7.  (SBU) Spending plans will be formally announced in the 
Chancellor's Pre-Budget Report.  Speculation is rife that the 
Chancellor will have to announce an amendment to HMG's sustainable 
investment rule, implemented while Gordon Brown was Chancellor, 
which limits national debt to 40 percent of GDP.  The Chancellor 
will also have to concede that the Treasury's economic forecast in 
the March Budget was too optimistic. 
 
8.  (SBU) In public comments, Opposition leader David Cameron 
accused the PM of aggravating the credit crunch by overseeing a 
decade of heavy borrowing and lax regulation.  He said the 
government has presided over ten years of irresponsible capitalism 
and that the 'complete and utter failure' of their economic record 
is now clear.  The Conservatives favor measures giving small 
businesses the chance to defer value-added tax (VAT) bills for up to 
six months to offset cash flow problems posed by tight credit 
conditions.  They also advocate cutting the payroll taxes for firms 
with fewer than five employees by 1 percent. 
 
9.  (SBU) Comment: The UK's slide into recession was not unexpected. 
 The OECD predicted almost two months ago that the UK was the most 
likely among G7 countries to experience such an economic downturn. 
Sterling's plummeting value vis-`-vis major economies will 
exacerbate pressures on exporters, who already have seen their 
access to credit dry up.  While accelerated spending plans will give 
a shot-in-arm to the economy, no one expects any type of recovery 
until the latter half of 2010. 
 
 
LEBARON