Why Britain’s recession nightmare is a long way from over

“Unbelievable, literally”. That was the response of one economist at US investment bank Goldman Sachs to the news last month that Britain was still in recession. The Office for National Statistics (ONS) had just announced a 0.4 percent decline in real GDP – the sixth quarter in a row that the economy has shrunk. According to the ONS, the economy had declined 6 percent from its peak. But economists at Goldman Sachs were unconvinced. Business surveys pointed to a much stronger economy, they claimed. The official data were “hardly worth the paper they were printed on”. Yet a month later Britain is still in recession. Last week’s figures show a decline of 0.3 percent. This recession is proving all too stubborn – and a closer inspection of the data shows why.

There was a record decline in output for “restaurants/hotels”, which fell 7.7 percent year on year. This category encompasses a range of recreational services, many of them provided by smaller companies. These are not reflected in the business surveys that drive sentiment in the City, and which led economists to conclude that the UK had escaped recession.  The widely-followed purchasing manager indices (PMIs), provided by private firm Markit Economics, only cover 600 companies. The ONS surveys 30,000. Not surprisingly, its official statistics are proving a better judge of the squeeze on smaller businesses. Many of these have suffered from the clampdown in lending by banks as they continue to shrink their balance sheets. According to the Bank of England, lending to companies shrank by a record 3.5 percent in the year to October.

But it is not just small businesses that continue to suffer from a credit squeeze. Banks are also cutting credit lines to individuals. Consumer credit has shrunk for four months in a row, another record. Last year’s collapse of Lehman Brothers continues to cast a long shadow. And wages are being squeezed as well; in real terms, wages have now fallen for five straight quarters. All of this is taking its toll on public finances. Last month saw a record increase in government borrowing, a rise of £11.3 billion compared to the same month in 2008. (This is the most useful comparison to make, because of the strong seasonal swings in tax receipts and spending.) Some continue to cite runaway public spending as the culprit. But the facts suggest otherwise.

So far during the current financial year, spending has risen 6 percent year-on-year in pound terms. That is less than the budget set by the Treasury in April. By contrast, tax revenues have shrunk by 10 percent. That is well beyond the 6.5 percent decline projected in April. This year, tax revenues as a proportion of GDP will fall to lower than any level under Margaret Thatcher or John Major. The Tories trumpet a low-tax economy as the way to recovery – but New Labour has already done that, and Britain is still in recession. Any upswing will be slow, as companies continue to cut costs and banks retrench. The Bank of England could cut interest rates from the current level of 0.5 percent all the way down to zero, but at this late stage the impact would be limited. The programme of quantitative easing – buying gilts (government IOUs) – is more aggressive than in any other major industrialised economy. The Bank of England is unlikely to sanction much more of it when the budget deficit is spiralling upwards.

If the world economy takes a turn for the worse, Britain will be in trouble. The next government will be cutting spending and hiking taxes in the eye of the storm. The risks are numerous. What’s happening in Dubai is a reminder of the credit problems that still litter the world. In Germany, the central bank announced last week that banks would have to find a further 90 billion euros to cover expected losses on toxic loans. Lending is shrinking across the Eurozone. Banks are weighed down by bad debts. Consumer spending continues to slide in the majority of member states. Ireland and Greece remain in deep financial trouble. And in the US, Obama has failed to tackle the foreclosure crisis. By the end of September, one in seven with a mortgage was either in arrears or in the process of being repossessed. Early indications from Freddie Mac, one of the biggest US lenders (now nationalised), suggest these delinquencies rose again last month – and the increase is accelerating. Long-term unemployment has hit a post-war record and is driving more borrowers to default. Despite repeated bailouts, capital injections and tax-subsidised incentives for banks, the homelessness crisis is intensifying. The US faces economic and political turmoil in 2010 if Obama does not act. And the US remains a major risk to any possible recovery in the UK.