By using this service and related content, you agree to the use of cookies for analytics, personalised content and ads.
You are using an older browser version. Please use a supported version for the best MSN experience.

Money Top Stories

Revival over… is the next recession due?

The Telegraph logo The Telegraph 19/06/2017 By Tim Wallace
Replay Video

Watch: Signs the UK could be headed for a recession (The Street)

Seven years have passed since the Great Recession came to an end. Seven years of mediocre growth and grumbling that we are still suffering the fallout from the financial crisis.

Yet this is typically a time when analysts would start to worry about the next downturn.

Traditionally a recession of some sort has taken place roughly every decade. This time it feels as though the recovery is only just getting under way, as growth has proven lacklustre since the financial crisis.

The global economy is indeed picking up, which should be good for the UK. But economists are highlighting the risks, even pencilling in an outside chance of recession as unexpected political events take their toll on business confidence.

Combine that with the risk of a US slump as the world’s largest economy moves into the later stages of its economic cycle, and there is the potential for a serious slowdown.

The Federal Reserve increased interest rates last week  for the second time this year. A traditional trigger for recession, this process of raising rates has economists watching closely.

Revival over… is the next recession due?

James Carrick, at Legal & General Investment Management, was alert to the risk at the start of this year.

“A recession comes when a central bank is damned if it does and damned if it doesn’t,” he says, pointing to the financial crisis as a point when policymakers could keep interest rates low and risk inflation blowing up, or hike rates but ruin the banks.

When US inflation was on the rise this year, the Fed signalled its clear intention to raise rates, and Carrick feared that it could set off an economic slump. But as price pressures have dropped back unexpectedly, he now hopes the US will avoid a recession.

“The clouds on the horizon have dissipated, inflation is not there at the moment,” he says. “The Fed is under less pressure to keep turning the screws. If there are any signs of growth deteriorating, it can choose to stop tightening.”

Financial markets may be a better place to look for emerging risks. Analysts are already worried that volatility is unusually low. That might seem an odd complaint – after all, investors usually claim that uncertainty and volatility is bad for confidence.

But when volatility is ultra-low, analysts fear complacency has crept into markets. The VIX index, which monitors this, is at levels rarely seen – except in periods such as 2006-07 on the eve of the financial crisis.

James Binny, State Street’s head of currencies in Europe, the Middle East and Africa, pointed out the worryingly low volatility in 2006, but markets continued to rise for another year or more. “By the time volatility did take off, everyone had forgotten about it. That is the problem, we can all say volatility is ridiculously low, it probably can’t be sustained here, but actually calling that bottom is, I suspect, actually impossible,” he says.

“Everyone is looking for crises at the moment, so that is the big difference [compared with the pre-crash complacency]. I find it unbelievable that volatility and risk is priced this low, but it could be here for a long time.”

Shares soared after President Trump’s election as investors focused on promised tax cuts and spending splurges . But it is far from certain that those stimuli will emerge given the political difficulties in passing a radical budget in the US.

A combination of higher rates and a failure of this stimulus would risk a more serious downturn.

Bank of America Merrill Lynch’s latest survey of fund managers reflects some of that concern – last week’s study found a net 44pc in the industry think shares are overvalued, the highest on record.

A net 84pc see the US as the most overvalued region, indicating a fragility in the market that could turn on bad news.

A key warning for Britain comes from economist David Page at Axa Investment Management. “Should we not see that stimulus come about, then you’re in a situation not too dissimilar to the UK – where US households are seeing a significant slowdown in real income growth, nominal employment growth is slowing, wage growth is pretty subdued on average,” he says.

Rising inflation is hitting real incomes.

If “that slows US consumer growth to below trend into 2018, [then it] could set in train further deceleration into 2019”.

Britain’s slowdown has already arrived. Growth was 0.2pc in the first quarter of the year in a surprise slump following unexpectedly strong GDP figures through the second half of 2016.

The driver of that growth, consumer spending, could be cut off at the knee.

Prices are rising substantially faster than wages, and borrowing cannot plug the gap forever. “The pressure on household budgets is really intense,” says Samuel Tombs at Pantheon Macroeconomics.

He predicts the economy will grow by just 0.2pc again in the second quarter of the year, which would mean 2017 getting off to the worst start for a year since 2012.

“Real incomes are under a lot of pressure and growth in borrowing has stabilised so it is no longer providing the boost to spending that we saw last year,” says Tombs.

“It is no longer impossible that we could get a couple of quarters of negative growth in consumer spending, if households start to get a bit more cautious on greater political uncertainty. It is not my central forecast, but it is a clear risk.”

Other key economic variables are also performing poorly. Exports have failed to take off so far despite the sharp fall in the pound, and even those businesses that are benefiting from the more competitive exchange rate are reluctant to invest – if they do not know the shape of Britain’s trade rules after Brexit, then it is difficult to commit to any major projects.

Hammond insists UK economy is resilient as growth slumps 01:02

Domestic political uncertainty will not help either.

Given the volatility in economic figures, it is not unthinkable that the UK could see a small fall in GDP numbers in the near future, rather than a small rise.

If GDP falls for two consecutive quarters, then the country would officially be in a recession for the first time since 2009.

That would not translate into anything like the damage caused by the financial crisis, but would still be an unpleasant event after years of moderate recovery.

Economist Alan Clarke at Scotiabank predicts GDP growth of 0.2pc in the final quarter. “All it would take is just over a 0.2pc downward surprise on that to get me into negative territory,” he says, estimating the UK has a 25pc chance of entering a recession.

“The GDP data can surprise. If it were to happen, it would be that the consumer decelerates [on higher inflation] but we don’t get as much of an offset via stronger investment or stronger net trade, or increased borrowing.”

Tombs agrees. “The economy is very close to stagnating, it would not take much of a shock to push the UK into a minor recession. It is within the realms of possibility,” he says.

“Policymakers are not in much of a position to respond – interest rates are already very low, QE dubious in its effectiveness, and it doesn’t look like there will be any loosening of fiscal plans for now.”

A slowdown is widely anticipated, though its extent is up for debate – the consensus among economists is for growth to slow from 1.8pc in 2016 to 1.7pc in 2017 and 1.3pc next year before recovering to 1.9pc in 2019.

Clarke even believes the surge in inflation could lead – over time – to some more positive outcomes.

“Perversely, it may be a catalyst for faster wage growth, which we’ve been longing for,” he says.

“One excuse for low wage rises was that inflation was so close to zero that employers could say you are only getting a 2pc pay rise when in the past it would have been 4pc or 5pc, because in the past inflation was 2pc or 3pc, so in real terms you are no worse off. So as inflation rises towards 3pc or more, employers no longer have that excuse.”


More from The Telegraph

image beaconimage beaconimage beacon