Could there be a recession on its way to the UK?
Current Affairs

Could a UK recession be on its way?

“No more boom and bust!” was the repeated battle cry of then-Chancellor Gordon Brown, as Labour swept into power in 1997. It turned out to be a questionable statement on numerous levels, but perhaps the pitfall which was most pre-ordained was the fact that economic performance is inherently cyclical. As the axiom goes, “every 5-7 years, people forget that a downturn happens every 5-7 years.”

Interestingly, the UK economy finds itself in its eighth consecutive year of recovery following the earthquake of the financial crisis, and it has caused jitters among some economists that a recession is thus overdue. And, given that the UK currently finds itself saddled with debt, dealing with the uncertainty of Brexit, facing poor wage growth, and with little in the way of monetary policy headroom given record-low interest rates, the fear is that an impending bust could leave a severe trail of destruction.

But the duration of the economic cycle in itself is an insufficient indicator upon which to base any predictions. Indeed, the UK enjoyed 17 years of growth prior to 2008. What’s more, a downturn and a recession are not the same thing; the former is merely a cause of the latter.

So, what else should be factored into our calculations?

Brexit

The vote to leave the European Union, according to many economists, spelled doom and gloom on numerous economic fronts for the UK. However, the robustness of the economy has continued to confound experts nearly a year later. Given that the process of severing ties with the Brussels club only officially began a month ago, there may yet be a delayed effect, and the uncertainty over our future relationship with the EU will do little to promote investment in business.

But so far so good, and Bank of England Governor Mark Carney has even dismissed any prospects of a recession prior to 2020, with growth forecasts of 2 per cent for 2017, 1.6 per cent for next year and 1.7 per cent in 2019 (figures recently validated by the usually-pessimistic IMF). Carney has even gone on record as saying that Brexit could lead to faster growth in the UK, provided the exit goes smoothly.

Perhaps it is that final proviso which will best determine what impact Brexit has on the economy in the short run.

Exports and international developments

The depreciation of sterling has been a great boost for exporters. This wasn’t an economic inevitability as, although it makes them more competitive in the global economy, it is contingent upon there being ample global demand for UK goods. Fortunately, the combination of better-than-expected growth in China and rising commodity prices has ensured steady demand, and the benefits to the wider economy have been felt as a result.

Yet there remain concerns about the Chinese banking system, and/or that policymakers may seek to devalue the Yuan in the quest for growth. On the other side of the globe, President Trump’s promise to indulge in a spending spree could see negative consequences manifest in two ways. Either he fails to go ahead, and dents the confidence of market participants; in turn reverberating around the wider economy. Or he does go ahead, fuels growth, but overheats the economy, thus ‘speeding up’ the business cycle towards a recession. Needless to say, a bust for America – the major global economy – would have significant consequences for Britain.

On our doorstep, meanwhile, the Eurozone has enjoyed steady expansion recently, and appears to have got through some potentially-unsettling general elections unscathed. However, the spectre of the Greek debt crisis and other issues within the banking systems of Southern European countries remains an ongoing threat, which would almost certainly have an impact domestically.

The British consumer

There has been an almost-defiant approach from British consumers since the referendum, and the wheels have kept turning. Consumer spend is the engine of UK growth, given that it accounts for two thirds of GDP. But this is invariably dependent upon real wage growth, and although economic data suggests this has been positive in recent times, the fear is that the inflationary effect of sterling’s depreciation could scupper consumer spending.

Interestingly, unsecured lending has risen sharply since April 2016. Concerning for some, perhaps, and with chilling echoes of the build-up to the recent crisis. The flip side of the coin though is that it also comes on the back of greater regulation certainty for banks, and suggests that their balance sheets must be healthier if they are proceeding as such. Increased lending is positive for the economy in the medium run too, as it stimulates consumption, production and investment. And, given that such loans are unsecured, there is no link to the housing market, as was so ruinously the case in 2008.

All of the above, though, relies on continued consumer confidence. Recessions are self-fulfilling, and it thus remains vital that the British consumer continues to spend (although within his or her means, of course).

Final thoughts: past, present and future

Does the current situation bear any resemblance to 2008? One interesting pre-cursor to most recessions (as with 2008) is that they are normally preceded by a period of sustained increases in interest rates, and slowing economic activity. While on the other side of the Atlantic, the Fed has gently dipped its toe in rate increases, it’s fair to say that this is hardly a global trend. And in terms of slowing economic activity, well, so sluggish and painful has the recovery been that growth has generally flat lined for much of the last decade, and there is no domestic data to suggest that we are in the midst of a slowdown.

Of course, a continued slump of sterling could lead to rate increases, while any of the cocktail of threats identified above could derail economic growth and activity. More likely, though, is that the slow recovery, and cautionary policy decisions, have elongated the natural economic cycle, thus suggesting we may be spared the damage of a “bust” for at least a few more years.

Certainly as a peer-to-peer lending platform, we steer clear of any complacency on this front, and continue to uphold the highest standards of loan underwriting, with ongoing vigilance with respect to arrears and defaults to shield our customers from any economic downturn. We stress test our credit models against data from recessions in 2009 and 2011 to ensure that our loans perform well throughout the cycle.

But we also have a profound sense of optimism for the years ahead – optimism which is underlined by Carney’s forecasts. We all have our role to play in society, and a good dose of old-fashioned British stoicism at consumer level, coupled with sensible regulatory, policy and business decisions further up, can help to ensure that our economy faces any headwinds with its house firmly in order.

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Michael Todt

Mike joined Lending Works in early 2015 with a background in marketing and journalism. Having long held a passion for economics, he is now the chief contributor to the Lending Works blog, and regularly writes about all things peer-to-peer lending, fintech and personal finance.