Britain Appears Recession-Bound

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The industrial sector has gradually lost significance over the past few decades. And the long-term trend for domestic oil production is set for a decline as North Sea deposits dry up. Tighter credit conditions, increased competition from abroad, falling global demand, and squeezed profit margins from rising commodity prices will accentuate the slowdown in industrial production.

Profit Squeeze

Producer price data indicate that businesses are feeling pessimistic about the strength of demand for their products. Unable to pass on recent commodity price increases fully, companies are now internalizing input price increases to the largest extent seen in at least 33 years, which is squeezing their profit margins. Industrial production fell 0.2% quarter-over-quarter in the first quarter, and we look for flat-to-negative quarterly growth figures for the remainder of the year.

The Q2 British Chamber of Commerce survey suggests that if the current trend continues, the British business sector is just one quarter away from a technical recession. The survey, released July 8, showed both services and manufacturing domestic sale indexes negative for the first time since the early 1990s, with the service home-sales index at its lowest since the third quarter of 1992 and the manufacturing index at its lowest since the fourth quarter of 2001.

Meanwhile, prices within the manufacturing sector were the highest since comparable records began in 1997, while prices in the service industry slipped marginally, though remained elevated. Profitability confidence within the service sector was the weakest since 1990, and for manufacturers this measure was its weakest since 1998.

Meanwhile, the National Institute of Economic & Social Research (NIESR), a British think tank, estimated GDP growth of 0.2% quarter-over-quarter in June, versus 0.1% in May. NIESR noted that "although quarterly falls in output are possible in the near future, it remains most unlikely that output in 2008 will be lower than in 2007."

It looks as if the British economy was still expanding in the second quarter, with consumer spending possibly having held up well enough to ensure overall positive quarterly growth. However, we expect negative quarterly GDP growth in the third quarter and the outlook for the fourth is bleak. Recession is a clear risk for the second half of 2008.

Despite this dire outlook, we expect the BoE to keep the repo rate steady at 5.0% well into 2009, as upside risk to inflation remains a serious threat. The inflation threat is thus limiting the central bank's ability to loosen monetary policy to boost growth, suggesting a tough couple of years for Britain.

Weise is a senior European economist for Action Economics .