Is the U.K. Headed for a Big, Fat Recession?

Assuming consumer spending continues to deteriorate, then yes, and before the end of next year, in my view.

Consumer spending accounts for two-thirds of the U.K. economy, according to a Bloomberg story I saw going by a few days ago. (Web link no longer available, unfortunately.) I would argue that a substantial part of that money has come from the housing market in recent years via capital gains and mortgage equity withdrawal. I didn’t know where to find a figure for capital gains on property sales, but Britons borrowed £51 billion last year via mortgage equity withdrawal, according to the Bank of England. I had a surprising amount of trouble finding out what retail sales were last year, but as a proxy this report from National Statistics gives the average weekly value of retail sales in May as £4.62 billion, which equates to an annual figure of £240.2 billion. So mortgage equity withdrawal alone has played a substantial role in fueling consumer spending, it seems to me.

Well, evidence that the country’s housing market has come off the boil continues to mount, which would seem to me to have problematic implications for Britons’ continued ability to use their houses as cash machines. At the same time, five interest-rate increases by the Bank of England from November 2003 through 2004 have boosted borrowing costs, and energy costs and taxes have climbed, all of which have cut into incomes. Note how mortgage equity withdrawal dropped as 2004 went on and interest rates rose.

The results seem clear to me at personal, corporate and macroeconomic levels. At the personal level, HSBC, Barclays and Lloyds TSB, three of the U.K.'s biggest banks, have referred recently to increases in bad debts, credit-card delinquencies and people having trouble meeting payments. And Tesco, the country’s biggest supermarket operator, has said business is getting tougher for its personal-finance operation. More than 13,000 people filed for insolvency in England and Wales in the first quarter, or more than 1,000 every week. When this company, which advises debtors, listed its shares in London last month, it cited a Bank of England report that found 42% of unsecured debtors (i.e. credit-card borrowers) having trouble making repayments.

At the corporate level, the effect is most obvious on companies that depend on spending for home improvement. Same-store sales (or sales at stores open at least a year, which reflect the growth a company is getting from its existing business by eliminating new outlets) at B&Q, the home-improvement chain owned by Kingfisher, slid 7.7% in the latest quarter; it was the second drop in a row after, IIRC, 2 1/2 years of gains. Shares of Floors 2 Go, the country’s biggest retailer of laminated flooring, lost almost half their value in a day after the company put outthis little gem of an update. But the effect is clear across the industry, from specialists such as photo retailer Jessops, where sales of digital cameras deteriorated earlier this year, to generalists such as Woolworths - sales are down and the outlook is gloomy. Dixons Group, the country’s biggest consumer-electronics retailer, recently said it may cut as many as 800 jobs, and there will be plenty more before this is over, I fear.

Other companies that depend on consumer spending are feeling it as well. Auto dealer William Jacks has just said sales of new cars to the private sector - two-thirds of its business - have dropped 12% nationwide. And when holiday-park operator Parkdean Holidays reported results recently, the company cited “erratic holiday sales patterns” since April. We’re also starting to get the first profit warnings from the housebuilders themselves, such as this statement from George Wimpey. While it’s not surprising that earnings would be down from last year’s record level, the comapny’s comments on the U.K. market are hardly inspiring.

At the macroeconomic level, retail sales are in the toilet. The British Retail Consortium has just reported what IIRC was the third drop in a row in monthly national same-store sales, and the three-month trend rate for same-store sales dropped to -2.4% from -1.5%. Clearance sales and better weather were the only reasons the month wasn’t as bad as May. Another recent report by the Confederation of British Industry showed the biggest drop in monthly sales in the study’s 22-year history.

I don’t know about you, but I have a hard time being optimistic about this. Consumer debt topped £1 trillion in 2004, and IMHO there’s very little appreciation of the consequences of borrowing in a low-inflation environment, namely that the debt won’t be eroded by inflation as was the case in the past. Property markets are like supertankers - they take a long time to turn around, but once they’re headed in a particular direction they tend to keep going that way for a while. It seems to me this one is changing direction, and if that’s the case I don’t see how the country can escape a classic consumer-led recession.

Any guesses as to whether the Old Lady will cut interest rates tomorrow?

Update: the Bank of England left its repurchase rate unchanged at 4.75%. I should have specified in the OP that I didn’t expect a cut today, but there was a recent groundswell of opinion in that direction on the part of some analysts.