Identifier
Created
Classification
Origin
08LONDON1917
2008-07-23 12:30:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy London
Cable title:  

SQUEEZED IN THE JAWS OF THE CREDIT CRUNCH -- UK ECONOMY

Tags:  ECON EFIN ETRD UK EINV 
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VZCZCXRO4253
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHLO #1917/01 2051230
ZNR UUUUU ZZH
P 231230Z JUL 08 ZFR ZFR ZFR
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 9259
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBL/AMCONSUL BELFAST PRIORITY 1085
RUEHED/AMCONSUL EDINBURGH PRIORITY 0950
UNCLAS SECTION 01 OF 04 LONDON 001917

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD UK EINV
SUBJECT: SQUEEZED IN THE JAWS OF THE CREDIT CRUNCH -- UK ECONOMY

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UNDER MRN
QUARTERLY UPDATE

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QUARTERLY UPDATE



5. (U) ITEM expects CPI to remain above the Bank of England's target

range of 1-3 percent for the next 12 months. It predicts that
inflation
will average 3.5 percent in 2008, coming down to 3 percent in 2009
and 2
percent by 2010. It notes that this forecast assumes that wage and

domestic cost inflation remain subdued. In the UK there is
currently a
significant push for higher wages to offset price increases. This
pressure is particularly acute in the public sector where pay
increases
have been held below those in the private sector and below the cost
of
living for two years. Chancellor Darling has called for pay
constraint
but unions are threatening a season of industrial action if pay
deals
are not reopened. ITEM urged the government not to accept any
excessive
public sector pay demands which could put severe pressure on any
attempts to dampen inflation and potentially destroy any hopes of a

medium term recovery.


6. (U) During the first quarter of 2008, the largest upward pressure
on
inflation came from food, mainly meat, vegetables, and non-alcoholic

beverages, and fuel, particularly heating oil. Despite growth in
the
CPI, however, the UK inflation rate is below the provisional figure
of 4
percent for the European Union as a whole. The main factors
affecting
the CPI also affected the RPI. However, the Retail Price Index
experienced a downward contribution from housing. This came mainly
from
mortgage interest payments as lenders passed on April's quarter
point
decrease in the bank rate to customers, in addition to house price
depreciation.

(Annual inflation rates - 12 month percentage change)

--------------
Jan08 Feb08 Mar08 Apr08 May08 Jun08

CPI 2.2 2.5 2.5 3.0 3.3 3.8

RPI 4.1 4.1 3.8 4.0 4.3 4.6

--------------

Employment Stable
--------------


7. (U) Overall employment and unemployment figures have remained

fairly
stable, despite volatility in the economy. The total number of
people
in work rose in the three months to May to an all time high of 29.59

million. However, the number of people in the UK claiming
unemployment
benefit saw the biggest jump in 16 years. The claimant count has
risen
by 45,000 since the end of January 2007, to 2.6 percent of the
working
age population. Job losses are most prominent in the building and
financial sectors.


8. (U) Professor David Blanchflower, a member of the Bank of
England's
Monetary Policy Committee who has voted for interest rate cuts for
the
last nine months, has predicted that the UK is heading for a
recession
which could cost hundreds of thousands of jobs. He expects
unemployment
to rise from 5.2 percent to more than 7 percent. While ITEM is
forecasting a rise in the overall numbers of unemployed, it remains

hopeful that it will only be a modest jump, particularly in
comparison

LONDON 00001917 003.4 OF 004


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with previous downturns. A major contributory factor to the limited

nature of this increase is that poorer UK employment and economic
prospects, combined with a weaker exchange rate, is causing a
reversal
in migration flows. However, it still anticipates that unemployment

will rise from 1.6 million at the end of 2007 to the 2 million mark
by

2010.


Seasonally Adjusted (Percentage)

-------------- --
Q107 Q207 Q307 Q407 Q108

Employment 74.3 74.4 74.4 74.7 74.9

Unemployment 5.5 5.4 5.4 5.2 5.2
-------------- --

Interest Rate, Pulled Both Ways, Doesn't Move
--------------


9. (U) The Bank of England's Monetary Policy Committee (MPC) has
resisted calls to cut the interest rate as the economy continues to

falter. With inflationary expectations rising in line with headline

inflation figures, the MPC has felt unable to offer relief from a
lower
base rate. However, ITEM expects a slowdown in consumer spending to

pave the way for a rate cut this winter, perhaps as early as
November.
Beyond that, interest rate decisions will likely be determined by
the
behavior of commodity prices. If crude oil prices follow the
expectations of the futures market and peak at $150 a barrel this
fall,
before easing back, ITEM expects interest rates to fall back to 4
percent by the end of 2009. This will help to put a cushion under
the
level of demand in the economy and set the scene for recovery in

2010.

-------------- --
Jan08 Feb08 Mar08 Apr08 May08 Jun08

Bank Rate 5.50 5.25 5.25 5.00 5.00 5.00
-------------- --

Public Finances Breaking the Rules
--------------


10. (U) HMG's current budget deficit in May, at GBP 9.1 billion, was
the
worst May figure since monthly records began in 1993, and the second

worst figure on record. Tax receipts in the first two months of the

fiscal year (which begins in April) were up only 3.6 percent year on

year, worse than the 4.8 percent forecast by the Chancellor in his
March
Budget. The Chancellor has predicted public sector net borrowing to

reach GBP 43 billion at the end of the financial year, but analysts

believe he will exceed this target by a substantial margin.


11. (U) There has been media speculation, widely regarded as
accurate,
that Treasury officials have begun working privately on plans to
rework
the fiscal rule, established by Gordon Brown as Chancellor, that
limits
public sector debt to 40 percent of national income. Following the
rule
changes, it is likely that public sector debt could rise to 42-45
percent of GDP. At a Downing Street press briefing, the Prime
Minister's spokesman noted that according to the IMF's latest
estimates
for 2008, the UK is in a stronger position than most countries. Net

debt in the Euro area as a percentage of GDP is currently 55.9

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SQUEEZED IN THE JAWS OF THE CREDIT CRUNCH -- UK ECONOMY
QUARTERLY UPDATE

percent
and in the U.S. is 47.9 percent.

-------------- --------------
Apr08 May08 Jun08

Current Budget (Billions) 0.6 (9.1) (7.6)
(Deficit in brackets)

Public Sector Net Lending 0.5 (11.0) (9.2)
(Billions-Borrowing in brackets)

Public Sector Net Debt 36.5 37.2 38.3
(Percentage of GDP)
-------------- --------------


Chancellor to Pay the Price?
--------------


12. (SBU) Darling threatened to resign twice prior to publishing the

2008 HMT budget report, according to recent reports in the media.
One
influential MP told us that a shake-up of Brown's cabinet is very
likely
in the fall, confirming press reports. Darling could likely lose the

Chancellorship in any government re-shuffle, given Brown's need to
demonstrate a response to the growing public perception of economic

malaise in the UK. Darling has also been the point person in
multiple
unpopular tax proposals that were later revised or scrapped,
including
the non-dom tax changes, car taxes, and most recently a tax on
passive
income for multinational firms. The constant reversals have battered

Darling's and the government's reputations as responsible guardians
of
the British economy.

TUTTLE