ECONOMIC RECOVERY A LONG WAY OFF SAY BANKERS

UNCLAS LONDON 002783

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV UK
SUBJECT: ECONOMIC RECOVERY A LONG WAY OFF SAY BANKERS

Summary
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1. (SBU) The UK economy will not begin to recover until the end of
2009 at the earliest, and the road back to health will be slow, said
Stephen King, Group Chief Economist at HSBC Bank plc and Melanie
Baker, Vice President at Morgan Stanley. High loan burdens for
banks, rising unemployment, and declining consumer spending will be
the most significant problems of the year to come. End Summary

UK Housing and Mortgage Markets
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2. (SBU) Although the current financial crisis was triggered by
problems with U.S. subprime mortgages, King told econoffs in an
October 28th meeting that there is little sign of a "housing
bubble" in the UK. Price to income and debt to income figures have
declined from their levels of two years ago, when both were higher
than in the U.S., according to King. One problem that remains,
however, is the loan to deposit ratio. King said that the loan to
deposit ratio for UK mortgage lenders is 140 percent. (Note: The
loan to deposit ratio in the U.S. has risen from about 70% in the
early 1970s to about 100%. End note) In the current environment, UK
lenders are working to bring down this ratio, but there is no
consensus or official guidance on what the loan to deposit ratio
should be. The loan to deposit ratio at Northern Rock was 215% when
it was nationalized.

Macroeconomic Forecasts
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4. (SBU) the UK will experience 4 - 6 years of "sluggish
performance" as de-leveraging (selling off of non-performing assets
to reduce debt) continues, in King's view. He forecasts that the UK
bank rate will be cut from 4.5 percent to 2 percent by the fourth
quarter of 2009 as the Bank of England will be forced to adopt an
expansive monetary policy.


5. (SBU) King expects significant increases in unemployment. He
said that much of the UK job creation under the Labour government
has been in three sectors: government, financial services, and
construction. Since the current economic downturn is affecting
financial services and construction more than other sectors, he
expects unemployment in these sectors will outpace that of the
general economy. (Note: financial services contributed 20 percent to
tax receipts in 2007 and 15 percent to GDP. End Note)


6. (SBU) Baker at Morgan Stanley was only slightly more sanguine in
her outlook. She forecasted zero percent GDP growth in 2009 but
predicted the UK economy would "muddle through" 2009 and begin to
recover in 2010. However, she said that if credit conditions are
seriously disrupted for a protracted period, a very sharp downturn
is plausible. She put the probability of a 1990's style recession
at 25 percent.


7. (SBU) In contrast to King, Baker forecasted the UK Bank rate
will decline by only .5 percent to 4 percent, possibly by the end of

2008. Baker said she expects consumer spending will be constrained
by the fall in house prices and a squeeze on discretionary income
for years to come. Business investment intentions have
deteriorated, but in Baker's opinion, UK firms are well-placed to
weather difficulties: leverage is not at extremes and corporate cash
balances are high. Baker said UK unemployment is rising faster than
expected although the current Morgan Stanley forecast is 5.4 percent
at year-end 2009.

TUTTLE