The pound not so sterling, Britain grapples with deepening recession

McClatchy NewspapersJanuary 23, 2009 

LONDON — The British economy on Friday was officially declared in recession as a galloping economic crisis has driven down the value of the British pound to a 23-year low and threatened to remake the country's political landscape.

Britain's Office for National Statistics said Friday that the economy contracted by a stunning 1.5 percent in the fourth quarter of 2008. That followed a 0.6 percent contraction in the three months between July and September.

Recessions typically are defined as two consecutive quarters of economic contraction, and the last time Britain found itself in this state was in 1991. Like the United States, Britain is wrestling with a financial crisis that seems only to grow worse.

Evidence of the storm is everywhere. The unemployment rate is now 6.1 percent, up almost a full percent from a year ago, and this week the government of Prime Minister Gordon Brown unveiled a second big package to stimulate lending by banks, including a guarantee plan to protect them against losses on bad assets.

Britain also increased the government's stake in the Royal Bank of Scotland to 70 percent, giving it a controlling interest. As in the United States, British banks have come under fire for failing to increase their lending to consumers and businesses despite receiving a big injection of government capital last October.

"The UK's economy is much more dependent on the financial sector than is the U.S. economy, and the financial sector is at the epicenter of this global crisis," said Nariman Behravesh, chief economist for forecaster IHS Global Insight in Lexington, Mass. "The UK's housing bubble was twice as big . . . so the crash is bigger, and everyone is factoring that in to the calculus on the pound (sterling)."

The British pound fell 7.3 percent against the dollar this week to close at $1.3673. During Friday trading, the pound briefly touched $1.3570, its lowest point against the U.S. dollar since 1985. It fell to record lows this week against the Japanese yen.

Some big-name currency traders have suggested that the pound "is finished," a charge that provoked a strong reaction from Brown on Friday. Brown admitted that "nobody" saw the "possibility of complete market failure," but he said that an American stimulus package due to be completed in the coming weeks "will give Britain and the rest of the world a boost" and that the pound will regain its lost value.

Behravesh and others, however, think that Britain's recession will be even deeper than the one unfolding in the United States, which already is expected to last longer than any other one since the Great Depression. The British economy will contract by 3 percent to 3.5 percent before it starts to recover, he said.

For Prime Minister Brown, a staunch U.S. ally, the deepening crisis adds to the gloom in a winter of discontent. A few months ago, he was viewed as a savior of the global economy when he bucked Washington's initial approach to the financial crisis and injected cash directly into his troubled banking system. The U.S. Treasury Department had intended to purchase the troubled assets clogging up the credit markets, but reversed course and followed Britain's lead.

Now the Obama administration expects to return to the original plan, while in Britain, there's talk of bank nationalization. Brown's popularity at home, and that of his Labor Party, is sinking faster than the pound.

A poll published by the Sunday Times found that the opposition Conservative party now has a 13-point edge in public opinion polls.

Much of Labor's good standing a few months ago was based on confidence in Brown's ability to right the economy. For a decade before becoming prime minister in 2007, he was Chancellor of the Exchequer, the equivalent of Treasury secretary. Brown enjoyed the credit during Britain's boom, but now, he's taking knocks.

"I blame our government for not seeing this coming," said William Hewson, an 82-year-old retiree, pointing to spiraling property prices in recent years. "I would have thought they've got more brains than me. Anyone with any sense could see it wouldn't last. They say it's all over the world now, but I don't think that's any excuse for the government."

The drop in the pound has hit Britons hard. The country has refused to adopt the euro, the currency used in much of the European Union, and that's left the pound more vulnerable as the economy shrinks and the banking system slides deeper into disarray.

The pound is the world's third most popular reserve currency, behind the dollar and euro, and the fourth most traded currency, after the dollar, the euro and the yen, and its fall has reignited debate over adopting the euro.

Nick Clegg, the leader of the Liberal Democrats, the country's third-largest political party, said Britain had an "extremely dangerous" exposure to global money flows and that switching to a "major reserve currency" would offer stability and protection.

Some financial experts agree.

"Why would you at this point buy sterling assets and add to your risk when the UK economy is disastrous?" asked Paul Goldschmidt, a former director of investment bank Goldman Sachs & Co., and a former European financial policymaker.

Now an analyst for the Thomas More Institute, a research center in Brussels, Goldschmidt said that a shift to the euro would reduce currency risks for British businesses and give the entire region more muscle globally.

A national poll last month, however, found that more than two-thirds of British citizens prefer to stick with their beleaguered currency.

(Sell is a McClatchy special correspondent in London. Hall reported from Washington.)

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