Here we are, turning yet again another ghastly chapter in this horrific crisis of the century which had engulfed the global economy in misery since the latter half of 2007. The 2009 chapter was printed in all the colors of the rainbow and ended up being marked as the reform year, since the extent of the damage embarked on leaders and central bankers to take unprecedented measures to salvage the economy from the worst crisis since the Great Depression. It was indeed a brutal year; some might call it the abysmal record breaking year, or maybe by the year of money printing machines and even the recession year or even the public debt year, call it what you may but to us it was that bad and even worse!

For the British economy, this year was its worst post-war year on records. The financial crisis, which originated from the properties market in the United States , viciously spread its way into the global economy in the form of securitization and collateralized debt, spiraling into the United Kingdom that was one of the worst that hit economies, especially since its past decade of economic boom was fueled by properties as well.   

Subsequent to the financial crisis pinning its fangs into the British financial sector in the latter half of 2008; the poison diffused into the harsh economic layers of the economy, where this year was the year of the contagion. The economic fever continued to rise and the recession deepened its grip onto the economy in 2009, as we are ending the year with a slight spark of hope with a flavor of positive data, as the recession finds its bottom.

We will walk you through the economic distress and prescribed painkillers from the Bank of England and the Treasury to ease the pain, but no matter what you choose to call this year, it will always be known as the post-Lehman era!!!

The First Quarter: History Repeats Itself!

As 2008 ended, it left behind it dilemma, confusion and fear; kick starting 2009 with a deep recession that started in the second quarter of 2008! By the first quarter of 2009, we were no longer just roaming a state of panic and a frozen financial sector, yet the weakness was clearly evident in the real economic heart as the recession hit all the sectors, crumbling demand and halting factory wheels.

The devastated confidence in the financial sector and amid banks, which had started to hoard cash, managed to cripple the economic cycle; halting liquidity and forcing companies to result to extreme measures to allocate liquidity, especially since many were forced out of the game and into bankruptcy. 

In the first quarter alone, investments dropped to their lowest since 1984; dropping 7.6% investments in the services sector, which holds the lion's share in the economy by about 75% of the GDP, slumped 9.4% on its own as industrial investments fell 4.2%. As for the sector that was hit the most in the financial crisis, it was the construction sector originating from the nature of this crisis, which had stemmed from no other than the properties market; investments in this sector account for about 6% of the GDP, crumbled 14.0%.

In addition to the brutal inventory cycle and destocking that rattled across the industries, sectors contracted severely in the first quarter and intensified the pace of the recession, as demand halted and jobless rates began to rise! Meanwhile, the services sector contracted by 1.6% in the first three months of the year, to continue the degradation process that had started in May 2008. The industrial sector also extended the slump, which started on June 2008, where the construction sector contracted by 6.9% in the first quarter. 

In the first three black months of 2009, government spending declined to 0.2% from 1.1% in the last quarter of 2008, especially after the government's tax receipts slumped on the back of halted economic activity across the nations.

As for household spending it declined to its lowest since 1980, where infamous spend-thrifty Britons were incapable of enjoying their shopping sprees anymore; household spending fell 1.3% along with deteriorating confidence, crashing market, and diminishing wealth along with freefalling home values all toxically coated with the crumbling labor market! Companies suffering liquidity shortages and contracting demands resulted to massive layoffs to cut their expenses to stay afloat, which was only additional downside pressure on the already weak economy.   

By the end of the first quarter, the jobless rate surged to 7.1% its highest since 1981, as 2.2 million Britons were sitting now on the sidelines and searching for jobs in a non-hiring economy! The slack in the economy and labor market, pressured waves lower to contract by 0.4%, but with the lack of income families have started to dig into their savings, therefore also causing it to declined, combined with all the these factors pressured demand heading south, dragged general price levels down with it! 

Inflation has indeed started to retreat, sparking fears of deflation which ironically followed the peak hit in September, when annual CPI hit 5.2%, where by March inflation was back to 2.9% and from there the door was open for the general downside spiral, especially after oil ranged $40 a barrel! The threat of deflation was persistent and evident in recessionary conditions, especially if we look at the wider gauge; the previous benchmark for inflation in UK , the RPI, fell by 0.4% setting its first drop on records since 1960 sparking danger on the way!!!

The downside spiral in prices was supported by a number of factors, and oil was not the only reason, where food prices also dropped and demand stood at a standstill, pushing spare capacity pressured prices lower. In addition to that, the VAT reduction continued to take course after it was cut in December 2008 to only end in December this year in means to support the battered economy.

The global economy was in ruins in the beginning of 2009, after the intensification of the crisis in the latter half of the previous year exhausted the economy that fell in recession. The British economy was not alone in its recession, but in tandem with its counterparts and suffered the blues of contracting demand not just domestically but foreign demand as well. Export orders slumped for the UK and affected the trade balance, which suffered from falling exports, slightly balanced by the drop of imports which was not a pretty sight either!

Exports contracted by 6.9% in this quarter, deepening the fall from a 4.1% decline in the last quarter of 2008. Global demand continued to decline for British goods at the time global unemployment rates were soaring and investments were dwindling. Demand declined on capital and consumption goods, amid dried liquidity and lack of confidence in the global economic order. 

The decline in sterling's effective exchange rate in that period did little to help exports amid the dearth in global demand, even with the weak domestic demand pressuring imports to drop by 6.7% on the quarter and did not help much in sustaining prices from falling, as domestic demand was still frail. 

Those facts contributed in pushing the economy to contract deeply in the first quarter, which some described as the nation falling back half a century; where the GDP contracted by 2.4%, the worst since 1958. The economy started its year off with hazardous performance mirroring the inheritance of 2008, which ended with 1.9% contraction in the last three months.

The BoE resorts to unorthodox measures to halt the economic hemorrhaging

As the economy sinks into the depth of the dark recessionary seas, the Bank of England stepped up the efforts to salvage the economy throwing in one straw after another, although will all efforts the economy continued to drown. The BoE started their aggressive monetary easing since October 2008, implementing a series of rate cuts which totaled to 4.50%, till rates reached near zero at 0.5% in March 2009, which was the lowest in the Banks prestigious history and since its establishment in 1694! 

The BoE has taken rates to their bottom and had no more room to maneuver the worsening economic conditions with rates, which barely managed to unclog dried markets or even steer the dead economy. The financial sector continued to hoard cash and liquidity was still short, as businesses and households still could not attain loans since banks were reluctant to lend.

The only way out was unorthodox! The bank resorted to unprecedented measures and stepped in to support the market with liquidity in an unprecedented step that had not been seen in fifty years. They followed the lead of their American counterpart in applying quantitative easing measures to stimulate the economy with the supply of liquidity, and also acted against rising threats of deflation, initiating what they called the Asset Purchase Facility "APF". 

Under this facility, the bank was granted the authority to access primary and secondary markets to purchase securities and primarily gilts to increase liquidity, in addition to also fight deflation threats. The facility was aimed at lowering market rates as well and bringing down yields, which will help in stimulating lending and investments once again as well as help strengthen confidence with the BoE as a partner.

The program was initiated with 75 billion pounds under the capacity, where the Treasury allowed the BoE to print 150 billion pounds worth of bank notes; yet the BoE favored pumping the money in cycles in the economy.

The government continued to do its part in hopes to sustain the degradation of confidence; their bailouts continued and the nationalization of Northern Rock was followed by acquiring a share in Royal Bank of Scotland and Lloyds Banking Group. Adding to that, Gordon Brown's government agreed to guarantee some of the toxic assets with banks totaling 585.0 billion pounds, to unburden their balance sheets and ease the run on cash that crippled them, in exchange for their part to extend lending to the economy to help find a bottom to the slump.  

The measures taken by the BoE and the government helped in establishing a streak of hope and aided the rebirth of confidence, where financial markets started to shake off the panic attack; as FTSE 100 did find its bottom in that quarter. The bottom was hit at 3440.00 down by almost 17% in that period extending the 32% drop of 2008. The case was the same for sterling, which hit the year's low against greenback nearly around $1.35 almost 36% down from the records of 2007! 

From April to September: The Gradual Bottoming

As the year progressed, the Bank of England continued to extend its support for the economy in the second and third quarters, where conditions continued to be rough and accessibility to loans was still ridged for businesses and consumers. Therefore, the bank decided to expand its APF program by an additional 50 billion pounds in May and another 50 billion in August; totaling 175 billion pounds. The bank held the rate steady at its historic low of 0.50%. The BoE opt to extend the support for the economy and fight the recession better than doing little, which will have worse outcome over the long run. 

The result was evident, and measures applied have started to work their way into the economy, as the pace of the contraction eased and the financial sector started to lean and respond to the entire stimulus and liquidity measures provided, while money market rates dropped strongly. The economy contracted by 0.6% in the second quarter and 0.2% in the third quarter which was considered a milestone compared to the contraction in the first quarter. Nevertheless, the economy remained in its recession contracting for six consecutive quarters, recording the worst performance since 1955.

This gradual improvement was a reflection to the bottom hit and the start of recovery to major moving sectors in the economy. After the strong destocking and the inventory cycle took its harsh turn, sectors started to stabilize where the Industrial and services sector each contracted by 0.1% in the third quarter after 0.6% contraction in the first half of the year.

Household consumption also managed to find support as the year progressed and the recession eased and their access to liquidity started to improve, alongside the improvement eyed in the housing market, which slowed the degradation to their personal wealth. Household spending contracted by 0.6% in the second quarter and then reversed to expand by 0.1% in the three months running into September. Government spending on the other hand managed to support the economy in the second quarter by expanding 0.6% and then eased to 0.3% in the third quarter.

International trade on the other hand provided support to the economy as exports started to gradually improve, yet remain subdued as global demand is still fragile. Sterling 's weakness helped slightly as well; after exports and imports contracted by 1.4% and 2.2% respectively, in the second quarter they managed to rebound in the third quarter as glimpse of recovery started to be seen in UK and in the global economy. In the three months leading to September exports inclined by 0.8% and imports rose by 1.5%, yet all in all they remained frail.

The recession in the labor market added downside pressure upon expenditure in the UK , where the unemployment force inclined by 220 thousand in the second quarter to 2.44 million, the highest since 1995, while the unemployment rate peaked in July at 7.9% the highest since 1996. The pace of layoffs started to ease within the third quarter and the jobless rate slightly retreated to 7.8%, although it still lingers at its highest in thirteen years and risks continue rising.

The rise of spare capacity in the economy, alongside subdued lending and spending keep the lid on price developments in the economy. The BoE's benchmark for inflation annual CPI returned to target and fell below 2.0% target range. By the end of the second quarter in June, inflation was at 1.8% which was the first time since September 2007 where the door was open for further decline; in September it recorded 1.1%, which was the lowest in five years. That increased the pressures on the BoE in fear of falling in a deflationary trap, as rising economic slack continued to offset rising pipeline pressures.

Budget Deficit

The government increased borrowing in an attempt to support its spending and stimulus measures to the economy which was suffering the recessionary blues. The recession did not only hit the private sector and households, it also distressed government finances with the need to increase spending on the back of declining tax receipts and revenue. The 09/10 Budget, presented expanded borrowing by 329.00 billion while they set a ceiling for public debt by 178.0 billion which resembles 12.6% of the GDP according to the PBR, which will be detailed later on! In the first half of the year the deficit compiled to 86.9 billion.

In an attempt to balance its deteriorating finances; the government increased income tax by 5 basis points to 50% on annual income that exceed 150 thousand pounds, effective April 2010; while they also increased taxes on gas, tobacco and alcohol. 

With deteriorating finances and the widening budget deficit, the ability of the British government to borrow is at risk and could be faced with the pressure of higher borrowing as their debt rating is under the scope! Standard & Poor's said downgraded their expectations for the Kingdom's security rating risking their AAA rating, since they pinned them within the same grade down to "negative" from "stable".

Equity markets on the other hand managed to survive the pessimism and started to shake off the effects of the crisis and built the bullish wave with the start of the second quarter. The measures taken and the easing contraction started to provide the market with confidence that the worst might have passed supporting FTSE 100 to rise by 34%, compared to the first quarter and by 48% from the bottom hit early this year, to end that period around 5100.00 levels.

Sterling also started to rise after it was hammered with excessive pessimism and was oversold in the market. Sterling appreciated versus the dollar by 26% from the bottom recorded also in the beginning of 2009 and hit its highest this year at 1.7041.

Quarter Four: Awaiting Growth!

As we ended 2009; the GDP estimates were not yet released for the fourth quarter, yet based on the incoming data for the three months running to December the Royal economy might indeed have started to grow its way out of the recession snapping six consecutive quarters of contraction, and even if it missed expansion it will be contracting at the slowest pace since the start of the recession. 

As for the performance of leading sectors in this quarter, the corner stone for the economy, the services sector continued to expand for the seventh consecutive quarter. According to CIPS PMI; the sector expanded by 56.9 in November and expectations are for the sector to have expanded by 1.0% in this quarter. As for the industrial sector, it is also stabilizing in the last three months of the year, especially as factories are starting to build their inventories after the strong inventory de-leveraging. Meanwhile, global demand started to strengthen gradually and factory orders were rising and that helped in stimulating the sector further.

Meanwhile, the construction sector continued to ease its decline but held on to the contraction which started in March 2008. The sector took a turn since May after seemingly hitting the bottom; and according to the latest November data the sector still holds to the gradually pace of improvement but still needs more time to recover. On the other hand, the housing market started to stabilize, where house prices advanced for the seventh consecutive month in November, yet remain down by 13% from their 2007 peak. Still, the main support for rising house prices is that sellers withdrew their properties from the market shrinking the supply of unsold properties, which managed to ease the freefall. The labor market is still contracting and lending is still dry and though the development was slight and we sensed improvement in approvals yet not that strong demand.

The labor market is a key factor holding back growth, as household income is subdued and spending is accordingly restrained. Unemployment was at 7.9% with the end of October and though the layoffs pace declined to 21 thousand, the lowest since May 2008, yet still the unemployed labor force remains inflated at 2.49 million.

In regards to price stability, commodity and energy prices started to rise with the brighter outlook for the global economy, alongside sterling's weakness it managed to reflect the base effects that supported prices to rise. Annual CPI rose to 1.5% in October and then further to 1.9% in December to linger around the 2.0% target.

In the fourth quarter, the Bank of England took another step to support the economy and further expanded the APF by 25 billion to 200 billion pounds and held rates steady at 0.50%. King left the door open for further increase to be administered, according to the economic need where the bank will assess its facility in February when it comes to end.

As for the governmental support, Alistair Darling committed his support for the economy in his latest Pre-budget Report PBR. He opted to be blamed for extending further measures, rather than doing little for the economy as he held his continued support to the nation on the expense of increased borrowing and a widening deficit. Net debt is expected to reach 56.0% of the GDP during this year and the data in this quarter showed that the deficit continued to rise lingering at its highest since data were collected.

The risk of this ever lasting expansion of the deficit pressed Fitch to say that the UK is not immune from testing the "Aaa" boundaries, although they assured that their debt rating is still stable at the pace of this deterioration in UK 's public finances, might increase the pressures of loosing their top rating!

Despite Darling's enthusiasm and inexorable efforts to continue to support the economy; he maintained his grounds in regards to VAT, which will be reversed back to 17.5% as of the start of 2010 after it was cut in December 2008 to 15% to support the economy.

Britons are waiting for the final figures from this quarter to assure that the economy has found the path to recovery, and what a treat to soar eyes will it be seeing the economy record expansion in the last three months of this year. It will be the perfect closure to such a hectic chapter and Britons can then start 2010, with aspirations of stability to find its way back to the royal economy...

ecpulse.com