Britain ‘to fall into recession’

Many exporters have been hit by the stronger euro

The UK, Germany and Spain will fall into recession in 2008, the European Commission has predicted.

Brussels said the three countries would see two negative quarters of economic growth in a row, which is the technical definition of a recession.

In its latest economic forecast, the commission also downgraded its outlook for eurozone growth again.

It said the 15-nation bloc would now grow by 1.3% this year, against previous projections of 1.7%.

Earlier this month, data showed the region’s economy shrank by 0.2% between April and June – the bloc’s first decline since its creation in 1999.

The contraction was driven by a slowdown in exports and consumer spending.

But high inflation in the region led policy makers at the European Central Bank to keep interest rates at 4.25% at its latest meeting, allowing no relief for the eurozone’s slowing economies.

In its latest report, the commission believed that inflation was now likely to creep up to 3.6% in the eurozone – above its previous predictions of 3.2% and way above the government’s target of 2%.

Gloomy outlook

Shaken by a housing slump and volatile financial markets, the Brussels-based organization predicts that the UK economy, which is not a member of the eurozone, will shrink by an annual rate of 0.2% in each of the next two quarters.

The grim outlook echoes forecasts from the Organization for Economic Cooperation and Development (OECD) out earlier this week, which were even worse.

According to the latest official figures, the UK economy did not grow at all in the second quarter of 2008.

The European Commission said the UK economy would grow by 1.1% in 2008 – much less than the 1.7% previously forecast and a sharp reduction from the official Treasury forecast of 2.5%.

A second quarter of negative growth is also expected in the German and Spanish economies, which are expected to contract by 0.2% and 0.1% respectively.

Stubborn inflation

Economic and Monetary Affairs Commissioner Joaquin Almunia blamed ructions in the financial markets, soaring commodity prices and the housing slump for the gloomy outlook.

“In a context of an unusually high degree of uncertainty, the external headwinds not only had a direct adverse impact on inflation and capital costs, but also an indirect one on confidence,” he said.

Stamping out hopes of an interest rate cut in the near term, Mr Almunia said even if economic activity were to slow further, inflation risks were still “tilted to the upside”.

“The risk of second-round effects can not be excluded, although there is no evidence of any widespread such effects so far.”

US lenders ‘face state takeover’

US mortgage giants Freddie Mac and Fannie Mae are set to be put under government control in an attempt to rescue the firms, media reports say.

Treasury Secretary Henry Paulson will outline government plans at a news conference at 1100 (1600 BST).

The move to shore up the shareholder-owned firms, which hold or guarantee half the US mortgage debt, would be the US’s largest ever financial bail-out.

In July, Congress approved a plan aimed

at offering them more liquidity.

This followed huge losses by the two firms as result of a big increase in defaults and repossessions in the US housing market.

‘Management told’

On Saturday, a senior politician, Barney Frank, chairman of the House Financial Services Committee, said US Treasury Secretary Henry Paulson had told him the government would use its powers to ensure the continued and stable functioning of the companies.

The Washington Post, quoting senior administration sources, said the firms would be put under a legal status known as “conservatorship” which would greatly reduce the value of the two companies’ common stock.

This is an event of profound significance for the global economy BBC Business Editor Robert Peston

Other securities – including company debt and preferred shares – would be guaranteed by the government, the paper added.

The New York Times reported that senior executives at Freddie Mac and Fannie Mae were informed about the plan on Friday.

The Wall Street Journal said it would include changes in the top management.

There would also be quarterly infusions of cash to keep both firms afloat, the papers say. The total cost to taxpayers is not known but could amount to billions of dollars, they add.

The government was being forced to step in because it was dangerous for the US economy for doubts to persist about the two firms’ viability.

Struggling homeowners

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The two contenders for the US presidency, Barack Obama and John McCain, have been briefed on the takeover by Mr Paulson.

“We’ve got to keep people in their homes,” said the Republican candidate, John McCain.

“There’s got to be restructuring, there’s got to be reorganisation, and there’s got to be some confidence that we’ve stopped this downward spiral,” he added, saying that the takeover of Fannie Mae and Freddie Mac must not benefit executives at the two companies.

The Democratic Party candidate, Barack Obama, said any action should be focused “on whether it will strengthen our economy and help struggling homeowners”.

“We must not allow government intervention to protect investors and speculators who relied on the government to reap massive profits,” he said, adding “we must protect taxpayers, not bail out the shareholders and management of Fannie Mae and Freddie Mac”.

Fragile

On Friday, America’s Mortgage Bankers Association reported that at the end of June, about four million homeowners with a mortgage – representing a record 9% – either were behind in their payments or faced repossession.

In the past year, the financial crisis has taken a heavy toll on both Fannie Mae and Freddie Mac.

The country’s two largest buyers and backers of mortgages lost a combined $3.1bn between April and June.

Both companies say they have the resources to weather the losses, but their shares have fallen sharply on fears that they could go bankrupt as borrowers default.

The rescue plan passed by Congress in July gave the US government the authority to buy shares and offer liquidity to companies to keep them afloat.

Many analysts believe their collapse would be a major shock to the already fragile global financial system.

Together, the two firms own or guarantee about $5.3 trillion worth of home loans – about half the outstanding mortgages in the US.

That is about 25 times as big as the obligations of Northern Rock – which was nationalised by the UK government earlier this year, and twice the size of the UK economy.

Global economy woes shake markets

Japanese shares felt the force of the economic uncertainty

Fears about a global economic slowdown, heightened by worsening US job figures, have continued to undermine stock markets around the world.

London’s FTSE 100 index lost 2.3% – taking its weekly decline to 7% – its biggest since July 2002.

Markets in Paris and Frankfurt fell by 2.5% as economy concerns spread.

On Wall Street the Dow Jones index clawed back early losses to edge higher despite figures showing the US economy shed 84,000 jobs last month.

But the benchmark US index still had its worst week since May.

Earlier, Japan’s main share index fell nearly 3% while markets in Hong Kong, China, Australia and India all slid 2%.

‘Ugly’ data

The US labor market figures – which showed the unemployment rate rising to 6.1% – were a further jolt to investors who have had to swallow a slew of poor economic data in recent days.

Economists had been expecting 75,000 jobs to be lost while the government also revised upwards.

“This was an ugly number that pretty much confirms that our economy continues to trend downward,” said Jack Ablin, chief investment officer of Harris Private Bank.

“This just knocks the legs out of any hope of seeing much economic improvement right now.”

‘Uncertainty’

Amid the uncertainty, few investors are willing to buy Masayuki Otani, Securities Japan

The FTSE 100 closed down 2.3% at 5,240.70 points. The last time it lost so much value in a week was more than six years ago in the wake of financial scandals such as Enron and WorldCom.

Markets in Paris and Frankfurt continued their recent downward trend, both the Cac-40 index and the Dax-30 dropping about 2.5%.

The Dow Jones index, which lost 3% on Thursday, rose 32.73 points, or 0.3% to 11,220.96, but still ended down 2.8% on the week.

“Given the fact we were down so much yesterday we’re seeing a bit of a reflex rally with investors wanting to take advantages of some of the bargains,” said Bucky Hellwig, senior vice president at Morgan Asset Management.

The Nasdaq index slipped 3.16 points, or 0.1% to 2,255.88, ending the week 4.7% lower.

Earlier Japan’s benchmark Nikkei index fell 361.54 points to 12,196.12 amid a widespread sell-off of shares in Asia.

The Hang Seng index fell more than 3% in Hong Kong while markets also fell sharply in China, Australia and India.

“Amid the uncertainty, few investors are willing to buy,” said Masayuki, Otani, chief market analyst at Securities Japan.

“Several bad things happened at once,” he added, explaining the fall.

Gloom

Worries about inflation have prevented central banks in Europe from cutting interest rates to help forestall a slowdown.

But analysts believe this could change soon with economic forecasts across Europe looking increasingly gloomy.

The European Central Bank cut its 2009 growth forecast from 1.5% to 1.2% on Thursday while the UK economy stalled in the second quarter.

In a separate development, the Russian rouble fell against the dollar a day after Russia’s central bank intervened to support the currency amid concerns about a flight of foreign capital after the conflict with Georgia.

The central bank sold up to $4bn in reserves, the Financial Times reported, after the rouble slipped to its lowest level since February 2007.

Sterling losses gather momentum

The pound has fallen further against the dollar, hitting its lowest level in almost two years amid fears the UK will fall into recession.

Sterling touched its lowest level since October 2006 at $1.8617 but later edged up to trade at $1.8691.

Measured against a basket of trade-weighted currencies, the pound is now at its weakest level since 1996.

The pound dropped sharply on Wednesday after the Bank of England issued a gloomy assessment of the UK economy.

The fall in sterling will hurt holidaymakers who have benefitted from a strong pound when traveling overseas- and make it more expensive for people to buy second homes abroad.

However, it could help exporters whose goods will be cheaper overseas.

The Bank’s governor Mervyn King said economic growth would be flat for the next year or so and that inflation would rise to 5% or above before falling.

But with domestic demand weak, a revival of exports could help the economy and limit job losses.

Rate cuts

Economists had thought inflation would prevent the Bank of England from cutting rates, but the Bank’s suggestion that inflation will begin to ease raised expectations of interest rate cuts and this hit the pound.

We have long argued that sterling has been significantly overvalued in recent years Jonathan Loynes, Capital Economics

Lower interest rates mean investors get lower returns on sterling deposits, which makes the pound less attractive.

Simon Derrick, currency strategist at Bank of New York Mellon, described the pound’s fall this week a “dramatic collapse” that recalled the aftermath of sterling’s ejection from European Exchange Rate Mechanism (ERM) in 1992.

However, he said the currency’s slide should begin to ease.

“Even within the most ferocious sterling downtrends in the past, significant corrections emerged in the middle of the moves,” he said.

But Jonathan Loynes, chief European economist at Capital Economics, thinks the pound could fall as far as $1.65 by the end of 2009.

“We have long argued that sterling has been significantly overvalued in recent years,” he said.

Deteriorating outlooks

Recent official figures have already shown the UK is struggling with high inflation and faltering growth.

Fears about European growth have also helped the dollar bounce back from record lows.

The US economy is still reeling from the credit crisis but analysts say the deteriorating outlook elsewhere in the world has given the dollar a boost.

Falling commodity prices have also supported the US currency. Investors had bought gold and oil to protect against dollar weakness and are now unwinding their positions.

The euro was trading at $1.4816 on Thursday, almost at the six-month low of $1.4815 struck this week. Earlier this year, the euro was trading at $1.60.

The euro has been further undermined by the military conflict in Georgia.