Worsening expectations in the United Kingdom

The worsening economic environment is affecting Credito y Caucións forecast for UK corporate insolvencies: from the 5% decrease estimated early this year to a further increase.
Analisis Credito y Caución
Madrid - 31-out-2011

According to the second estimate by the Office of National Statistics [ONS], in Q2 of 2011 GDP grew by only 0.2% on the previous quarter and 0.7% year-on-year. While construction output increased 0.5%, following its 3.4% decrease in Q1, the contraction of production industries accelerated to 1.6% after a 0.1% decrease in the previous quarter. Services maintained 0.5% output growth. Economic performance has barely shown growth since Q3 of 2010, and remains depressed by massive budget cuts and lower household consumption.  Consecuently, Credito y Caucion consensus economics forecast has been revised for United Kingdom downwards to 1.2% in 2011 and 1.8% in 2012, from May forecasts of 1.6% for this year and 2.2% in 2012.

No relaxation of austerity measures

As a consequence of the credit crisis and governmental investment in stimulus measures, the fiscal deficit rose to 10.1% of GDP in 2010 and will stand at 8.5% for 2011, with public debt increasing sharply since 2009: to 65% of GDP. The governments aim is to cut the fiscal deficit to 1.9% of GDP by 2015 to avoid adverse sentiment by international financial markets.

Comprehensive austerity measures and tax rises are designed to save £80 billion and to bring in an additional £30 billion by 2015. In the process, more than 300,000 jobs in the public sector will be lost, but the government believes that a revival in the private sector will create job opportunities to compensate for this. While there is evidence of job creation in the private sector, there is no doubt that the average salary will not be comparable with that of the public sector, and this needs to be taken into consideration when looking at future consumer expenditure trends.

There has been mounting pressure on the government to soften its fiscal tightening, to avoid another recession. Some prominent economists warned that cutting spending may exacerbate the already tense situation by further dampening demand, and that what is needed is a strategy for growth that will reduce the budget deficit while boosting demand. So far, the government has ignored these alternative views and the expectation is that there will be no major change to the current strategy.

Inflation continues to climb

Throughout 2010, consumer price inflation was above 3%, and rose above 4% in 2011, exacerbated by Januarys VAT rise from 17.5% to 20%, which was introduced to help tackle the budget deficit. In August 2011 the consumer price index stood at 4.5%, up from 4.4% in July and 4.2% in June, and remains far above the Bank of Englands target rate of 2%.

That said, the Bank of England is maintaining its benchmark interest rate at 0.5%, keeping in place its monetary policy of low interest rates to help mitigate the effects of fiscal tightening and to avoid stalling the already weak growth. However, with global commodity prices continuing to have an impact, it is difficult for the Bank of England and the government to regain control, and there is the danger that higher price expectations become entrenched. Overall it is expected that inflation will peak at around 5% as early as November, due in part to rising energy costs, but then drop fairly quickly throughout the first half of 2012.

While in May Crédito y Caución forecast that household consumption would increase by 0.5% in 2011 and 1.5% in 2012, forecasts have been revised steeply downwards as far as a 0.4% decline this year, followed by 1.2% growth in 2012.

Manufacturing growth to slow down in 2011

After falling 10.6% in 2009, manufacturing production grew 3.6% year-on-year in 2010. However, industrial production has begun to decrease again: by 0.3% year-on-year in June 2011 and 0.7% in July.

Manufacturing played a pivotal role in the economic rebound in 2010. British manufacturers have profited from a weakening sterling exchange rate and, according to the ONS, the volume of exports of goods [excluding oil and erratic items such as aircraft that may skew the figures] rose 12.0% year-on-year in 2010, while imports increased 12.2%.

However, falling exports - down 1.1% in Q2 on the previous quarter - and export orders are a worry for British manufacturers due to dampened domestic demand. In particular, exports to the US fell by £1.2 billion and the level of trade with China also fell. This is disappointing as a stronger relationship with China could play a pivotal role in the UKs economic revival. In fact, with the slowdown of growth in the Eurozone and the US, it is even more important that the 7% of UK trade currently channelled towards the leading emerging markets [China, India, Brazil, Russia, Mexico, Indonesia, and Turkey] is significantly increased.  Manufacturing production is expected to slow down: to 2.7% in 2011 and 2.4% in 2012.

Insolvencies expected to increase again in 2011

2008 and 2009 saw spectacular year-on-year increases in corporate insolvencies: of 24.2% and 22.8% respectively. While in 2010 insolvencies decreased by 15.9%, this improving trend has not continued.  In Q2 of 2011 the number of insolvencies [compulsory liquidations/creditors voluntary liquidations] in England and Wales increased 4.4% year-on-year and 2.7% on the previous quarter: to 4,233 cases.

Due to the worsening economic environment, Credito y Caución has revised it UK corporate insolvency forecast for 2011: from the 5% decrease estimated early this year to a further increase.

In the domestic market, the governments austerity measures continue to have a negative impact, as is highlighted by the forward order books of many construction companies. Add to this the minimal pay increases and high levels of inflation and it is clear that the UK market is currently a difficult one to be focusing on. Moreover, for those businesses reliant on a buoyant export market there is little good news from either the Eurozone or the US. Latest forecasts for the Eurozone now anticipate minimal if any growth in the second half of 2011. This is clearly bad news for UK businesses that focus on export as a way to achieve growth while sterling remains weak.

Against this backdrop, it is our belief that UK business insolvencies are likely to increase by up to 5% year-on-year in 2011. This increase also takes into consideration the unknown impact of the HMRC [Her Majestys Revenue & Customs] Time to Pay scheme which could potentially lead to a number of insolvencies, as HMRC take a tougher line on those businesses that default on their rearranged tax payments.

With the continuing very difficult trading environment and so many unknowns [e.g. proposals to reform the banks, which could lead to a significant increase in the cost of funding] Crédito y Caucion believes that 2012 UK business insolvencies will remain at 2011 levels, i.e. stabilising at around 5,000 business failures per quarter.

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