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Crisis sinks pound, rattles Britain

(Agencies)
Updated: 2009-01-23 10:57

LONDON – A plunging pound. Surging unemployment. Worries the banking system may collapse and take the country's credit rating with it.

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Fears are growing that Britain's economy is falling off a cliff amid the world financial crisis. Growth figures due Friday could show the country in its worst downturn in nearly 30 years, capping a terrible week that saw unemployment figures surge and mounting talk that the country's debt could face a humiliating downgrade.

Official fourth-quarter 2008 figures are sure to confirm a recession, after the economy shrank 0.6 percent in the third quarter. They could be the worst since a 1.8 percent drop in the second quarter of 1980, when the British economy was mired in a deep recession after the new government of Prime Minister Margaret Thatcher raised interest rates to rein in double-digit inflation.

Analysts said Friday's figures will provide a suitable bookend to a wretched week for the British economy. Unemployment figures Wednesday showed a 6.1 percent jobless rate and 1.92 million out of work, the highest since September 1997.

"In terms of U.K. economic news, this past week takes some beating," said Neil Mackinnon, chief economist at ECU Group.

"There are no green shoots of recovery, no light at the end of the tunnel and the GDP figures will be grim and underscore the depth of the recession," he added.

In significant ways, Britain is paying a higher price than other major European economies France and Germany. They are also seeing painful economic contractions, but Britain has kept its own currency instead of joining the euro, exposing it to the risk of devaluation against its neighbors and major trading partners.

It also indulged in a US-style, credit-fueled real estate boom, which has turned to bust amid sinking house prices. Meanwhile, London, as a financial center rivalling New York, rode higher in the boom years and now has farther to fall.

A major victim has been the pound, which on Wednesday fell to a near 24-year low of $1.3622; as recently as July, it was over $2. Another is the banking sector, which has experienced savage share price declines over the past week.

The most spectacular decline was seen at the Royal Bank of Scotland Group PLC (RBS), which plunged by two-thirds on Monday even though the government unveiled its second bailout of the sector in just over three months in a further attempt to deal with the toxic assets on the banks' balance sheets. Its current share price of just above 10 pence (14 US cents) compares dismally with the 3 pounds plus ($4.20 plus) it was trading at just a year ago.

Many predict the government will step in and fully nationalize the bank soon. As part of the package of measures unveiled on Monday the government said it would be raising its stake in RBS to 70 percent from 58 percent. Many think that the newly-merged Lloyds Banking Group PLC will follow.

If they are nationalized then the state will be fully responsible for the banks' liabilities and that has stoked fears that Britain, the world's fifth largest economy, may see its credit rating downgraded -- as Spain and Greece have recently -- and that the consequent debt payments increase could fuel a self-feeding cycle of economic and financial distress.

"The unpalatable truth that policymakers have to accept is that a depression is not the worst fate that can befall an economy," said Stephen Lewis, chief UK economist at Monument Securities.

"The collapse of the currency and of the nexus of financial claims and liabilities in that economy can be even more destructive of social order and political stability," he added.

So far there hasn't been a downgrade, but Moody's, one of the world's biggest credit ratings agencies, said Thursday that the latest government bailout would not affect Britain's triple A rating -- if the economy rebounds, that is.

Prime Minister Gordon Brown managed a short-lived bounce in the opinion polls after he was seen to be a man of action in dealing with the crisis. But now there are signs that nerves are fraying and the blame game is getting under way.

Business minister Baroness Shriti Vadera was vilified for claiming to have seen the "green shoots" of recovery. Calls have arisen to strip the knighthoods from Sir Fred Goodwin, former chief executive of Royal Bank of Scotland, and Sir Victor Blank, the chairman of Lloyds Banking, as their previously cash-rich companies face the unedifying prospect of being taken over by the taxpayer.

Even the press is in the firing line, with an influential group of British lawmakers revealing Wednesday that they would hold an inquiry into the role of the news media in the banking crisis and whether journalists should be partly gagged in periods of market volatility.

And in European capitals, a beady eye is being kept on Britain. France's finance minister, Christine Lagarde, even laid into the Bank of England for failing to provide enough support for the pound.

But Bank of England governor Mervyn King thinks the fall in the pound is a necessary adjustment for the British economy provided it has not occurred because of a complete lack of confidence in Britain's assets.

"The pound was seriously overvalued in 1997-2007, with Britain at the center of the global financial boom-bubble and now it has burst, the pound needs to be undervalued for a good stretch to adjust the economy," said Charles Dumas, an analyst at Lombard Street Research.