But now the idea that the good times are over is going mainstream: not only is the “nice” decade – Non Inflationary Consistently Expansionary – ending, but the “nasty” one could well be starting, says analyst Tim Bond of Barclays Capital.

But what does that really mean? And how will Britain be dragged down into another recession?

Over to the strategy team at Legal and General. They’ve charted a ‘heat map’ of factors that could push us over the cliff edge. And it’s enough to get anyone steamed up…

…Legal and General’s SatNav is now on red alert. According the them there’s now a 95% chance that Britain is heading for recession!

While you’ll find plenty of commentators who will happily chat in gloomy terms about all sorts of possible problems, and then make a comparison with some point in history, Legal & General has taken the analysis a stage further.

Having totted up all the potential perils facing UK plc, the L&G team then rated each risk on a scale between ‘Good’ to ‘Danger’. Everything in the latter category, you won’t be surprised to hear, is coloured bright red on the heat map.

Why the likelihood of a recession is so high

So after examining sky-high personal debt levels, soaring oil prices, crimped bank lending and tension in the money markets, as well as a few other areas of possible pain, the strategists reckon that the odds of Britain suffering a recession are now about 95%. And what raises the stakes so high is the likelihood that everything will go wrong at exactly the same time. Which also makes it a racing certainty that the recession will prove to be just as bad as both the early 1990s and early 1980s.

How long will it last? The official description of recession by economists is “two quarters of negative growth” (only economists could actually talk about minus numbers as negative growth).

The Legal eagles have been pretty downbeat for some while, but until now have been telling us to expect perhaps two years of the economy going nowhere.

But recently the L&G ‘recession model’ has taken a real turn for the worse, and is now warning of a long decline in economic activity, by as much as 2% year-on-year. That may not sound huge, but if it happens, life could get very unpleasant and we’ll all feel the squeeze.

Cheap Asian imports are getting more expensive

Already there’s lots of talk about the dangers of Asian inflation and what this means for us here in the UK. Instead of picking up all those nice cheap Far East-made goods on our credit cards, we’ll soon find that the prices have gone up quite a lot (see this week’s Moneyweek for more on this).

But in future, the Legal analysts suggest that little luxuries will soon be off the menu anyway. If we do have a little leeway before hitting our credit limits, we could soon need it, plus any spare cash we can lay our hands on, just to pay the petrol bill to get to the supermarket.

Spending in the shops will suffer, profits in consumer businesses will slump and jobs will get cut. Meanwhile, the housing market will get much worse as mortgage problems mount. The Council of Mortgage Lenders now sees house prices dropping 7% this year, with transactions down by over a third on last year.

And banks will become less and less willing to lend money to all those people who’ll need it more and more. Don’t believe we can’t have a recession at this level of interest rates. If the banks close the loan shutters, we can.

Why the Bank of England is a lot gloomier than the Government

It seems the Bank of England is finally catching on, too. Today’s FT reports that the Threadneedle Street thinkers are now a lot more gloomy than official Government forecasts. Indeed, the Bank now believes that “a long period of weakness” is needed to bring inflation under the thumb, as I talk about below.

What’s more, the Government, i.e. taxpayers like you and me, won’t be able to do much about helping out, now that Gordon Brown has broken his Golden Rule by reeling in Northern Wreck.

UK public debts have now smashed through the government’s official ceiling of 40%, preliminary figures suggest, reaching 43.1% of gross domestic product (GDP) in March. And although Chancellor Alistair Darling has said that any impact on the public finances by nationalising Northern Rock would be “temporary and exceptional”, just remember Milton Friedman’s comment that “there’s nothing so permanent as a temporary government programme.”

Historically, governments have been able to use our cash to boost the economy. But Howard Archer, chief UK economist at Global Insight, said the government’s aim to keep borrowing down to £43 billion in the current financial year is “wishful thinking” should the economy slow sharply.

And because of inflation, the Bank of England won’t be able to help either. The hands of the rate setters on the Bank’s Monetary Policy Committee (MPC) are well and truly tied by the CPI (consumer price index) hitting 3% and looking like it’s going some way higher, rather than lower.

In short, there should be no more interest rate cuts on the MPC’s agenda for the moment. Not that they were doing much good anyway. What matters most to the majority of homeowners is the level of mortgage rates. These are priced off so-called swap rates, in turn based on LIBOR – the interbank rate at which lenders lend to each other. Libor rates have stayed stubbornly high, the best part of 1% above base rates, despite the MPC’s earlier antics.

This may all sound like a technicality, but it isn’t. What it’s saying is that there’s still a lot of nervousness left in the banking system. Mortgage variable rates won’t fall until the markets regain confidence in the Bank’s bank rate.

So the picture’s looking bleak on all fronts. Recession looms, consumer prices soar, public debt climbs. Not nice at all.

Source: Why There’s a 95% Chance of a Recession

On the credit front, banks around the world may have lost somewhere in the region of a $1trn between them, so something has to give. Namely loans to customers. Whether they be first time buyers trying to get a foot on the housing ladder, a business needing finance or some private equity house putting together a leveraged buyout. Subprime has blown a large hole in the banks, and that means credit rationing for customers.

On the subject of mishaps… The one-time claim of Swiss banking conservatism looks again to be a claim as hollow as their Emmental today as Credit Suisse revealed anything but credit. They notched up a first quarter loss after a $5.2bn write-down.

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The problem is you need to help your old fighter in the blue corner back on his feet, but that is only going to wind up the bruiser in the red corner. That help is principally interest rates. But if you keep cutting them while a loaf of bread is £1.20 and rising and a litre of petrol is £1.09 and rising – £1.12 is anticipated next month – then that escalates the risk of ‘flation going berserk and flattening all in sight.

But if you don’t cut rates to choke inflation you risk a ‘70s style housing crash, says Edmund Conway of The Telegraph. This dilemma is taxing the nine member MPC and has created an unusual split in their thinking. Last time around, the majority voted on a quarter point cut, one voted for a half point cut and two voted to keep on hold.

The good news is Lombard Street Research note is that although food/fuel prices are on the march, this has not yet shown up in higher wage growth. To us, the key caveat there are the two words ‘not yet’. Today there’s a teachers strike today for the first time in 21 years as they bid for an inflation-proofed pay deal. Will more follow their example?

As for the era of cheap food, its return looks unlikely unless there’s a catastrophic reversal of the long-term economic and demographic growth trends in place. Or agricultural production revives once again confounds global warming and the Malthusians. China will one day boast a middle class whose numbers will equal the entire population of the US. Will they want to subsist on a bowl of rice a day?

No. They’ll be wanting hamburgers, pizza, steak and sushi… or the cultural equivalent thereof. The rich world will just have to learn to share with the nouveau riche world and bid more for it. Food rationing in the east. Food rationing in the west. Mighty US retailer Walmart is limiting the purchase of rice, reports Bloomberg, and another US retail giant, Costco, is considering a similar move. Elsewhere, Irish Banana importer Fyffes reports higher import costs are accelerating fruit price inflation.

And then there’s cheap energy… Well, maybe one day we’ll be saved by science, but the quest for an alternative to finite hydrocarbons remains a live one. And until that day comes we’ll continue to be pay close attention to the oil price, now retreated to $117 from its recent relentless march up to $120 high. And on the idea mentioned recently of what price oil has to hit before people start giving up on the car, a reader writes…

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“Oil at 200 bucks within the next five years? Quite probable, but down to 80-85 first as this spike runs out of steam. Overall when peak oil ( maximum daily supply exceeded by minimum daily demand – not the stuff in the ground ) hits us then the price will go as high as it can ($400) before the global transportation infrastructure grinds to a halt and with it the global economic infrastructure . Global warming just doesn’t stand a chance because we won’t see 2100 as a civilised planet.”

*** An item of business news catches the eye this morning…

Britain ’s largest housebuilder, Persimmon plc. reports sales have slipped by 24% this year and warns it faces the worst mortgage market since the ‘70s. News that has had investors running for cover and sent the shares more than 8% lower together with the broader market, down more than 100 points. But what did they expect? If you can’t get a mortgage how can you buy a house even if you’re brave enough to want to. The sector is facing a “triple witching” says Merrill Lynch:

“Worryingly, it is clear that the UK housebuilders are entering a new and potentially volatile period characterised by significantly constrained mortgage availability, buyers deferring purchases in anticipation of price falls, and, most recently, their growing concerns about employment security.”

One of the potential market movers this week – for both
the UK stock market and the forex markets – is the Bank
of England rate decision tomorrow.

My learned colleague, Ben Traynor, picked up on this in
today’s Fleet Street Daily e-letter…

—————————
Will there be a cut at all?
—————————

“The doves are out in force. The Bank of England’s
Monetary Policy Committee (MPC) meets tomorrow, and an
interest rate cut is most definitely on the agenda.

“Pretty much everyone, from homeowners to the
Confederation of British Industry (CBI) wants rates to
come down… the market has priced in a quarter-point
cut… and what’s this? Gordon Brown – the same Gordon
Brown who, as chancellor, granted the Bank operational
independence in 1997 – is also sticking his beak in.

“If you look at this situation, because we’ve got low
inflation we can cut interest rates,” the prime
minister said.

“Hang on, Gordon. Isn’t the MPC is supposed to set
rates independent of political considerations? Naughty,
naughty Mr Brown…

“In fact, there’s some speculation that Brown’s
comments may have angered the MPC hawks, who’ll now
argue more fervently to keep rates on hold. I’ve said
before I’ve got this hunch the MPC might take the
chance to wrong foot the market and boost its
credibility. Now that Brown’s lumbered into the debate,
might that now prove too tempting a proposition?”

Ben follows the UK economy closely for his readers and
tries to piece together events as they unfold,
examining how they affect the big picture… and what
it all means for investors.

Each working day he writes a round-up of the big events
that are moving the financial world – to keep his
readers one step ahead of the crowd. If you have a
second, sign up to Ben’s free Fleet Street Daily email:

http://signup.fspinvest.co.uk/LF/fsd.html?newsourcecode2=XFSDD304

————————————-

Looks like a half-point cut is out…
————————————-

Ben’s right about most people calling for a quarter-
point cut. In fact, 81% of economists surveyed by
Bloomberg have predicted a 25 basis point cut in UK
base rates when the Bank of England announces its
decision on Thursday at noon.

And whilst there may have been an outside chance of a
50-point cut – given the volume of bad news coming out
about the UK economy and the latest housing market data
– this morning’s better than expected UK manufacturing
output data should put paid to such drastic measures.
Personally, I doubt it’s strong enough to keep the Bank
from a quarter-point, though.

And with the European Central Bank likely to keep their
rates on hold, once the UK rate cut is announced, we
could see further pressure on the pound which is
hitting all-time lows against the euro on the back of
all that bad news for house prices and the IMF’s latest
UK growth forecasts.

And if we get anything totally unexpected tomorrow,
then watch for the market moves.

————————-
Gold continues to confuse
————————-

Meanwhile, gold’s not done with sending confusing
messages to traders. Anyone who’s been making lots of
money spread betting the shiny yellow stuff all the way
up from $600 or so must be hating all this indecision.
Gold is no longer a one-way ticket…

I’m still in the bullish camp – even if $1,000 seems a
long way off again. We all know just how quickly gold
can move, once the conditions are right. There could be
some more profit taking still to come… but gold will
likely be higher than it is now in six months time.
It’s just a case of waiting for that next leg higher.

Adrian Ash from BullionVault follow’s gold’s moves
daily. If you’re keen on knowing what makes gold move,
he’s a good guy to know about – here are his
observations today:

“Spot gold prices slid into the London opening on
Wednesday, reaching a four-session low of $903.60 per
ounce before bouncing 1.4% to recover the day’s losses
on news that US gasoline prices have reached a new
record high for consumers.

“The average price of regular unleaded has now risen to
$3.343 per gallon according to the AAA survey, almost
20% higher from this time last year.

“International commodity prices meantime reversed an
earlier 0.5% fall, while the US Dollar fell on the
currency markets and Wall Street stocks opened lower
from Tuesday’s close.

“The subprime crisis presents a strong case for gold,”
said Philip Klapwijk, head of the GFMS consultancy, at
the launch of the group’s Gold Survey 2008 today
in London.

“Pointing to growing risk aversion amongst investors,
negative real rates of interest on the US Dollar, and
sharply falling earnings from S&P equities, Klapwijk
also noted a hitherto overlooked threat – a “sharp
deterioration” in the United States’ fiscal position as
a result of “the Federal Reserve’s largesse” in bailing
out Wall Street banks.

“We’ve been told by pension and other institutional
investors that they’ve been looking at gold for a long
time,” Klapwijk said.

“Now they’ve taken a position – or they’re just about
to – they say they won’t be distracted by short-term
moves in the price.”

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————————————————-
Will margin calls lead the property market lower?
————————————————-

The key to the property market – and whether this
latest headline-grabbing 2.5% fall statistic has more
serious implications – looks to be buy-to-let
investors, specifically the ones who stumbled into it
late, when the party was in full swing. I’m talking
about all those people who got sucked in over the past
two or three years by the “Become an armchair property
millionaire!” newspaper ads for property seminars
promising spectacular gains.

A rush to the exits by these “greater fools” as they
start receiving margin calls from their buy-to-let
mortgage lenders and we’ll start seeing a new surge of
supply in the market and lower or at least
stagnating prices.

Wow! Look at the oil price! $111 a barrel – more on
this and how to play it as we work it out…

That’s all for today.

Until Friday…

Best regards,

Frank Hemsley
Profit Watch

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