UK Risks A Japan-Style Lost Decade

UK Risks A Japan-Style Lost Decade, BoE Will Warn

By Edmund Conway | 10 August 2009

Year zero: the UK risks a 'lost decade' of deflation like Japan, the Bank of England fears
Photo: Reuters

Britain has not yet shaken off the risk of slumping into a Japan-style "lost decade", the Bank of England will this week indicate as it downgrades its growth forecasts, and casts deflation as a significant threat.

The Bank's Governor, Mervyn King, will use Wednesday's Inflation Report to signal that the risk of falling victim to a "debt deflation trap" was one of the primary reasons why the Monetary Policy Committee extended its controversial Quantitative Easing (QE) programme last week. And in a further sign of the fears still surrounding Britain's economy, a prominent expert has said that next year (2010) could be even more painful than 2009 as the UK suffers a second wave of the slump. The news will raise questions over the robustness of the apparent recovery, signalled by the sudden improvement in a wide variety of economic indicators. Sushil Wadhwani, the former MPC member who now runs hedge fund Wadhwani Asset Management, said "the rebound could be snuffed out by a second dip next year".

Mr Wadhwani said that there was growing evidence that the UK is merely tracking the path trodden by the Japanese economy in 1990s, which saw the world's second-biggest economy apparently recover from its initial economic crisis only to become trapped in stagnation for two decades. "The recession is over, in the sense that you will probably now get three to four quarters of a decent bounce— just as Japan did in the early 1990s," he said. "People think things will then return to normal— but these bounces are driven by temporary factors— for instance destocking turning to restocking, or factors like that you go only so long without replacing your car, or by the VAT stimulus.

"The second half of 2010 could be more difficult for the UK than 2009. There will be a big fiscal tightening, the VAT tax cut will have gone; and the world as a whole will be slowing at that point. You will have several things coming together which will dampen the economy." According to The Sunday Telegraph, the Conservatives are already considering plans to raise VAT, which has been temporarily reduced by 2.5% from its 17.5% level, to as high as 20% as part of an emergency Budget likely to follow the next election.

Britain has been warned by Standard & Poor's that it could sacrifice its triple-A credit rating if it does not bring its budget back under control. So, whoever wins the election will have to take a knife to the budget deficit. Mr Wadhwani's warning is likely to be echoed by Mr King this week. The Governor will concede that the worst of the recession is now passed, and that economic output could swing into positive territory towards the end of the year.

He will add that the financial crisis, and the knock-on effects of lending to companies and individuals, means that the 'recovery' will feel almost as painful as the acute phase of the downturn itself. He will refuse to rule out extending the QE scheme beyond even the £175bn level set out by the MPC at its meeting this week. The MPC decision came as a major surprise for markets, which had been largely expecting the Bank to pause the QE programme.

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