The U.K. Economy: Look Out Below!

09:20:00, August 29, 2008

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The fallout in the U.K. housing market is gaining momentum and will deliver dramatic knock-on effects for the aggregate economy. The BoE will be forced to respond aggressively.

Our U.K. housing model has been predicting double-digit price declines for some time. Alarmingly, the housing market appears to be slipping even faster than the model predicted. Yesterday's release showed that nationwide house prices plunged in August to -10.5% YoY (from -8.1% in July). Still, U.K. housing remains extremely overvalued and none of the leading real estate indicators suggest that the market is likely to find support in the coming months. In turn, the negative wealth effects will continue to mount, keeping the consumer depressed and hesitant to spend. The poor consumer outlook is highlighted by the dismal CBI retail survey for September. The financial sector will also remain under pressure as banks face a second bust in the commercial real estate market. Bottom line: The BoE will need to respond by aggressively lowering interest rates (beginning before yearend) in order to limit the fallout in the overall economy. Stay bearish the pound and overweight gilts within a global hedged fixed income portfolio.