Economic contraction to accelerate in 2009

Interest rates to fall to 3.5 per cent by Christmas

The steepest plunge in business confidence on record means economic contraction in the UK is likely to accelerate in 2009, according to the latest UK and Euro Area Business Trends report from accountants and business advisers BDO LLP.  As a result, the Bank of England could slash one per cent off interest rates by Christmas and rates could even fall to two per cent by the end of 2009, the lowest for 70 years.

UK businesses predict contraction will accelerate over next two quarters

The report’s Output Index, which measures UK business confidence one quarter ahead, dropped to 94.3 in October from 97.2 in July. In addition, the report’s Optimism Index, which measures confidence two quarters ahead plunged from 100.0 in July to 94.1 in October, the steepest fall on record. This implies businesses expect economic contraction not only to continue in the final quarter of 2008 but also to accelerate in the first quarter of 2009. This suggests decisive action is now needed by the Bank of England to cut rates to 3.5% before Christmas.

More optimistic outlook for euro area businesses

In contrast to the continued contraction that is expected by UK businesses, Euro Area businesses are more optimistic for a much quicker return to growth. The Euro Area Optimism Index suggests the Euro economy will expand by 0.2 per cent in the first quarter of 2009; a marked difference to the more prolonged period of recession expected by the UK.

However, UK-style plunges in business confidence could soon be seen in the Euro Area. UK businesses had been lulled into a false sense of security by the ‘nice’ decade and consistently expected things “to get better soon” until a recent rude awakening. Confidence levels in the euro area could soon follow suit.

Peter Hemington, Partner at BDO, says: “The steep fall in confidence means that dramatic rate cuts are now necessary. It won’t be a surprise if base rates are as low as two per cent by Christmas next year. October’s rate cut has been a welcome relief for many homeowners and following Mervyn King’s speech last week, the indications are that the Bank has accepted the need to loosen monetary policy considerably.”

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For more information, please contact Kara Hill at Blue Rubicon on 020 7260 2700, or Stephanie Aneto at BDO on 0207 893 3073.

Notes to editors:

1. The BDO Business Trends Report Indices are calculated by taking a weighted average of the results of all the UK’s main business surveys carried out during the last month.

2. Methodological notes:

The BDO Monthly Business Trends Indices are prepared on behalf of BDO by the centre for economics and business research (cebr).

Taken together the surveys cover over 11,000 different respondents from companies employing approximately five million employees. The respondents cover a range of different industries and a range of different business functions. Together they make up the most representative measure of business trends available.

The surveys are weighted together by a three-stage process. First, the results of each individual survey are correlated against the relevant economic cycles for manufacturing and services. This determines the extent of the correlations between each set of survey results and the relevant timing relationships. Then the surveys are weighted together based on their scaling, on the extent of these correlations and the timing of their relationships with the relevant reference cycles. Finally, the weighted total is scaled into an index with 100 as the mean, the average of the past two cyclical peaks as 110 and the average of the past two cyclical troughs as 90.

The results can not only be used as indicators of turning points in the economy but also, because of their method of construction, be seen as leading indicators of the rates of inflation and growth.

3. BDO is the UK member firm of BDO International, the world’s fifth largest accountancy network, with more than 600 offices in over 100 countries. 

BDO LLP and BDO - Belfast are both authorised and regulated by the Financial Services Authority to conduct investment business.

BDO is an award winning firm.  Recent achievements include:

• Sunday Times Top 100 Companies to Work for 2006
• Accountancy Age Global Firm of the Year 2006
• Accountancy Age Large Firm of the Year 2005
• Accountancy Age Employer of the Year 2004 and 2005

4. cebr is an independent economics and business research consultancy established in 1993 and provides macroeconomic forecasts and advice to City institutions, government departments, local authorities and numerous blue chip companies throughout Europe.