Cablegate: Economists Warn Uk's Economic Recovery Is Fragile

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UNCLAS SECTION 01 OF 02 LONDON 002237

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TAGS: ECON EFIN ETRD EINV UK
SUBJECT: Economists Warn UK's Economic Recovery Is Fragile

LONDON 00002237 001.2 OF 002

1. (SBU) Summary: Economists at a Business for New Europe seminar (September 25) said the UK is recovering economically but warned about a false euphoria. Panelists were concerned that a premature tightening of monetary policy would harm the recovery. Banks are still not lending to small businesses and government efforts to promote lending are insufficient. They agreed the next government will need to tackle the sizeable deficit and expected the Conservative Party - if elected - to quickly implement spending cuts and higher taxes. They warned against protectionism and stressed the importance of completing the Doha trade round. End summary.

UK Economy Recovering - But Potential For False Dawn -------------------------- -------------------------

2. (SBU) It would be a huge mistake to assume the UK economy had returned to "business as usual," according to Roland Rudd, Chairman of Business for New Europe, at a panel discussion on the role of the G20 in rebuilding the global economy. Rudd warned that the recent improvement in the UK stock market was not an indicator of economic recovery, since equity markets tend to recover up to twelve months ahead of the broader economy. His comments were echoed by Financial Times Editor Lionel Barber who said there is a false sense of euphoria. Barber said the markets are "frothy" and valuations seem too high, perhaps because of the extraordinary monetary and fiscal stimulus packages. He said there is still considerable risk in the market. While banks are lending to blue-chip companies, small companies are still struggling to access funds because banks are under tremendous pressure to recapitalize. He said HMG's efforts to stimulate bank lending have proved insufficient and a lack of lending will remain an obstacle to recovery.

Premature Tightening of Monetary Policy Will Damage Fragile Recovery ------------------------- ---------------------------------

3. (SBU) The Bank of England's quantitative easing (QE) program has been "keeping the system afloat," according to FT Editor Barber, who warned that prematurely reducing the support or tightening monetary policy could damage the UK's fragile recovery. He expected the Bank to start reducing its position in early 2010. Gerard Lyons, chief economist at Standard Chartered Bank, noted that while it is important to have an exit strategy, it should not be focused on a particular date but instead should revolve around conditions that must be met before the QE program ends.

Next Government Will Need to Tackle Sizeable Deficit with "Serious Tax Rises" -------------------------- ------------------------------

4. (SBU) Tackling the UK's sizeable budget deficit will be a priority for the next government and will involve delicate decisions about what taxes to raise, according to Barber. However, he commented that this requires coordinated global action, not isolated decisions by the UK government. He said the Conservative Party is doing some "serious thinking" about a comprehensive spending cut and tax package that would be introduced quickly if the Conservatives win the next election. He said the Tories are conscious that then-Prime Minister Margaret Thatcher did not act quickly enough to address economic problems under her Government. The Tories under David Cameron are keen to avoid the same mistake. Barber noted that it is "extraordinary" that the Tories have pushed the government into talking about spending cuts, when previously the Prime Minister had been keen to focus solely on investment.

Concern Over Protectionism --------------------------

5. (SBU) Standard Chartered's Lyons said there is a danger that while leaders talked globally in Pittsburgh, they will act nationally with protectionist measures. Helen Alexander, President of the Confederation of British Industry (CBI), commented that the protectionist urge needs to be curbed, particularly in the United States. She said the CBI places great importance on the completion of the Doha trade round. Barber warned that protectionist measures would be particularly damaging to developing countries. He said such measures could result in a number of failed states, causing great instability.

Lack of Implementation May Impede G20's Effectiveness --------------------------- --------------------------

6. (SBU) All panelists agreed the G8 grouping is moribund and the G20 will remain the primary global policy forum in the near term, with the G2 (U.S. and China) being the key decision-makers. There is increasing pressure to rebalance the G20, with European countries taking a lesser role, according to Barber. Lyons noted that if Europe loses seats in the G20, the seats would have to be filled by proactive players if the G20 is to remain effective. He added that, LONDON 00002237 002.2 OF 002 in the medium term, Asian members might decide the G20 is too big, although he doubted China would care about the size of the grouping as long as it does not threaten its permanent position on the UN Security Council.

7. (SBU) Alexander said the G20 is "broadly relevant" from a business perspective, but "only up to a point." She said its lack of an enforcement mechanism will impede its effectiveness. Deliverable action from the G20 is too heavily dependent on national policy decisions. Lyons, however, thought the G20 will be very relevant in forming the new financial architecture. He said leaders should be wary of rushing from too little regulation to too much regulation. Doing too much, too quickly could harm the global economic recovery. SUSMAN

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