Here comes the downturn

The outlook for '98: as the fallout from Asia reaches Britain, 'deflation' will be the word on everyone's lips

It won't be a happy or prosperous New Year for the world's big economies and financial markets. 1998 threatens to be one of the most deflationary years since the 1930s as the fall-out from the ongoing financial turmoil in Asia contaminates the rest of the world. It means prices, interest rates, wages and employment will all fall and the danger of a world recession can not be dismissed.

Financial markets in Asia and the US rallied on Friday on the news the International Monetary Fund and the G7 group of industrialised countries were to rush through $10bn (pounds 5.9bn) emergency aid to South Korea. The rally, already exaggerated because of the thin volume of shares traded, will be short-lived. The evidence shows the worst is far from over.

"The downturn in Western economies could be greater than what most people are forecasting," said George Magnus, chief economist at UBS. Even if the Far East Asian economies manage to keep their heads above a fully- blown recession there is a high risk of a devaluation of the Chinese currency in 1998. That would give a second severe shock to the region," Mr Magnus warned.

Mr Magnus's concerns echo those of the International Monetary Fund, which last week cut its forecast for world growth in 1998 by a staggering 20 per cent, to 3.5 per cent, from 4.3 per cent. The IMF warned that if the downturn in the Japanese economy continues, it may have to slash its estimates for world growth even further. The IMF predicts the Japanese economy will grow by just 1.1 per cent next year, compared to a previous IMF forecast of 2.1 per cent. The performance of the Japanese stock market on Friday, where shares fell 3.25 per cent despite the rally elsewhere in the region, highlights investor concern that the country is not out of the woods.

The New Year will begin with an unprecedented wave of corporate and bank bankruptcies in the Far East, especially South Korea and Japan. The withdrawal of Asian money invested in factories abroad - and the ensuing loss of jobs, such as Samsung Electronics' delay of a $450m factory on Teesside - will be just the start of the chill that seems set to blow from Asia to the West.

Exports to the region from Europe and the US will fall sharply, hitting corporate profits here. The collapse of South Korean and Japanese companies will make banks in the West anxious about their positions there and credit lines to the region's corporations could be pulled. UK banks are owed around $6bn from Korean creditors alone, just a fraction of the debt to American, Japanese and other European banks. In a bid to halt the rot, the Bank of England asked British commercial banks on 24 December to extend the length of their loans to ease South Korea's financial crisis.

"Although we can make reasonable judgments about how trade and gross domestic product will be affected we can't measure the effects of the financial gridlock most of Asia is going through," said Mr Magnus. But the trends are clear; and they are depressing.

Decelerating growth in the UK had already been forecast, with the IMF forecasting this year's current rate of economic expansion of 3.5 per cent to fall to 2.4 per cent. A straw poll of City economists by the Independent on Sunday suggests the rate of growth could be much lower, probably around 1.5 per cent. A handful of the most bearish banks actually suggest a technical recession - when the economy actually shrinks for two consecutive quarters - in the second half of the year. Windfall spending will dry up; higher interest rates will take their toll, and the strong pound will have stifled export growth. Retail sales over the Christmas period already reflect a sharp fall in consumer confidence.

All these factors will accelerate the decline in economic growth. Despite the current tightness of the UK labour market this will inevitably lead to a rise in the number of people looking for jobs.

The majority of City analysts polled expect a small quarter of a per cent rise in the base lending rate in the first quarter, after which the cost of borrowing in the UK will come down again by the end of next year or the beginning of next. However, events in Asia could put pressure on Western central banks, including the Bank of England, to sharply lower interest rates in a desperate bid to absorb the shock from the Far East and reverse the decline in growth. That may force sterling downwards on the international markets although foreign investors could buy UK bonds, seen as a safe haven in an unstable global economy.

As world growth shrinks, European governments will find it hard to stay on course with the budget-deficit cutting measures required by the Maastricht treaty for European monetary union. EU leaders are due to decide which countries have reached the convergence criteria to join the single currency in May 1998. If it becomes apparent that the course to monetary union will be less smooth than currently expected, European financial markets could also be in for a shock. You have been warned.

Start your day with The Independent, sign up for daily news emails
News
Professor David Nutt wants to change the way gravely ill patients are treated in Britain
people Why does a former Government tsar believe that mind-altering drugs have a place on prescription?
News
Norway’s ‘The Nordland Line – Minute by Minute, Season by Season’ continues the trend of slow TV
television The BBC have commissioned a series of programmes doing away with high-production values, commentary, script or drama
Arts and Entertainment
art
Sport
Jonny Evans has pleaded not guilty to an FA charge for spitting at Papiss Cisse
football
Life and Style
Kate Moss will make a cameo appearance in David Walliams' The Boy in the Dress
fashion
News
The image released by the Salvation Army, using 'The Dress'
news
Sport
Liverpool defender Kolo Toure
football Defender could make history in the FA Cup, but African Cup of Nations win means he's already content
ebooks
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Customer Relations Officer

£13000 per annum: Recruitment Genius: This is an exciting opportunity to join ...

Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Jemma Gent: Project Coordinator

£12 - £15 Hourly Rate: Jemma Gent: In this role you will report to the Head of...

Recruitment Genius: Evening Administrator

£8 per hour: Recruitment Genius: This Pension Specialist was established early...

Day In a Page

Homeless Veterans campaign: Donations hit record-breaking £1m target after £300,000 gift from Lloyds Bank

Homeless Veterans campaign

Donations hit record-breaking £1m target after huge gift from Lloyds Bank
Flight MH370 a year on: Lost without a trace – but the search goes on

Lost without a trace

But, a year on, the search continues for Flight MH370
Germany's spymasters left red-faced after thieves break into brand new secret service HQ and steal taps

Germany's spy HQ springs a leak

Thieves break into new €1.5bn complex... to steal taps
International Women's Day 2015: Celebrating the whirlwind wit of Simone de Beauvoir

Whirlwind wit of Simone de Beauvoir

Simone de Beauvoir's seminal feminist polemic, 'The Second Sex', has been published in short-form for International Women's Day
Mark Zuckerberg’s hiring policy might suit him – but it wouldn’t work for me

Mark Zuckerberg’s hiring policy might suit him – but it wouldn’t work for me

Why would I want to employ someone I’d be happy to have as my boss, asks Simon Kelner
Confessions of a planespotter: With three Britons under arrest in the UAE, the perils have never been more apparent

Confessions of a planespotter

With three Britons under arrest in the UAE, the perils have never been more apparent. Sam Masters explains the appeal
Russia's gulag museum 'makes no mention' of Stalin's atrocities

Russia's gulag museum

Ministry of Culture-run site 'makes no mention' of Stalin's atrocities
The big fresh food con: Alarming truth behind the chocolate muffin that won't decay

The big fresh food con

Joanna Blythman reveals the alarming truth behind the chocolate muffin that won't decay
Virginia Ironside was my landlady: What is it like to live with an agony aunt on call 24/7?

Virginia Ironside was my landlady

Tim Willis reveals what it's like to live with an agony aunt on call 24/7
Paris Fashion Week 2015: The wit and wisdom of Manish Arora's exercise in high camp

Paris Fashion Week 2015

The wit and wisdom of Manish Arora's exercise in high camp
8 best workout DVDs

8 best workout DVDs

If your 'New Year new you' regime hasn’t lasted beyond February, why not try working out from home?
Paul Scholes column: I don't believe Jonny Evans was spitting at Papiss Cissé. It was a reflex. But what the Newcastle striker did next was horrible

Paul Scholes column

I don't believe Evans was spitting at Cissé. It was a reflex. But what the Newcastle striker did next was horrible
Miguel Layun interview: From the Azteca to Vicarage Road with a million followers

From the Azteca to Vicarage Road with a million followers

Miguel Layun is a star in Mexico where he was criticised for leaving to join Watford. But he says he sees the bigger picture
Frank Warren column: Amir Khan ready to meet winner of Floyd Mayweather v Manny Pacquiao

Khan ready to meet winner of Mayweather v Pacquiao

The Bolton fighter is unlikely to take on Kell Brook with two superstar opponents on the horizon, says Frank Warren
War with Isis: Iraq's government fights to win back Tikrit from militants - but then what?

Baghdad fights to win back Tikrit from Isis – but then what?

Patrick Cockburn reports from Kirkuk on a conflict which sectarianism has made intractable