Don't let a double dip get you down

Spending cuts could well push Britain back into recession next year. Rob Griffin has some tips on how to cope

Some leading economists are warning that the UK is in danger of sliding back into recession next year due to a potentially fatal combination of damaging government cuts and anaemic private sector growth.

They believe the much-feared double dip is more likely to become a reality the longer that the property market remains mired in misery, industries are affected by budget constraints, and the jobs market remains under pressure.

James Carrick, economist at Legal & General Investment Management, believes there is a one in three chance of the country going into recession, and warns that the current recovery is not strong enough to cope with a rapid removal of its stabilisers.

"I am concerned about the swingeing cuts to come – probably the biggest since the Second World War – and the fact that we need the biggest ever private-sector boom to offset it," he says. "I am struggling to see where this is going to come from."

The two most recent such booms, in the late 1980s and 1990s, were both accompanied by more agreeable economic conditions, he points out, whereas we are now getting negative news such as mortgage approvals falling again.

"Previously you have had either an equity market or property market boom and there was lots of household spending and corporate investing," he adds. "However, I cannot see that happening in the UK over the next couple of years."

Stuart Thomson, chief economist at Ignis Asset Management, also believes that growth will turn negative in the first quarter of 2011, and warns that the problem could deteriorate rapidly unless the Government revisits its policy of quantitative easing.

"Consumers are going to have a very tough time next year because they are being squeezed by the effects of higher inflation, higher taxation and subdued wage growth," he says. "If the Bank doesn't step in we'll have a full-blown recession."

But what would another recession actually mean? How would we be affected by another slump so soon after the last one, and is there anything we can do now to help protect finances and longer-term investments?

According to Justin Modray, founder of the website Candid Money, the overwhelming concern people have when the possibility of a recession is looming large on the horizon is protecting their income.

"The biggest fear is that they will lose their job or suffer a pay cut," he says. "Pay rises are also likely to be far harder to negotiate, as there is greater competition for jobs during a recession."

General finances

Top of the list is getting a handle on your debts – and then you can make sure you are invested in a way you feel comfortable, according to Julian Chillingworth, chief investment officer at Rathbone Unit Trust Management. "In these sorts of difficult times – which are not going to ease imminently – you need to make sure you have your personal debts under control, and if possible, get your mortgage down as well," he says. "The advice is always to pay off the highest credit cards and loans first so that you are not paying too much interest."

Geoff Penrice, an independent financial adviser with Honister Partners, agrees and suggests people should consider putting a financial safety net in place, especially if they have some available cash at the moment. "There is definitely the risk of a double-dip recession if there is not a large enough pick-up in private-sector activity to offset the jobs lost through public-sector cuts, so it is a good idea to have a contingency plan should redundancy strike," he says. "I would normally encourage people to have three months' salary set aside which will help tide them over while they find alternative work."

If redundancy is a real concern you could insure against it, points out Justin Modray at Candid Money. "Cover is usually limited to involuntary redundancy and payouts rarely last beyond 12 months, but it could prove worthwhile short-term if it will give you peace of mind. Cover is usually limited to £1,500 per month, with £1,000 of cover typically costing around £30 per month."

Investments

The fact is that no one knows for sure what the next year will bring, which is why individuals must retain as much flexibility as possible, points out Andrew Merricks, head of research at Skerritt Consultants.

"If we go into recession you will want exposure to high-quality corporate or government bonds," he adds. "However, the risk is if it does not become a recession and the markets rally as you will end up being in the wrong place at the wrong time."

Those who fear the prospect of a recession should consider global equity income funds – which have a broader exposure than just the UK market – as well as high-yielding, defensive stocks that will be able to continue paying dividends.

However, it is vitally important that people are not persuaded to pin all their hopes on one outcome. "You need to keep your options open instead of tying your money up and be prepared to move it should the need arise," he adds.

Patrick Connolly, head of communications at AWD Chase de Vere, believes it is best for investors to adopt a diversified approach as it is expected that world economies will recover over the medium to long-term.

"They should hold growth investments such as shares and property, which should do well when economies recover, but alongside these hold fixed interest and cash which will provide protection should we fall back into recession," he explains.

Housing market

Those looking to buy a house may be advised to sit tight – and if they find a property of their dreams to bargain hard as this is certainly not a seller's market by any stretch of the imagination.

UK house prices have fallen by 3.4 per cent in the last three months – halfway towards wiping out the gains made in the first half of the year, according to research from the property website Rightmove. Its latest monthly report found that new sellers dropped average asking prices by 1.1 per cent (£2,474), while the number of new properties coming on to the market is just 26,000 – the lowest since April.

According to Miles Shipside, director of Rightmove, there is plenty of evidence to back up those who are feeling downbeat about the market, and properties need to be spruced up and priced competitive to sell. "They can cite tough competition amongst sellers and agents struggling to find buyers for their record levels of unsold stock," he says.

Further gloomy news came this week from the Council of Mortgage Lenders (CML), which revealed that gross mortgage lending declined to an estimated £11.4bn in August, down 14 per cent from £13.3bn in July and 6 per cent from £12.1bn in August 2009. This is the lowest August total since 2000 (£11.1bn).

Lending volumes are likely to remain below last year's level in the coming months as activity was buoyed by the upcoming end of the stamp duty holiday in the last few months of 2009.

Bob Pannell, the CML's chief economist, believes that the outlook is challenging. "We face the prospect of a difficult second half of the year," he says. "However, the Bank of England is likely to keep interest rates at record lows for longer to support the economy. This will continue to alleviate payment pressures for many borrowers."

On the high street

Food inflation has already increased to 3.8 per cent in August from 2.5 per cent the previous month – the highest it has been since July 2009, when the level was 3.8 per cent, according to the British Retail Consortium (BRC).

Stephen Robertson, the BRC's director general, concedes that food inflation is at a 13-month high, but says the country is nowhere near seeing the return of the double-digit inflation of two years ago, and insists that a third of groceries are now on promotion.

"Past rises in the cost of global commodities, such as wheat and sugar, are filtering through to food prices," he says. "In response, retailers are offering more deals. Milk and bread are particularly competitive battlegrounds."

There is also one potential upside of a recessionary environment, as long as you keep your job and don't suffer any major cuts to your monthly pay packet, according to Justin Modray of Candid Money. "Your monthly income might stretch further because retailers are likely to cut prices in the face of falling sales," he says. "This means there will be a greater opportunity to grab discounts and bargains."

Therefore consider holding off big-ticket purchases, and if you do want to buy, make sure you shop around and get the best deal you can.

Conclusion

So where does that leave us? It all depends on what happens to the economic outlook over the next few months and how the Government chooses to respond, according to Stuart Thomson at Ignis Asset Management. "Mervyn King coined the phrase 'the nice decade' in 2003 and declared it over three years later," he says. "We think the new decade is VILE – volatile, inflation, less expansion, so from a consumer's perspective these are not comfortable times."