In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, considers the consequences of this summer’s global financial crisis for the UK economy and the world as a whole. His main points are as follows:

• This summer’s global financial crisis is likely to lead to a widespread re-pricing of risk, a general reduction in the appetite for lending and borrowing, lower economic growth, interest rate cuts and a significant fall in the dollar. The end result could be an increase in the political pressure on countries such as China to alter their exchange rate policies. The upshot is that the financial crisis may trigger events that lead to unprecedented changes in the shape and dynamics of the world economy. 
• Although the trigger for the crisis was the emergence of losses in the US sub-prime mortgage market, its origins lie much deeper. Indeed, the seeds of the crisis were sown by two developments that occurred years before, namely the sustained period of ultra-low global interest rates in the early 2000s and the markets’ excessive embrace of risk.
• In recent years, the era of low real interest rates largely reflected the economic policies and the savings behaviour of countries such as China, Russia, the Middle East oil producers and Japan that essentially sucked demand out of the world economy. The rest of the world was faced with little option but to boost domestic demand through low interest rates, which drove returns on conventional instruments down to exceptionally low levels.
• At the same time, the financial community persuaded itself that the world was less risky than it had been, and that financial innovation enabled the little risk that remained to be borne more easily as it was sliced and diced and distributed widely throughout the global financial system.
• Accordingly, one of the legacies of this summer’s crisis will be a necessary and long-overdue re-pricing of risk that results in future financial valuations being more closely aligned to economic reality. In other words, the heady-returns generated by some asset classes in recent years may be a lot harder to find in the years to come, even if the world economy were to remain strong.
• The crisis is also likely to usher in a more stringent regulatory regime. The crisis highlighted the fact that governments cannot afford to let the public lose their bank deposits. There is a clear incentive, then, for governments to take a more active role in the regulation of the other side of banks’ balance sheets, namely their assets.
• The more immediate impact of the crisis, though, will be to reduce economic growth across the globe and, accordingly, interest rates. The US economy will be the hardest hit, with GDP growth likely to slow to just 1.7% next year and US interest rates set to fall to 4.25%. The euro-zone and the UK will not escape unscathed either. Economic growth in the euro-zone is set to slow from 2.7% this year to about 2.2% next year. Meanwhile, the UK will experience a slowdown in growth from 3% to about 2%, prompting interest rates to fall to 5% by the end of next year.
• This combination of events is likely to result in a significant fall in the dollar. This will increase the political pressure on the super-saving nations – such as China – to alter their exchange rate policies and to boost domestic spending.
• If China and the other super-savers heed the warnings of the West, then the lasting legacy of this summer’s financial crisis may be a more balanced, more stable and more prosperous global economy. However, if these countries refuse to alter their policies, a lurch towards protectionism could see the whole process of globalisation go into reverse. The stakes could not be higher. The long-term prosperity of the world economy hangs in the balance.

Ends

For further information, please contact Roger Bootle, Economic Adviser to Deloitte, on 020 7823 5000 (office), or 07887 955 875 (mobile), or Danielle Anthony (Deloitte press office) on 07715 496 512

Notes to editors
This press release has been prepared by Roger Bootle, Economic Adviser to Deloitte.  If you have any questions regarding the views in it, please contact Roger Bootle directly on 020 7823 5000 or via email on business@capitaleconomics.com.

This press release contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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