Almost every day there seems to be another news headline about the economy, house prices, inflation, or debt.
The reality of the situation is that we are now in a volatile and uncertain economic environment. Over the last two weeks, stock markets around the world have become increasingly erratic; the U.S. Federal Reserve made a decision to slash interest rates by one and quarter point to 3.0%; house prices fell in January 2008 – they have now been falling in the UK for four consecutive months; it was announced that the UK economy grew by 3.1% in 2007.
Where does all this leave us?
Read on to find out more about what has been happening and what you can do to meet the challenges of an uncertain marketplace.
The challenges presented by the current economic context
The credit crunch
The ‘credit crunch’ has been the buzz phrase of the last six months. It has been the root cause of the recent market jitters and has led to a heightened volume of discussion about that wretched word ‘recession’.
The credit crunch arose as a consequence of U.S. lenders granting mortgages to individuals with poor borrowing records, in which a significant proportion of borrowers are now beginning to default.
Additionally, the credit crunch has resulted in many having to pay higher rates of interest to borrow money.
While the costs of borrowing for consumers has increased a little, the greatest impact has been on business borrowing – particularly impacting the banking sector heavily as many lending organisations function on a business model that requires borrowing from other lenders, on the wholesale money markets, to operate.
The stock market
Global stock markets have been erratic over the last two weeks. The fluctuations in the value of the stock market affect all of us – either directly or indirectly.
If you own shares or stocks in a company, the value of those shares depends on the value determined by the stock market. A large proportion of the value of our pensions is determined by the value of the stock market, as pension funds tend to invest a substantial proportion of the money they manage in the stock market.
The value of many pension funds is also linked to the performance of the stock market so for people nearing retirement the stock market wobbles are of particular concern.
Therefore changes in the value of the FSTE 100 – an index of the 100 largest companies in the listed on the London Stock Exchange – is of interest to all of us.
Furthermore, falls in the value of the stock market play an important part in affecting levels of consumer and business confidence in the economy. High levels of both consumer and business confidence are important because they lead to high levels of spending and investment.
Both spending and investment are essential drivers of economic growth and job creation.
The property website Rightmove recently revealed that property prices for January fell by 0.8%. This means that over the last year property prices rose by just 3.4%, compared to an annualised rate of close to 10% early in 2007.
The average cost of a home is now £174,700.
The Council of Mortgages Lenders (CML) expect there to be a 50% rise in home repossessions in 2008, totalling 45,000 throughout the year. One key factor that could drive this is the credit crunch, mentioned earlier. With approximately 1.5 million mortgage borrowers coming off fixed-rate deals in 2008, these borrowers are likely to have to accept higher interest payments as a consequence of the credit crunch. It is important if you do have a mortgage that making your mortgage payments takes priority over paying off unsecured credit like credit cards, personal loans or overdrafts.
Both food and fuel prices are on the rise.
Everyday essentials such as milk and corn have doubled in price over the last 12 months. Crude oil prices have recently been over US$100 a barrel– it was only 2005 when economists were debating whether the economy could sustain its growth with oil prices rising to about US$40 a barrel!
To help cool inflation, a standard monetary policy response is to increase interest rates. However, with the credit crunch, fluctuating stock markets and a cooling housing market demanding that interest rates be cut, increasing interest rates to cool inflation is not a viable strategy.
These are the challenges, but how bad is it really?
The above paragraphs seem to make out that the situation is all doom and gloom, but this is not the case.
In spite of the credit crunch, growth in the UK (as measured by Gross Domestic Product) stood at 3.1% in 2007. Unemployment is still at low levels historically and global economic growth remains strong – China’s economy is expected to grow by close to 10%, and the world economy by 4.1%, in 2008 according to the latest forecasts from the International Monetary Fund (IMF), an organisation the works to secure global financial stability.
Moreover, the Monetary Policy Committee (MPC) still has a lot of room to manoeuvre with interest rates. Cutting interest rates has a big impact on helping to reduce the pressure on borrowers – both individuals and businesses. Many feel there that there will be a number of rate cuts during 2008.
While the MPC have space to make a few more interest rate cuts, the situation may not demand it. There is undoubtedly some truth to the old adage ‘when America sneezes, the whole world catches a cold’, but in the UK our biggest export market is Europe, where growth remains strong. We are not totally dependent on a strong U.S. economy for economic development.
All these factors mean that a recession in far from inevitable.
The formal definition of a recession is two consecutive periods of negative growth. We are a long way from that right now.
What should I do now?
Thankfully, there is no reason to panic.
However, there are a few steps that you can take now that will protect you, if we were to be faced with an unfavourable situation.
Firstly, if you haven’t already, it is important to put money away for a rainy day. Having two or three months’ income saved up will help you greatly if there are unfortunate circumstances beyond your control, such as a job loss or a period of sickness. Think about Saving, it can help incredibly.
Secondly, it is important to create a budget and to monitor it regularly (once a month for 15 minutes). You might like to try using a Budget Calculator or the Moneybasics Spendometer to keep track of your spending.
The Moneybasics Spendometer allows you to download a budgeting tool onto your mobile phone, set budgets and budget categories, keep track of your ‘going out’ spending the day after and get weekly or monthly reports of your spending. Sometimes it is the small things that you buy regularly that quickly add up. It’s often not until you record all your spending for a week or two that you see where your money has been going. Why not download it now and begin to take control of your finances?
Thirdly, look for opportunities to increase your income. Perhaps you could teach English a couple of hours a week or you could rent out a spare room in your house? Try to be creative. Think about what skills you have and how you could use these to generate extra cash.
Fourthly, look for opportunities to reduce your spending. Use price comparison websites before making purchases to shop around for the best deal. Have to look at Credit Action’s Money Saving Ideas to see how you can cut expenditure now.
Finally, you may want to seek independent financial advice as to whether buying a house is the right option for you at this moment in time, sometimes renting is a better option. Take a visit to the Buying or Renting section of Moneybasics for a good starting point.
For more information visit:
MoneyBasics: www.moneybasics.co.uk – Simple, clear, independent information about money.
Credit Action: www.creditaction.org.uk/ – For ‘better thinking about money’ and help with budgeting.
Consumer Credit Counselling Service: www.cccs.co.uk/ – Independent, free, confidential debt advice.
Prepared for Moneybasics by Jason Taylor, Advocacy Officer (Credit Action).