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UK economy set to shrink 2 per cent in 2009, says Schroders

Schroders’ Alan Brown is predicting the UK economy to decline by 2 per cent next year and expects a “weak recovery” in 2010.

According to the group chief investment officer this drop would see a 50 per cent decline in earnings and 25 per cent reduction in dividends but would still leave the UK market “very attractively priced.”

However, if there is a further 2 per cent decline in 2010 and earnings slump of 80 per cent as there was between 1917 and 1922 then “all bets are off.”

Brown says a key indicator of any future recovery is the Libor spread as this reflects the cost of bank funding much more closely than official rates. He says: “A return to spreads of less than 25 basis points will be a clear indicator that the banking sector is getting back on its feet allowing the normal monetary policy transmission mechanisms to function once again.”

Other key markers will be the expansion or contraction of central bank balance sheets, the monetary base and the multiplier. He says: “Shrinking central bank balance sheets and a declining monetary base, and a rising multiplier would all indicate that the period of quantitative monetary easing is coming to an end and credit is beginning to flow again.”

Tax cuts must be spent and not saved and expanding fiscal deficits must provide enough demand to break the downward spiral of activity, says Brown.

He also points towards consumer confidence and retail sales as indicators to watch for early signs of a pick up. He says: “When the indicators we have outlined begin to turn in the right direction, that is likely to indicate the beginning of the end of this particular financial crisis and may well herald a sizeable recovery in risk assets of all forms credit, equities and property.”

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