FINANCIAL OUTLOOK 2008

BARCLAYS: SKATING ON THIN ICE

Barclays Wealth 2008 Annual Outlook

Key themes for 2008:

• We put the probability of a US recession at 40pc.

• If there is a US downturn, the European economy will be hurt.

• Despite the market turmoil, there are several reasons to be positive on equities.

• There will be greater equities opportunities in the UK and Europe than in the US.

• Were there to be a recession, equities markets would be likely to rebound quickly.

• Banking sector stocks still look cheap.

• We continue to favour large-cap stocks.

• We think a sharp fall in sterling is likely.

• Commercial property still appears overvalued.

Macroeconomic view

A close call on a US recession

We put the probability of a US recession at 40pc, with a more likely scenario being continued, if sluggish growth. In the past, housing market busts have been like a slow-motion train crash, with severe consequences.

But the US Federal Reserve, and other central banks, seem much more willing to bolster demand than in previous crises.

US macro data remain strong, and we think that debt defaults are likely to have less of an impact than expected.

But we do think the downturn in the US housing market will have a greater impact on the demand for credit and (through ‘collateral’ effects) on consumption than most models foresee. So our forecasts for US growth are below the consensus.

Michael Dicks, Head of Research, Barclays Wealth comments: “Our analysis points to a significant global slowdown, but not a crash.

"We do not have a US recession as our central scenario – although we do put chances of a recession at 40pc.

"We are also pessimistic about the euro area, believing that it ‘cannot go it alone’. In the UK, we believe that the Bank of England will have to deliver at least 100bp of interest rate cuts if growth is to reach anywhere nears its forecasts of 2pc.”

Europe can’t go it alone

If there is a US downturn, Europe will be hurt. Economic models on economic interrelationships between countries have tended to focus heavily on trade flows.

But economic performance is in fact much more correlated than these models would predict, with financial linkages more significant than trade. There are also important ‘CNN’ effects – bad US news sending European stockmarkets and business confidence down.

In a globalised world, European firms are having to react much more aggressively to changes in economic circumstances – rather than being able to fall back on cosy relationships with bankers.

Our models suggest that the slowdown in Europe will be greater than most, or indeed the ECB, forecasts. A possible further appreciation of the Euro would not help matters.