King may be sleepwalking into recession

The British haven't had a recession for so long, they appear to have forgotten what they are like. They are about to get a sharp reminder.

The UK economy is sliding into trouble faster than anyone could have imagined. House prices have started the slow decline that was almost certain to happen.

The pound is dropping, and the confidence of consumers is in freefall. Some economists are starting to see recession as a possibility. If so, it would be the first time the nation's economy has contracted since the early 1990s.

And yet, the Bank of England appears to be sleepwalking into disaster. True, Governor Mervyn King has been warning everyone there are tougher times ahead. So far, the bank has done little to help, with the exception of two quarter-point cuts to 5.25 per cent, still among Europe's highest interest rates.

That isn't good enough. The UK needs far deeper reductions in interest rates "" and the sooner the better. The Bank of England might as well act now because when it is forced to lower borrowing costs later in the year, it will be too late.

There is no mistaking the dark clouds gathering over the British economy. House prices have now been falling for six months in a row, according to a report by Hometrack.

The declines are still marginal, and prices are still broadly stable over the year, but a market has to turn somewhere. For UK real estate, the only way is down. The only question is how far it will fall, and how much damage that causes to the economy.

Confidence has already taken a battering. According to the polling firm GfK NOP, consumer confidence has reached its lowest level in 15 years as higher prices, rising taxes, and the turmoil in the credit markets deter people from spending.

Next sub-prime casualty
Meanwhile, sterling is touching record lows against the euro: It only looks strong against the equally beaten-up dollar. That is going to make the cost of everything Britain imports more expensive "" and it is an indication of how the currency markets think the UK is the next sub-prime casualty. It is no great surprise, then, that economists are busily slashing their forecasts for growth this year.

"The probability of a technical recession of two quarters of negative growth at some point over the next two years has now risen, in our view, to about 35 per cent while we put the probability of an outright recession of negative year-on-year growth at 20 per cent," Lehman Brothers Holdings Inc said in a report last week.

Lehman's forecast
Others find even that forecast too cheerful. "Lehman estimates the risk of recession is 35 percent; we believe that it is 55 percent,'' Stuart Thomson, who manages 23 billion pounds ($45.7 billion) in bonds at Resolution Investment Management Ltd. in Glasgow, Scotland, said in a note to investors.

He said the impact of falling house prices on consumer confidence will be so severe there will be a big drop in demand.

Without the housing market and consumer spending to prop it up, the U.K. economy will quickly deflate. Worse, many of the hundreds of thousands of eastern European immigrants will quickly go home.

If the economy isn't booming, there will be nothing to keep them in the U.K., and as they leave they will suck even more spending power out of the economy.

In truth, all the forecasts so far are probably too cautious. The British economy has been so resilient for so long, nobody wants to look foolish by calling the end of the boom too soon. The chances of a recession are now more like 100 percent.

Last year, King was lecturing on ''moral hazard'' while mortgage lender Northern Rock Plc was running out of money. Now the Bank of England is lecturing people about discipline, while the economy is sliding toward recession.