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Friday, 21 September, 2001, 08:37 GMT 09:37 UK
Terrorist toll on the UK economy
The World Trade Center collapse juxtaposed against a trader and London's Tower Bridge
by BBC News Online's Emma Clark

Economic events in the US often provide a taster of "what's coming soon" to the UK.

Together the two economies stand and, inevitably, together they fall.

The financial repercussions of the horrific attack last week on New York's twin trade towers are already rippling across the Atlantic.

UK-based airlines British Airways and Virgin Atlantic, London's stock market and the insurance sector are taking the battering head-on.

However, the malign influence of the attacks could have an even more devastating effect on consumer confidence in both countries.

Feeling the blow

Unlike the airline and insurance industries, most parts of the UK economy will suffer through their ties to the US, rather than directly as a result of the terrorist attack.

The US was already on the brink of recession before last week. This will almost certainly tip it into recession

Philip Whyte

For the US, the attacks are the proverbial straw that broke the camel's back.

"The US was already on the brink of recession before last week," says Philip Whyte, a senior economist at The Economist Intelligence Unit.

"This will almost certainly tip it into recession."

The EIU predicts that the US economy will shrink for the last two quarters of the year, which technically constitutes a recession.

Impact on trade

Because of the close trading relationship between the two countries - about 15% of UK exports go to the US - there will be an unavoidable knock-on effect on British manufacturing.

Felixstowe docks
Recession in the US will have a knock-on effect on UK exports

UK manufacturing has already been in recession for six months, and an American recession will "intensify the pressure", according to Richard Iley, an economist at ABN Amro Bank.

In its September survey, the Confederation of British Industry found that the manufacturing sector had slumped to a near three-year low.

Close ties

But the ties between the US and UK run even deeper, in terms of business investment.

According to Mr Iley, about half of the profits for FTSE companies come from overseas - and 30% of that half derives from the US.

This means that substantial US investment in the UK will likely dry up.

Meanwhile, revenues from British companies with branches in America will be weak.

"The impact [of the attacks] will be obviously negative, the question is how negative," says Mr Whyte.

Consumer confidence

The real challenge is determining the effect on consumer confidence.

Shoppers in Oxford Street
Consumer spending has driven UK growth

Mr Whyte points out that it is hard to forecast consumer confidence because it is heavily based on psychology.

A cocktail of factors are pressing on consumers in the aftermath of the attacks, such as physical fear, depression, the falls in the stock market and lack of energy.

"People tend not to go out and have a good time," Mr Whyte says. "They stay at home and hoard money in times like this."

Any knock on consumer spending is particularly bruising because it has proved a key engine of growth both in the US and the UK.

How great a knock?

The extent of any damage to consumer confidence could hinge on the nature of US action.

American troops arrive in Oman
The nature of the US response is key

"If it is carefully thought out and targeted with a broad coalition, we could get out of the crisis without too great a knock to consumer confidence," says Mr Whyte.

However, he predicts a more durable impact on the economy if the US takes unilateral action and resorts to retaliatory air strikes.

Under such a scenario, any companies or sectors that have been weakened by the existing economic slowdown would be vulnerable.

As well as the manufacturing industry, new economy tech companies are expected to suffer, and the UK tourist industry will feel the absence of US visitors who prefer to stay home.

The City is also expected to see more job losses, following dramatic falls in the stock market.

Looking ahead

Since the attacks the EIU has revised down its estimates for UK growth to 2% during 2001.

At the beginning of the year, the unit had forecast growth of 2.5%.

However, both Mr Whyte and Mr Iley are confident that the UK will not a suffer a full recession, even if certain sectors fall into recession.

Mr Iley argues that the government's plans to invest heavily in the public sector will help drive the UK economy.

He adds that pre-emptive action by the Bank of England, which recently cut UK rates by a quarter of a percentage point to 4.75%, will also play a role.

"The Bank has considerable ammunition in its locker to shore up consumer and business confidence in the face of a US recession."

US rebound?

Economists are also anticipating that any recession in the US will be short-lived, as inventories run down this year and no longer place a constraint on production.

President George W Bush's tax cuts, and the Federal Reserve's aggressive interest-rate policy, are also expected to help the economy rebound some time next year.

In the meantime, UK manufacturing may even experience a benefit from the troubles in the US.

Part of the pain experienced by British exporters is the weakness of the pound against the dollar, and the strength of the dollar against the euro.

The UK exports even more of its goods to Europe than to the US, and yet it bears a lot of input costs from the US.

Any falls of the dollar against the euro would be welcomed by manufacturers and could "rebalance" the UK economy, says Mr Iley.

This, however, would be one small comfort among many possible dangers that lie ahead.

See also:

21 Sep 01 | Americas
Tourism shaken to the core
19 Sep 01 | Business
Fears grow for US economy
21 Sep 01 | Business
US slump could be 'steep but short'
18 Sep 01 | Business
UK rates cut to 1960s levels
20 Sep 01 | Business
UK trade gap widens
20 Sep 01 | Business
UK shares tumble
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