The economy of the UK is shrinking at its fastest rate since 1958.

Gross domestic product fell 2.4 percent from the final three months of 2008, compared with the prior measurement of a 1.9 percent drop, the Office for National Statistics said today in London. The median prediction in a Bloomberg survey of 28 economists was for a 2.1 percent decline. Construction activity plunged almost three times as much as originally estimated.

Bank of England Governor Mervyn King said last week that Britain’s recovery from recession may turn out to be “a long, hard slog.” While business surveys have indicated the economic slump is easing, unemployment may continue to increase and net mortgage lending is the weakest since records began in 1993.

The Pound fell 0.5% on the news, which brings us to another of today's headlines.

“The probability of a real sterling crisis is around one in three, and the probability of major tax hikes and cuts in public spending is roughly one in one,” the Harvard University professor says.

British financial historian Niall Ferguson is concerned with the out of control deficit spending, which is expected to hit 12.4% of GDP this year, and may reach as high as 17% next year.
Massive spending at such a rate, if done by an Asian or Latin American country, would have already triggered a currency crisis. The only thing saving the UK right now is their legacy.

“The big difference between the two countries is that the U.S. issues the world’s No. 1 currency and is regarded, partly for that reason, as a safe haven,” Ferguson says. “The U.K. used to be, but we’re not anymore. That means we have much more currency risk here.”

The government must sell about 900 billion pounds of gilts over five years, Clarke says. He estimates that the Bank of England will buy a third of these gilts to pump money into an economy mired in its worst recession since World War II. The government may struggle to find buyers for the rest, he says.

At the heart of the troubles is a shaky banking sector, and the cause of that is a bursting real estate bubble. So far this has mostly involved residential housing, but those days are about to pass. A new headache is about to strike - commercial real estate.

Approximately 15% of UK loans are in breach of a covenant or in outright payment default, and although at a historical high, this figure understates the full impact of falling capital values on UK CMBS leverage,” - Mario Schmidt, Associate Director in Fitch’s EMEA CMBS Performance Analytics team.

“Although less than 10% of loans report an LTV (loan-to-value ratio) above 100%, Fitch estimates almost 30% to be in negative equity. Over four-fifths of loans have Fitch LTVs over 80%, and given the scarcity of debt available at the moment, this leads us to believe that few of these borrowers would succeed in refinancing today,” says Gioia Dominedo, Director in Fitch’s EMEA CMBS team.