• The economic challenge

The financial crisis is finally moving out of the headlines. Unfortunately, it is because of the developing economic gloom rather than any formal conclusion to the financial problems.

Hotel investors, already battered by the tighter credit conditions, now face the prospect of a long and deep recession.

The depth and duration of the downturn seems to extend with every new economic forecast. The International Monetary Fund projected on November 6 that global growth would slow from 5% in 2007 to 3.75% in 2008 and then to just over 2% in 2009.

While the downward revisions for developed countries are worrying perhaps most surprising were the even larger reductions in the forecasts for developing countries. These countries were only a few months ago heralded as possible saviours of the current crisis.

On top of the declining economic conditions, the IMF points out that the financial crisis remains virulent. "Markets have entered a vicious cycle of asset deleveraging, price declines, and investor redemptions," it said in an update to its World Economic Outlook.

For the IMF, the issue now is the way consumers and firms are reassessing income prospects. "Beyond the direct impact of the financial crisis, activity is increasingly being held back by slumping confidence," it said.

But, and this is a big but, the gloomy forecasts do not include the impact of government interventions on both interest rates – an easing of monetary policy – and tax and spending changes – a loosening of fiscal policy.

In the press briefing on its update, the IMF said that if there is global fiscal expansion "then our forecasts may well turn out to have been too pessimistic".

There is certainly plenty of pessimism about. The Bank of England's latest Financial Stability Report described pressures on the UK banking system as being as severe as at any time since the beginning of the First World War.

The BoE report identified a "self-fulfilling spiral of falling confidence". Among the triggers for this were deteriorating macroeconomic prospects with weakening housing markets internationally.

The BoE acknowledges that corporate insolvency rates remain near historical lows. And, more importantly going forward, many companies have extended debt maturities during the recent boom. It cites data showing that only 10% of the stock of sterling-denominated bonds and loans outstanding are due to mature in 2009.

The worst outlook is for companies in retail or property, according to the BoE, plus any others that are highly leveraged. The BoE said that by September of this year, UK commercial property prices had declined by 24% from their June 2007 peak. It warned that some commercial property businesses would have to refinance or default.

There was considerable pain for securitised instruments with mark-to-market losses in the UK now standing at above £120bn, at almost $1,600bn in the US and at nearly Eu800bn in the Euro area. The BoE noted, however, that the eventual expected loss of economic value on these assets is likely to be lower.

In fact, the BoE concludes that the economic values of these securitised instruments "lie significantly above their current market values". It is the weak investor appetite for such instruments which is keeping prices low: people know they are worth more and that they will in the medium term fetch more but short-term fears are keeping prices down.

In fact, what the BoE report makes clear is that fear is what is dominating the thinking of most market participants at present.

A separate report from the BoE, the Inflation Report issued in November after the surprise 1.5 percentage point drop in base rates to 3%, directly addressed the question of how long and how deep the recession is going to be. Three key variables were cited: the prospects for credit supply; the response of domestic spending; and the outlook for world activity.

The BoE believes that credit supply will be tight in the near term with only limited credit growth in the medium term. But this forecast was described as having "marked uncertainties". On the upside, credit may return more quickly, alternatively, on the downside, macroeconomic conditions may deteriorate more than expected causing a further tightening.

This wide-range of possible outcomes follows through to the other two variables impacting on the nature of any recession: domestic and international demand. Alongside the fear therefore sits an enormous amount of uncertainty.

Forecasts from the Organisation for Economic Cooperation and Development follow the same pattern as the IMF and BoE. It projects a protracted downturn with GDP set to fall by a third of a percent next year.

The OECD has in its central case a quick end to the extreme financial stress that has occurred since mid-September. But it warns that 2009 will be characterised by financial headwinds.

Consumers will be boosted by falling commodity prices but this will be outweighed by the ongoing adjustment in housing markets which the OECD said still had a long way to go in many European economies. It forecast for 2009 a contraction of 0.5% for the Euro zone, of 0.9% for the US and 0.1% for Japan.

The European Union officially recorded a 0.2% decline in the third quarter of 2008 for the 27 EU countries. This followed zero growth in the second quarter.

Given the uncertain conditions, it is a huge challenge to make forecasts. PricewaterhouseCoopers is one firm that remains brave enough to put its head above the parapet and make a call on revpar.

PWC has put out a base case scenario based on a GDP growth in the UK of 0.5%. This looks optimistic if the other forecasters are right.

Even so, revpar would fall by 11.9% in 2009 in London on this scenario.

On the downside scenario, premised on a 1.9% slide in GDP, which is a touch pessimistic, revpar in London is forecast to fall by 23.3%.

Taking the half-way point between these two forecasts, which is where most GDP forecasts are currently positioned, gives an outlook for revpar in London in 2009 of a decline of around 18%. This puts the impending downturn at least on a par with the 1990s.

It may be the case that this is too pessimistic. It might be that the committed interventions by governments will head-off the recessionary bandidos at the pass. But there is a growing sense of fear.

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