Graphic: are prices falling

Thousands of Britons face the unpalatable choice next year of taking a pay cut or losing their job.

Unions representing 25,000 steel-workers at the steelmaker Corus have offered, on their behalf, that they all take a 10 per cent pay cut. The move has been proposed as an alternative to the closure of the Llanwern steelworks at Newport, Gwent, where more than 1,000 people work.

In October more than 4,000 employees at JCB, the digger maker, voted to work fewer hours, resulting in a £50-a-week pay cut, to save 350 jobs.

It is happening elsewhere in the world, too. CLSA Asia-Pacific Markets, the regional broking arm of the French banking giant Crédit Agricole based in Hong Kong, has asked 500 senior employees – a third of its workforce – to consider voluntary pay reductions of up to 25 per cent as an alternative to job cuts.

Temasek, Singapore’s state-owned investment company, last month announced pay cuts across the business, with the salaries of senior managers reduced by up to 25 per cent.

Welcome to the world of deflation. Most Britons under 35 are already experiencing something that they have never known in their working lives – a recession – while no one under 70 will have experienced interest rates at the current level of 2 per cent during their adult lives.

But this country has never experienced what could follow a serious bout of deflation – the extraordinary phenomenon of interest rates at zero.

Dismissed until very recently as something that could never happen here, zero rates are now being openly discussed in City circles, along with what they might mean for the economy. Is Britain in for a worse experience than Japan suffered when it was forced to cut rates to zero? Or is it better equipped to cope?

Howard Wheeldon, the senior strategist at the brokerage BGC Partners, believes that Britain could survive zero interest rates.

He said: “A major difference between here and Japan is that, in Japan, their banks were in a very precarious state – but for very different reasons than ours have been here. Japanese banks, by the early 1990s, had not been modernised. The whole system had served its purpose during the rush for growth in the 1960s and 1970s and, by the end of the 1980s, was top-heavy and inefficient.

“Japan fell into an inevitable period of decline because it had done so well. It didn’t fall off a cliff. It fell because it had nowhere to grow and when that happens, you just go sideways.

“Then zero rates came in and, of course, they didn’t get the economy going. Because the banks were so top-heavy and because they hadn’t thrown any senior people out of work, everything remained stuck as it was for ages and nothing moved forward.

“A lot of people talk about a possible Japanese situation here but they forget that the culture is very different in Japan – throwing people out of work was not something they do. The saving grace here is that our banking system is adjusting already.”

According to Matthew Sharratt, the UK economist at Bank of America, other things are likely to happen before Britain experiences zero rates, specifically the process known as “quantitative easing”, or, in layman’s terms, printing money.

He said: “Bank rate at 1 per cent could be the trigger for quantitative easing and the risks for that environment are definitely rising. We are expecting conditions here as were seen in the US one or two quarters ago. So, if you think it is bad in the UK and eurozone now, just wait for the tsunami that is coming through in three to six months.

“We think the fourth quarter here will prove to be decisively worse and the outlook is exceptionally gloomy. There is a growing risk that it will surpass what we saw in the early 1990s. The late 1970s, and all the chaos the economy experienced then, is now a more appropriate comparison.”

Mr Sharratt said it was likely that the jobless total would reach 2.7 million by the end of next year with unemployment rising more rapidly than at the end of the 1970s because employers can now shed staff more easily. A recovery in 2010 might be slow with both the labour market and the housing market taking time to pick up.

He added: “I think life will be very different going forward. There will be less borrowing, less spending, more saving, especially more saving before you’ve done your spending and, in general, a more thrifty household sector. With sterling weaker, there will be more of a transition to an export-oriented economy, eventually leading to a rebalancing.”

An environment where interest rates were close to zero may not be all bad, according to Geoffrey Dicks, the UK economist at Royal Bank of Scotland. He said: “In the 1950s, when the bank rate was just 2.5 per cent, I was a very keen young saver. People still do save . . . there is a chance that inflation will be negative in the next few months, so, in real terms, even very low interest rates on savings accounts would still be positive.”

Attempts by governments to hand money back to taxpayers were not guaranteed to work. “In the US, the experience has been that many of those rebate cheques mailed out earlier this year got saved,” Mr Dicks said.

Crucially, zero interest rates would also lead to a further collapse in the value of sterling, which had already lost a quarter of its value against the US dollar in the past year and a third of its worth against the euro since February last year.

Mr Wheeldon said: “We are no longer a manufacturing economy, more’s the pity, but we must also consider what happens to the pound. Does it inevitably mean we have to go into the euro? As sterling reaches parity with the euro, such calls are going to increase. And some are now saying that this is exactly what Gordon Brown wants – for the pound to carry on falling.”

Even zero interest rates and any amount of quantitative easing may not be enough to prevent the recession in Britain being protracted, however.

Mr Wheeldon said: “You can tinker with the system, you can print as much money as you like, but it will only do so much. We have had a capital markets crisis, then we had a credit markets crisis, we now have the rest of the economy in recession. Much of what the Government has already spent will be wasted because they are not allowing time for economic cycles to take their course.

“We have to go down to come back up again. We need to change the culture here. We had 15 bloody good years here and now we must pay a national price for that.”

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