This week’s Bulletin which contains the following points:

  • The US Federal Reserve took a big step in unwinding its stimulus programme
  • Britain may have come out of recession slightly faster than expected
  • Greece’s problems continue as EU negotiations are ongoing
  • Lloyds and RBS bosses come under pressure to waive bonuses

Fed Discount Hike
The financial world was taken by surprise late on Thursday, as the US Federal Reserve took a big step towards unwinding its massive economic stimulus programme. As reported in The Financial Times, the move by the Fed to raise the discount rate, the level at which commercial banks borrow from the central bank, was expected but the timing was still a surprise. In what is being described as a sign of the Federal Reserve’s increased confidence in sustained economic recovery, the discount rate was raised by a quarter of a percentage point to 0.75%, and the immediate impact was for the US dollar to leap to a 9 month high against both the euro and sterling. The Fed tried to dampen expectations by saying this would not necessarily be the start of a continual rate-rise, but the general consensus was that this decision will still affect markets, as the message it gives out is that the US Federal Reserve is the only major central bank that can even contemplate a rate hike in the foreseeable future.

As well as the immediate rally of the dollar, there was also knee-jerk selling of stocks, US Treasuries and commodities, amid speculation that it heralded a further tightening of US monetary policy. Subsequently, this was all reversed on Friday as investors digested the move, and took the view that this was merely the first move of many for the Fed going forward, and it was best to focus on the positives. Overall, the US equity market seemed to focus more on continuing positive economic data and corporate earnings, as well as benign inflation figures. In European markets, the Eurofirst 300 Index enjoyed its biggest weekly gain since July, with Financials leading the charge upwards, while Asian markets gave back the week’s gains in tough Friday trading. In the UK, the FTSE 100 index rose during every trading session, closing the week up 4.19% at 5358.17, taking optimism from positive corporate news and economic signals from the US.

Focus on the UK
Britain’s anaemic economic recovery could be slightly stronger than initial figures suggested, as official data is expected to show growth of 0.2% in the final quarter of 2009 rather than the anticipated 0.1% first announced. The Sunday Telegraph reported that an upwards revision of this sort shows improvement, but is still a fragile scenario nonetheless. The key will be the breakdown of expenditure and output data for the fourth quarter, which will provide a signal as to whether consumer spending is holding up and whether trade is providing the support to the economy that the government is hoping for.

Despite these reports that the UK may have limped out of recession slightly faster than originally thought, there are increasing concerns which continue to hit the value of the pound. This was also covered by The Financial Times, which looked at the increasing vulnerability of sterling while the world focuses on the problems of the euro. January is usually a month which swells the government coffers due to increased tax revenues, but this year saw a net borrowing of £4.3 billion, with analysts now suggesting that 2010 borrowing will be higher than the £178 billion that Alistair Darling has forecast. Such a deficit would be greater than the shortfall in Greece. This, combined with a contraction of UK lending to businesses and the potential for a hung parliament in May, results in there being few sterling bulls in the world. All in all, reported the paper, “the absence of any positive adjustment to the UK fiscal position runs the real risk of a run on the pound”.

Greek Fiscal Woes
The woes of the euro continued this week, as there were persistent concerns over the problems of peripheral Eurozone countries. However, the ongoing worries over the potential bail-out of Greece eased slightly as it emerged that there would be emergency funding if necessary. As if to highlight the high-risk premium attached to Greek Government debt at present, the 10 year yield jumped 27 basis points to 6.44%. Reports in The Financial Times on Saturday suggested that Greece was preparing to raise between 3 and 5 billion euros through a bond issue. This is seen as a crucial test of Greece’s credibility in the eyes of the world, and the success of the issue will determine whether an emergency bail-out is necessary.

The Independent on Sunday had a slightly different angle to most, with the emphasis being much more on the fact that Greece actually holds a strong hand in negotiations. While most see Greece as having to go cap-in-hand to the EU, the paper commented that the EU simply has to lend to Greece at the same rates as other countries, and that increasing interest rates for Greece would potentially push the costs of borrowing up for the likes of Spain and Portugal, and makes Eurozone problems much worse than currently.

Still on the Critical List?
With Royal Bank of Scotland scheduled to announce results later this week, the press discussed the possibility of the two state-owned banks showing £12 billion in losses, yet paying out in excess of £1.5 billion in bonuses to its investment bankers. The Sunday Times reported that the RBS Chief Executive, Stephen Hester, had not yet decided whether to accept the reported £1.6 million pay-out, despite the bonus being written into his contract when he was appointed, and was under increased pressure after two of Barclays senior board members recently rejected their bonus awards, despite being taxpayer funds-free and reporting a £11.6 billion record profit. The Sunday Telegraph reported that with RBS and Lloyds unlikely to show any profit before 2011, announcements of bonuses while making extreme losses would be “political dynamite”. According to the paper, neither lender will be able to escape the fact that the general public will not understand how a state-owned bank can award performance bonuses when declaring an overall loss.

Today’s Financial Times confirms that Mr. Hester is indeed to forgo his bonus for 2009 – a gesture seen as part of an effort to “depoliticise” RBS’s bonus issue and to help pave the way for the UK government to sign off the bank’s plans to pay a “commercial rate” of bonuses to its investment banking staff. The move will pile pressure on Eric Daniels, Mr. Hester’s opposite number at Lloyds, who has yet to make any declaration about his bonus plans.

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