In this week’s Bulletin:
- There is no Plan B for getting the UK economy on the road to recovery according to the Business Secretary Vince Cable in an interview with the FT – any change of strategy could lead to a loss of investor confidence in the government bond markets he said.
- This was evidenced by a warning from rating agency Moody’s which said Britain could lose it’s AAA rating if policies were abandoned
- Economic data for the UK was mixed – poor on the consumer front but much better from manufacturing with three major investments in the motor industry being announced, safeguarding thousands of jobs.
- Fuel bills are set to rocket after Scottish Power announced a 19% increase in gas prices and Centrica’s chairman told households to expect more – all of which will add to existing inflationary pressures.
- Oil prices jumped sharply on the news that OPEC had failed to agree to increased production – Saudi Arabia , de facto leader of the cartel, found itself out flanked by Iran.
- The Greek debt crisis worsened as policymakers argued in public about the best solution with Germany demanding private investors (the banks) bear more of the burden.
- Global equity markets retreated against this backdrop as investors sought the safety of US and German government bonds.
Sticking to Plan A
Against a backdrop of mixed and, in many cases, deteriorating economic data on the UK economy, the government has been coming under increasing pressure in recent weeks to come up with a new plan to boost the recovery. But there is no ‘Plan B’ it seems – the strategy is to strengthen Plan A according to Business Secretary, Vince Cable. In a candid interview with The Financial Times, Mr Cable admitted that the country is 10% poorer as a result of the recession, impacting significantly on living standards which in turn is being compounded by a commodity price surge and not helped by a sharp fall in the net worth of households (outside London’s honey pot). Oh, and don’t forget the painful fiscal consolidation caused by the current austerity measures. But there is no respite apparently because any change of plan would result in a loss of investor confidence in Britain. The Business Secretary’s comments coincided with an endorsement of the government’s strategy from the IMF but also a timely reminder of what might happen if there is any let-up in implementing Plan A.
Last week the pound fell sharply after rating agency Moody’s warned that Britain was in danger of losing its AAA credit rating. “Slower growth combined with weaker-than-expected fiscal consolidation efforts could cause debt metrics to deteriorate to a point that would be inconsistent with a AAA rating,” said the agency. Gilts also wobbled temporarily with prices falling and yields rising, implying the need for higher interest rates – not that there is any sign of rates moving anytime soon. The Bank of England (BoE) has now held interest rates at 0.5% for 27 months, despite rising inflationary pressures. Indeed, gilt bulls have high expectations that we will soon see the return of QE (quantitative easing) in the UK, hoping that policymakers will embark on a new round of printing money as a way to boost confidence, asset prices and recovery. For now though, gilt yields remain stuck in the 3–4% range as investor sentiment endures a push and pull effect of better, then worse, economic data.
Positive and Negative
Returning to the outlook for the economy, there was no shortage of evidence to support Mr Cable’s assessment of
how difficult the road to recovery is likely to be. House prices suffered their sharpest decline since 2009 in the three months to May, as consumers’ confidence continued to fall away. In its latest snapshot of the housing market, Halifax said that the average price of a home in the UK – notwithstanding the huge regional variations – had fallen by 4.2% in the three months to May, compared to a year earlier. The bank commented, “Low earnings growth, higher taxes and relatively high inflation are all putting pressure on household finances.” Not that retailers need reminding how fragile consumer confidence is. The dire state of the consumer economy was exposed last week when the owner of the Argos chain said that sales of TVs, iPods and electrical equipment had fallen 25% during March and April as its customers cut back. The Big Money Index from AXA showed that financial confidence has fallen sharply this year, with 40% of consumers cutting back and 25% of households having to dip into their savings.
But it was not all bad news. One bright spot in the recovery has been the increasing contribution being made by manufacturers and exporters to help rebalance the UK economy. Last week there was a triple whammy of good news from the car-making sector. Jaguar Land Rover announced a £750m investment in a new engine plant: Nissan also said its planned investment of £192m will safeguard 6,000 jobs and BMW revealed plans to invest £500m over the next three years into building a new generation of Minis, safeguarding a further 5,000 jobs. Britain’s automotive industry contributes over 10% of total exports by value, with 75% of cars made being exported. The news came alongside the latest data showing increased sales of new cars to fleets and a continuing rise in new van and truck registrations – the latter up some 17%.
Rising inflation is becoming an increasingly thorny issue – having been on the back burner for many years it is beginning to bubble significantly. Higher food and fuel costs on the back of rising commodity prices is, as discussed, taking its toll. Whilst the official measure, the Consumer Price Index (CPI), currently sits at 4.5% (well above the BoE’s 2% target), everyday prices are rising much faster.
Matters were made worse when Scottish Power announced a shock 19% increase in its domestic gas prices last week, alongside a 10% rise for electricity. And there’s more to come according to the owner of British Gas, Centrica, whose chairman said households should be prepared for further rises in their power bills. Economists promptly increased their inflation forecasts but, according to The Times, most still believe the BoE will keep rates on hold until the end of the year, pointing to weakness in the economy and a recent slowdown in factory gate inflation.
There was a reminder too that fuel prices are also subject to the vagaries of geopolitics. At its meeting in Vienna last Wednesday, the oil cartel OPEC dashed expectations that it would boost oil output in an effort to maintain price stability. Described as “one of the worst meetings we have ever had” by veteran Saudi oil minister Ali Naimi, the world’s largest oil producer found itself outvoted after a rearguard action led by Iran. After the meeting, OPEC issued a statement endorsing production quotas and said the failure to reach a consensus would not risk a crisis on the oil market. However, traders moved swiftly by marking up the price of both Brent crude and West Texas Intermediate – Brent ended the week up almost $4 per barrel at almost $120 and WTI moved back above the $100 per barrel level. Behind the scenes though, expectations are that Saudi Arabia will unilaterally boost its production, thus helping supply and hopefully bringing downward pressure on prices. Of course, it’s not just the West which frets about higher fuel costs – China has overtaken the US as the world’s largest consumer of energy, according to BP, and now accounts for around 20% of consumption.
Back on the Agenda
With inflation muscling its way towards the top of investors’ list of concerns, there was also another possible contender emerging – albeit with currently low odds – and that is the possibility of a double-dip recession in the US. According to one of the world’s leading economists, Robert Shiller, the US economy is at risk of double-dipping back into recession following a spate of weak economic data, including disappointments in the American housing market. Co-founder of the closely watched S&P/Case-Shiller index of US property values, Mr Shiller said, “Whether we call it a double-dip or not, I think there is a risk”. The property index showed prices falling 4.2% in the first quarter of 2011 (the largest since 2009) and Mr Shiller added that further steep falls in the next five years wouldn’t surprise him at all. American economic data has been deteriorating in recent weeks and news that unemployment edged higher last week – to 9.1% – merely confirmed worries that the recovery in the US jobs market has hit a wall.
However, markets were reassured with the release of the US Federal Reserve’s latest survey of business contacts – its so-called ‘Beige Book’ – which, whilst showing signs of a modest slowdown in growth, found little evidence the economy is heading for a double-dip. It found that only four of the twelve regional Fed banks had anecdotal evidence of a slower pace of growth, with the others saying growth was continuing at a steady pace and Dallas reporting a speed-up of growth. Elsewhere, the Beige Book reported loan demand was “steady to stronger” in most Fed districts together with a widespread improvement in credit quality. This, along with news that US exports reached a record level in April, gave investors a much-needed fillip. Fed chairman Ben Bernanke also took the opportunity to warn American lawmakers that sharp spending cuts designed to cut the deficit might be “self-defeating” and could derail a shaky economic recovery. But, whilst acknowledging the recent slowdown, he did not suggest the central bank was considering further monetary stimulus – disappointing some market participants who are expecting QE3 later in the year.
A Question of Semantics
Which do you prefer – ‘rollover’, ‘re-profiling’ or ‘restructuring’? It seems they all amount to the same thing as do a ‘ratings default’ and a ‘credit event’. As the Greek sovereign debt crisis rumbles on, investors are becoming increasingly irascible over the failure of the eurozone’s policymakers to agree and implement a solution. The latest twist has seen the matter become an open debate as the Germans publicly air their preferred solution, much to the annoyance of the ECB and France. Germany has demanded that commercial banks share more of the burden of tackling the euro debt crisis by signing up to a seven-year extension to the maturity of Greek bonds. Central bankers though have opposed a ‘re-profiling’ of Greek debt, which would involve investors voluntarily swapping existing bonds for longer-dated paper, arguing it would render the debt ineligible as collateral in ECB lending operations. They fear that such a move would constitute a Greek default, heightening the risk of crisis contagion into other parts of the eurozone.
Whilst policymakers wrangle in open, the whole issue is rapidly becoming farcical, according to Citi’s chief economist Willem Buiter. “We are getting to the point where the whole game is getting silly,” he said when commenting on using different words to describe the same event: a restructuring of Greece’s debt. Investors have found nothing to smile about – the cost of insuring Greek sovereign debt pushed to a record high amid fresh fears the indebted country is moving closer to default. These worries proved too much for global markets which moved into the red once more as investors fretted over the eurozone crisis and the mainly disappointing economic data. With no immediate sign of the Fed rushing to bolster the US recovery with fresh money and downbeat Chinese trade data – exports fell back in May – investors decided to seek the haven of US and German government bonds. By the end of the week, most major stock market indices had slipped back, with the S&P 500 down around 2% on the week; although Tokyo managed to buck the trend with the Nikkei 225 registering a small gain.