Autumn Statement sees George Osborne give with one hand and take with the other

In this week’s bulletin:

  • Markets maintain upwards momentum, although positive jobs news in the US is tempered by signs of stalling negotiations on Capitol Hill over the ‘fiscal cliff’.
  • Autumn Statement sees George Osborne give with one hand and take with the other. As the Office for Budget Responsibility cuts its UK growth forecasts for 2013, the Treasury dismisses talk of a ‘triple-dip’ recession.
  • Leading economist John Greenwood examines the progress made on debt reduction in the UK and US and reaffirms the need for investors to focus on good quality, income-generating assets.


Market Eye

  • Better-than-expected US jobless figures support positive investor sentiment
  • Greek government’s bond buy-back offer likely to be successful despite heavy discounting and losses for investors

Global markets maintained their upward momentum last week, albeit at a slow pace. Sentiment was supported by positive news on the US jobs front, following data showing an increase in non-farm payrolls of 146,000, significantly beating expectations. This enabled the US jobless rate to fall to 7.7%; its lowest rate for four years. However, some of the gloss was taken off the news when the latest consumer confidence figures showed a sharp drop, falling eight points to 74.5. It seems that political wrangling on Capitol Hill has unsettled households, with some 25% of consumers suddenly realising that there is a real possibility of tax rises should the US ‘fiscal cliff’ materialise. These budget negotiations between Republicans and Democrats have taken on a more acrimonious edge, with House Speaker John Boehner ramping up his criticism of the Obama administration. But whilst the employment figures were good, some analysts are reserving judgement, taking the view that the impact of Hurricane Sandy has yet to be felt in the jobs market and that there is the prospect of the numbers worsening next month.

In the government bond markets, yields fell slightly over the week as demand remained steady with the positive mood even managing to spill over into Greece. There, the government’s offer to buy back some of its own bonds at a steep discount was surprisingly well received by international investors, who offered to sell back some €15 billion of bonds, at around a third of their face value. Athens had offered investors some €10 billion of short-dated bonds issued by the European Financial Stability Facility in return for Greek bonds with a face value of €30 billion. It was probably no real surprise that the offering was well received overall given the fact that Greek banks were told that it was their “patriotic duty” to ensure the success of the buy-back: initial estimates are that the country’s four largest banks contributed anything up to 80% of their €17 billion holdings. Elsewhere in the financial markets, lower forecasts for German growth hit the single currency with the euro slipping to $1.29; whilst in the commodity markets, the price of crude oil fell as Middle East tensions eased.


Give and Take

  • George Osborne delivers a neutral budget but endeavours to give both growth and business a boost
  • OBR cuts its UK 2013 growth expectations to 1.2% from 2.0%
  • Some analysts see greater threat to UK’s AAA credit rating as borrowing climbs further.

Fiscally neutral: that was the outcome of George Osborne’s latest Autumn Statement, or mini-budget, last week. What he gave with one hand he took back with the other. High earners suffered cuts of £6.7 billion as a result of changes to pension tax-relief limits and below-inflation tax threshold increases. Low earners will suffer some £14.1 billion of cuts via changes to welfare benefits. The Chancellor received no help from the Office for Budget Responsibility (OBR), whose forecasts for UK growth were cut, whilst also expecting the government to borrow some £52.5 billion more than expected over the next five years. So with little room for manoeuvre, Mr Osborne made a judgement that the best course of action was to try and boost growth by bolstering business confidence and encouraging greater investment by companies and the public sector. His decision to increase capital allowances tenfold – up from £25,000 to £250,000 – was well received by business. The £5 billion for infrastructure spending was, however, deemed lacking.

“It’s not radical enough to unlock the resources needed to maintain and improve Britain’s business infrastructure.”

John Longworth, Director General, British Chambers of Commerce

Mr Longworth argued that there was too much political risk around infrastructure, deterring private finance. Will the Chancellor’s efforts be enough? Well, in the gilt market yields fell a little as investors responded positively, despite the news that public borrowing needs to increase, which ordinarily might have been expected to put pressure on the UK’s AAA credit rating. There was much noise around the fact that buried in the OBR’s report were figures showing that the UK’s debt burden will near 100% of GDP by 2015/16, higher than the 94.3% average for the eurozone. However, the markets appear to be taking the view that, even if the credit-rating agencies do decide to downgrade Britain to AA+, it will have little meaningful impact if the experience of the US and France is anything to go by. The consensus view seemed to be that there was never going to be a miracle cure and that the Chancellor cut his cloth accordingly.



  • Chief Secretary to the Treasury, Danny Alexander, dismisses talk of a ‘triple-dip’ recession for the UK
  • UK growth to resume next year but at slower rate

One unpleasant number last week came in the form of data showing that Britain’s manufacturing output had slumped by 2.1% in the year to October, according to official statistics. The poor data followed figures on Thursday which showed that the UK’s trade deficit had widened in October too. In response, some economists started talking about the prospects of Britain entering a third economic setback. “Triple dip watch starts here” was the opinion of Scotiabank economist Alan Clarke. That view was firmly rejected by Chief Secretary to the Treasury, Danny Alexander. But adding to the pressure was the OBR forecast that the economy was set to shrink in the final three months of 2012. The OBR growth forecasts show that, despite the UK economy’s return to growth in the three months from July to September, in the final quarter the economy will shrink again by 0.1%, before growth returns in 2013. The UK would experience a triple-dip recession if it had another two quarters or more of negative growth before the economy finally recovers from the 2008 recession.

Responding to questioning over the weekend about the likelihood of the UK facing a triple-dip recession, Mr Alexander said: “The OBR forecast is that the final quarter of this year would be negative, but that we would see positive growth slowly returning in every quarter of next year. That would suggest that we’re not going to have that [two negative quarters] happening. But it is an uncertain world out there. We’re seeing continuing problems in the eurozone, but I’m happy to rest on the OBR’s forecast, which is a bounce-back from the Olympic boost we saw in the third quarter causing a small negative in the final quarter of this year, but then steady growth slowly starting to return next year and the year after that.” With many City economists doubting the forecasting ability of the OBR, given its poor track record to date, Mr Alexander will no doubt be hoping that the OBR is not being too optimistic once more.


Compare and contrast

  • Will 2013 break the mould of recent years?
  • Leading economist John Greenwood shares his views on the outlook for the UK economy
  • Investors should focus on good quality, income-generating assets

As 2012 draws to a close, it’s a good opportunity to start thinking about next year and whether there is a real prospect of sunnier times ahead. Not that investment returns have been disappointing per se but, as we have discussed, the economic backdrop remains very challenging. Leading economist John Greenwood of Invesco Ltd recently summed up how he saw the situation. “My starting point is to focus on the progress being made with balance sheet repair: the overwhelming macroeconomic theme in the major developed economies. If we compare and contrast the US and UK, the US private sector has made good progress with deleveraging whereas adjustment in the UK private sector has been slower. One thing both have in common though is that public sector debt continues to rise as a share of GDP. By definition, balance sheet repair is a slow process which in my view is likely to be spread over two parliaments of pain. In this environment there remains an appetite in the financial markets for perceived ‘safe haven’ assets. It’s worth looking at how the two economies have dealt with the same problem – illustrated by the two charts below.






Source: Thomson Reuters Datastream, 27 November 2012

“As the left-hand chart shows, in the US private sector, debt as a share of GDP peaked in the third quarter of 2008 which then led to ‘Phase 2’ when deleveraging began. Most private sector debt reduction has been in the financial sector as a result of three main developments. First, banks have re-capitalised via the US government’s Troubled Asset Relief Programme. Secondly, mostly during 2009/10, banks have also engaged in debt forgiveness, writing off loans, coupled with reduced lending. Since then though bank loans have been growing again as they cautiously shift from risk aversion. Finally, assets of the ‘shadow banking sector’ [finance companies, funding corporations, money market funds et al] have fallen by a third to around $10 trillion. My view is that the US financial system is approaching the end of the deleveraging process. US households have also been successful in reducing their debt, although some 20% of mortgage borrowers are still in negative equity but there are signs now of increased borrowing again. Corporate balance sheets remain in good shape with ample levels of cash so, overall, the private sector has made good progress. Conversely, public sector debt continues to grow and this is the backdrop to the US ‘fiscal cliff’ which I believe will see a political compromise but also cause some drag to growth.

“If we now contrast the US situation with that of the UK, it is clear to see that there has been much less overall private sector deleveraging here. The right-hand side chart shows that private debt relative to GDP remains very high and little changed from its peak of over 800%. It is important to note that the high ratio is distorted by the large size of the UK financial sector and its importance in cross-border financial intermediation. As in the US initially, UK banks are reducing their lending, which is part of the process of strengthening financial sector balance sheets; and whilst more remains to be done, the banks have made good progress. In the household sector, UK debt relative to disposable income has fallen from around 175% to 146% and Britain’s debt-to-income ratios are now lower than those in either Canada or Australia. But given that the starting point was from a much higher point I still think further deleveraging is likely.

“What is my message for investors? I believe that the focus of asset allocation remains on the continued search for yield. The current sources of quality income flows are equities with strong, growing dividends, corporate bonds with high coupons and sustainable profits, and real estate with secure rental cash flows from strong tenants.”

John Greenwood is Chief Economist at Invesco Ltd. Invesco Perpetual.

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