IMF applauds the Bank of England’s ‘Funding for Lending’

In this week’s bulletin:

  • IMF warning on global growth prospects and concern about Japan’s banking system dampens investors’ mood as US earnings season gets off to a slow start.
  • Italy loosens the austerity screw with surprise tax cuts as consumer spending shows its largest ever yearly fall.
  • UK economy looks set to return to growth in third quarter as positive house lending and High Street data suggests improving consumer confidence. IMF applauds the Bank of England’s ‘Funding for Lending’ scheme aimed at boosting small businesses.


Market Eye

  • Global equity markets retreat as investors turn more cautious following the IMF’s report on the outlook for world growth
  • Markets disappointed as US earnings season gets off to a slow start

Investor optimism came under pressure last week despite good news on the US economy where data confirmed steady, if not spectacular, growth for the world’s largest economy. A downbeat forecast for global growth prospects from the International Monetary Fund (IMF) put a dampener on the previous week’s positive outlook, causing investors to become more cautious. The mood was not helped by the news from Wall Street where the third-quarter earnings reporting season has just kicked off, led by US aluminium producer Alcoa. The US giant announced a loss of $143 million which, whilst better than expected, was coupled with a warning that global demand for commodities was slowing due to falling demand in China. Conversely, fast-food operator Yum Brands said weakness in China was being offset in part by a programme of store openings, which helped earnings grow 25% compared to a year previously. Lacklustre earnings have mostly been discounted, according to analysts, but investors’ reaction appears to undermine, in the short term, the bulls’ case that there might be more surprises on the upside. So by the end of the week, most equity indices reversed some of the previous week’s gains with the exception of Hong Kong and Shanghai where investors took a more positive view.


IMF downgrades growth

  • IMF cuts growth forecast for world economy to 3.3% and warns for future outlook if policymakers fail to act
  • Italy eases back on austerity as Mario Monti plans tax cuts
  • Glut of Japanese government bonds weighs on Japan’s banks

“The intensity of the euro area crisis has not abated as assumed in previous projections.”

IMF World Economic Outlook

In its latest assessment for the global economy, the IMF has sharply downgraded its growth forecast for large parts of the world economy and at the same time warned of a more severe contraction if policymakers in Europe and the US mishandle current threats to global prosperity. Whilst the report failed to highlight anything new – ongoing concerns about the eurozone, the US ‘fiscal cliff’ and slowing growth in China have been on investors’ radar screens for some while – the tone was sufficiently downbeat to unsettle the markets. Warning about the ongoing euro crisis, the IMF said in its World Economic Outlook that “Risks for recession in the advanced economies are alarmingly high”.

The report chimed with other independent forecasts by saying the IMF expected the economies of Spain and Italy to contract this year and next as a result of fiscal austerity doing more damage than “expected”. Elsewhere, Europe’s problems have combined with a credit cycle downturn in Asia and Latin America. The IMF does expect the US to continue its slow pace of growth into next year but said the country needs to map out a credible fiscal plan to address the current deficit. Last week, the US Federal Reserve’s Beige Book – a survey of business activity across the 12 districts of the US Federal Reserve system – found that all districts grew in both August and September after slowing in the summer and are in little danger of falling back into recession. Based on past experience, it is unlikely that the Federal Reserve will rely on backward-looking anecdotal evidence to formulate policy. This means that the planned open-ended $40 billion programme of QE is almost certain to continue for the foreseeable future, helping support market sentiment.

The issue of austerity policies impacting more negatively than expected was a theme also taken up by the Chancellor last week, when he acknowledged that the damage to the UK economy by the financial crisis was worse than originally thought and subsequent plans to cut the deficit thus had a greater impact. With policymakers under increasing pressure to introduce growth plans, it was Italy’s turn last week to offer some relief to its citizens, after swingeing tax rises and spending cuts sent the economy into a tailspin by creating the largest ever yearly fall in consumer spending. Italy’s Prime Minister, Mario Monti, announced a surprise reduction in income tax alongside spending cuts in next year’s draft budget, signalling an easing of austerity policies. After the tangible effects of vigorous budget discipline Mr Monti said, “We can allow ourselves some moderate relief”.

There was one other area of note from the IMF: it also took the opportunity to sound the alarm over the stability of Japan’s banking system; saying its current huge, and rising, government-bond (JGBs) holdings leave it vulnerable to a rise in interest rates. Currently, Japan’s banks hold around 25% of their total liquid assets in JGBs. After years of low growth and mild deflation, Japanese government debt has ballooned to around 200% of GDP – the highest in the developed world and exceeding even that of Greece. However, although JGBs are still regarded as safe according to the IMF, any increase in interest rates would impact negatively on their capital value which in turn would hurt the banks’ liquidity. Years of low interest rates have, though, failed to stop the yen being seen as a haven currency and its inexorable rise has, as discussed last week, hurt its export-led economy. Once again, the Japanese stock market was one of the worst performing last week, falling almost 4.0% as investors continued to fret over low growth and lack of direction from policymakers.


UK to return to growth

  • UK economy likely to have returned to growth during third quarter
  • Housing market lending and high street sales perk up as consumers’ confidence returns
  • Hopes that ‘Funding for Lending Scheme’ will boost growth

The IMF also forecast that Britain’s economy would shrink this year by 0.4%, instead of achieving growth of 0.2% predicted a few months earlier, which seems to fit with other projections. In its latest report, the Ernst & Young Item Club says that, although the UK’s economy will rebound in the second half of the year, it still predicts that the economy will contract by 0.2% over the year as a whole. The Item Club’s quarterly forecast, which is produced using the same model as the UK Treasury report, says that the country’s trade performance has been deeply disappointing and this has offset the positive effects of lower inflation and rising employment. It goes on to forecast that economic growth will be 1.2% next year and 2.4% in 2014 and 2015, fuelled by higher consumer spending as a result of falling inflation and a better jobs market. It says these improvements will be boosted by a recovery in the mortgage and housing markets next Spring. However, it warns that a move back to balanced growth over the medium term is highly dependent on economic developments outside the UK, including in the US where taxes are set to rise and government spending cut – the so-called ‘fiscal cliff’ – unless a political deal is struck soon.

In terms of evidence as to how the UK economy is doing, data remains mixed but with an increasingly positive slant. According to the Office for National Statistics, output in Britain’s construction sector contracted in August, implying that it will fail to make a strong contribution to overall economic production in the third quarter. “The drop in construction output in August means that construction output will likely have been essentially flat quarter-on-quarter,” said Howard Archer, chief UK economist at IHS Global Insight, adding, “the best interpretation… is that at least construction did not contract enough to be a noticeable drag on third-quarter production.” But things may have already started to improve. Lending to homebuyers rose 12% in August and was up 11% on the same period last year, according to the Council of Mortgage Lenders. A total of 55,300 loans worth some £8.4 billion were advanced for house purchases. Hopes of an economic recovery have also been given a lift after September retail sales rose at their fastest pace this year: up 1.5% year-on-year. The British Retail Consortium’s Director General, Stephen Robertson, commented, “Customers are still cautious but less fearful than they were” and “there are signs that people are acclimatising to the new realities. Difficult has become the new norm.”

The IMF also applauded the Bank of England’s new ‘Funding for Lending Scheme’, describing the plan to increase the flow of credit as “innovative”. The hope is that banks will increase lending to the key growth areas which could help the economy, particularly small businesses. A recent report highlighted the fact that Britain’s small and medium-sized companies contribute 60% of private sector jobs and nearly half of turnover. So notwithstanding the slowdown during the Spring, hopes are high that the UK will be able to return to growth, if it hasn’t already, during the rest of the year and into 2013.

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