This week’s Bulletin:
- US and European equity markets retreated from recent six-month highs as concerns over Greece re-asserted themselves. Greece’s lenders are demanding more cuts to this year’s budget plus a written pledge that politicians will adhere to the cuts irrespective of the outcome to the upcoming elections.
- Despite violent protests by Greek workers, the additional cuts were approved by the country’s Parliament yesterday and today, equity markets have responded positively to the news.
- Last week the BoE announced the resumption of its quantitative easing programme, saying it planned to purchase another £50bn of government bonds as part of measures to avoid the UK economy slowing further.
- QE has come under criticism from a number economists who doubt its effectiveness and we discuss the merits or otherwise of the Bank’s latest plan to print more money.
- Return of the Bull – this year, many of the world’s stock markets have already erased losses seen last year as investor sentiment improves causing equity and corporate bond prices to rise. We look at the reasons behind the change in sentiment.
- The likelihood of higher-rate pension tax relief being scrapped appears to have increased following comments made over the weekend by Liberal Democrat Chief Secretary to the Treasury, Danny Alexander. Mr Alexander claims that the cost of the relief is unaffordable and his comments come as coalition ministers plan to meet this week to discuss tax plans ahead of the March 21 Budget.
· Greece approves further austerity measures
· Western markets retreat from six-month highs
American and European stocks took a breather last week and fell back slightly from their recent six-month highs as investors temporarily moved to the sidelines, citing renewed concerns over Greece as the reason. Inevitably, the latest twist in Greece’s long-running bailout saga made markets twitchy; although the view amongst analysts was that any default would come as no surprise to the markets and that any potential fallout was being priced into share prices. With the 20 March deadline looming fast – Greece has to find around €14 billion to repay a maturing bond – lenders upped the ante last week, telling Greece that it had to come up with €325 million of additional cuts to this year’s budget. The EU and IMF also demanded that the country’s political leaders pledge in writing that they will uphold the reform programme, even after elections due in the spring. In response to threats of more job losses and pay cuts, Greek workers took to the streets and six members of the Greek Cabinet resigned in protest.
However, with the stakes so high it was no surprise that Greece was once more warned by its prime minister that failure to agree to the demands would lead to a disorderly default, with all the associated ramifications. However, yesterday Greek MPs approved the controversial package of austerity measures demanded by the eurozone and IMF in return for the €130 billion ($170 billion: £110 billion) bailout. Tens of thousands protested in Athens, where there were widespread clashes and buildings were set on fire. Prime Minister Lucas Papademos urged calm; insisting that the austerity package would “set the foundations for the reform and recovery of the economy”. Whilst the outcome was probably never in doubt, confirmation of the vote has given global stock markets a boost this morning as investors reacted favourably to the news and removal of this latest uncertainty.
Away from Greece, economic news was much in line with expectations, with some signs that the UK economy was seeing some pick up in activity following positive manufacturing output and retail sales numbers. This didn’t, however, preclude the Bank of England (BoE) from announcing its long-expected decision to embark on a further round of quantitative easing, which we discuss below. By the end of the week, Western markets fell back a little; whilst in Asia, a more bullish mood prevailed, enabling Tokyo, Hong Kong and Mumbai to advance by almost 1%. In the commodity markets, gold continued its retreat whilst oil prices touched almost $120 per barrel.
Bank presses the button
· MPC announces further £50 billion QE
· Debate continues over its effectiveness
As expected, the Monetary Policy Committee (MPC) voted last week for £50 billion more quantitative easing (QE). Since it started QE, the BoE has injected £275 billion into the economy – an amount equivalent to nearly 20% of Britain’s GDP – but it seems a majority on the committee believe that this is not enough. Just to recap, the reasons for QE are straightforward enough: the BoE buys gilts; this increased demand pushes down yields, as prices rise; and the cash should then find its way into the British economy via increased bank lending and increased consumer spending. The net result should be to boost economic growth. According to some, the benefits of QE have not been as transparent and evident as they should be; so last week the critics were lining up to say the Bank’s response is too little, too much or beside the point. Against this backdrop, it’s worth looking at the evidence to date before damning the BoE outright.
Firstly, interest rates are undeniably lower as a result of QE – the government’s cost of borrowing over ten years has fallen from a little over 3% to around 2%, saving around £23 billion according to latest figures from the BoE. Aside from the fact that the BoE has made a paper profit of £40 billion from the exercise, has the economy grown? Well it did initially but growth slowed markedly last year and it actually contracted in the last quarter of 2011. But it’s also true to say that lending by banks has hit government targets, according to the British Bankers Association – some £215 billion was lent to businesses last year, against a £190 billion target – although loans to smaller businesses fell short. One other area of concern was the impact on inflation – whilst much higher than its 2% target, inflation has started to fall backwards, with expectations of it being 3.4% once last year’s VAT rise drops out.
So, back to the critics’ views. It is difficult (though not impossible) to argue that the policy is both impotent and inflationary – after all, if it’s courting inflation, then it must be doing something. Former MPC member, Andrew Sentance, has stuck with his longstanding view that the policy would do much for inflation, but not much for anything else. Matthew Hancock, a former economist at the BoE and former chief of staff to the chancellor, is more circumspect, hinting in his emphasis on the need for ‘credit easing’ to get money flowing to ordinary businesses, in addition to anything decided by the MPC. Lastly, what about the argument that the BoE ought to be doing more? Last week some were expecting an injection of £75 billion, rather than £50 billion. The reason for a smaller amount is probably because the latest news from the real economy has been surprisingly good. As mentioned, the UK’s manufacturing output in December was 1% higher than in November and our trade deficit in that one month was the smallest since 2003. However, given that the eurozone supposedly slipped back into recession at the end of the year, it’s good and surprising news that our exports to that region have been steady – in fact, up 1% in December.
So, will this £50 billion make a difference? The BoE must think it will. Its latest estimates show that the first £200 billion raised the real level of national output by up to 1.5% and inflation by about 1.25%. As ever, the markets will have to be patient and wait for the evidence but, in the meantime, it looks like ultra-low interest rates are here to stay for some considerable time. Whilst bad news for savers, it is good news for those with mortgages and crucially, companies looking to borrow money to grow their businesses, which is just what the UK economy needs.
The bulls return
· Increased risk appetite sees strong start to 2012
· Investors see grounds for optimism in three key areas
Just in case you hadn’t noticed, global markets have been enjoying rather a good time so far this year. After a pretty difficult 2011, investors have taken a brighter view on the outlook for stocks and shares, enabling global indices to register some significant gains year to date – erasing, for the most part, losses seen last year. For example, whilst the index of the UK’s top one hundred shares fell 2.2% last year, as at the beginning of last week the FTSE 100 had advanced 5.8% so far this year. In the US, the S&P 500 is up 5% this year and significantly, re-entered a bull market by having risen 20% since the lows of last October. The world index has recouped all of its losses from last year whilst corporate bonds have also advanced. It’s worth noting that last year’s best UK asset class performer, gilts, have slipped this year due to an increased risk appetite on the part of investors. Of course, one has to be very careful when looking at such short-term numbers but it is still worth thinking about what may have fundamentally changed in recent weeks to account for such a change in sentiment.
There are three key areas where investor perception has changed latterly. Firstly, a reduced threat of a eurozone banking collapse and credit crunch. Secondly, US economic data has proved to be much more robust than expected. Lastly, it is unlikely that China will experience a ‘hard’ economic landing at its policymakers endeavour to slow its economy in a manageable way. Taking Europe first, it was only back in December that there was a sense of impending doom in the eurozone as a result of turmoil in Greece. Fortunately, after much pleading, the European Central Bank (ECB) rode to the rescue by providing huge loans to the region’s banks. The ECB lent almost €500 billion to around 500 banks for three years at just 1% and there is promise of more to come. As a result, the cost of overnight borrowing has dropped and yields on the government debt of the region’s most troubled economies have fallen too. There was an extra bonus last week when the European Banking Authority said that banks’ plans to raise capital by July were on track.
In the US there is a growing ‘feel good’ factor too. Unemployment is falling faster than hoped for as businesses recruit more employees – new orders poured into American manufacturers last month, driving the sector’s growth rate to its highest for seven months, continuing a 30-month expansion. As a result, order backlogs are now at a nine-month high, meaning manufacturers will have to expand capacity. With news that some of America’s largest companies – including Caterpillar and Carlisle – are repatriating jobs to the US, President Obama’s re-election prospects are improving daily; unemployment has fallen from 10% to 8.3%. Even the moribund housing market is showing some signs of life – spending on construction rose in December for the fifth consecutive month, to the highest level in almost two years, which has been boosted by the building of single-family homes. Exports have boomed too – in December they grew 14.5% to $2.1 trillion. Against this positive backdrop, investors have decided to invest more in equities – from a valuation perspective the S&P’s price-to-earnings ratio of 13.9 has been below its long-term average of 16.4 for the past eighteen months.
And lastly to China. The world’s second largest economy has enjoyed growth of around 10% per annum for many years but signs of higher inflation – especially food basics and housing – led the authorities to raise interest rates. Recent signs of a slowdown in these key areas has led to policymakers taking their foot ‘off the pedal’, allowing growth to resume once more as inflationary fears ebb. The economy is still expected to grow this year at around 8.5% and, taking a global view, the IMF is expecting the world economy to expand by a respectable 3–4% this year.
So, as these key uncertainties diminish, investors have decided that for now, the outlook appears far more positive than could have been hoped for just a few months ago and as a consequence markets have started to price-in this better environment. Of course, there is the usual caveat for every investor and that is too ensure your portfolio remains aligned to your overall attitude to risk and is sufficiently diversified by asset class, geography and also at a fund manager level too.
The possibility of changes to tax-relief on pension contributions appears to have come back on the agenda as a result of comments made by Chief Secretary to the Treasury, Danny Alexander. In an interview at the weekend Mr Alexander re-iterated the Liberal Democrats’ commitment to scrap or further restrict higher-rate pension tax relief;
“If you look at the amount of money we spend on pensions tax relief, which is very significant, the majority of that money goes to paying relief at the higher rate. [For those with] very large incomes who are paying very large pension contributions… the country cannot afford to give you all the tax relief.”
A proposal to scrap higher-rate pension relief was included in the Lib Dem manifesto but was not included in the coalition agreement. Mr Alexander said that scrapping pension relief altogether would save £7 billion whilst axing it for those earning over £100,000 would save £3.6 billion. The coalition meets this week to discuss tax plans ahead of the March 21 Budget.