In this week’s bulletin:
- Politics and markets entangle as energy and housing sectors come under scrutiny.
- The UK’s Autumn Statement comes amid growing confidence over economic recovery.
- Hard-pressed savers welcome the U-turn on the Funding for Lending scheme.
- Scottish plans for independence include a sovereign wealth fund for North Sea oil revenues.
Tilting at windmills
Politics and politicians are never far away from markets – and such proximity is often deemed as a risk in itself. However, in the five years since the collapse of Lehman Brothers and the financial crisis, politicians have worked closely and constructively with central bankers to steer the global economy towards recovery. But, as loose monetary policy has started to support genuine growth for the advanced economies, the solutions with which politicians and bankers have induced this recovery – austerity, low interest rates and quantitative easing (QE) – have created anomalies that are now entangling markets with politics.
In the UK, for example, the cost of living and inflation are eroding wages, making rising energy prices more onerous, and triggering political talk of price controls and U-turns over policy. In the Autumn Statement this week the UK government is expected to reduce the impact of its environmental schemes on household energy bills, following on from the opposition’s pledge to freeze bills for 20 months after the 2015 general election. The political uncertainty around the future of the ‘green tax’ element of fuel bills last week prompted German-owned utility RWE to cancel its plans for a £4 billion wind-farm project in the Bristol Channel.
The political vacillation over how to manage the unintended consequences of financial policy is creating unforeseen problems. With RWE share prices also down 12% this year and its profits set to halve next year, the rising political heat over UK energy policy and energy costs and uncertainty over green taxes has halted its wish to pour money into a complex, major renewable offshore energy project. Politicians, business and investors face another conundrum posed by the experiment in ultra-loose monetary policy and financial repression that is also gradually – if, for many, precariously – bringing advanced economies back to life.
While the utility sector is at the centre of an inflamed political debate over the cost of living, there are direct winners in the era of quantitative easing – including the UK property and stock markets. With Nationwide reporting that house prices are 6.5% higher than November last year, the coalition government has looked to the housing market to drive further growth for the UK economy, aided by its extended Help to Buy scheme. Talk of an overheated UK housing market and consumer borrowing has marked much of the public debate about the economy in 2013.
Last week, the Treasury and Bank of England unveiled an overhaul of the Funding for Lending Scheme (FLS) to dampen stimulus to the housing sector, removing mortgage lending to households and refocusing the scheme towards small and medium-sized businesses. FLS was introduced in August 2012 to help banks and building societies access cheap funds to encourage them to lend, which resulted in mortgage levels falling to record lows as lenders competed to offer the cheapest fixed-rate deals. The Bank said it did not think the UK housing market was heading for a bubble, but it does want mortgage lenders to apply more rigorous tests to ensure borrowers could repay their mortgages when interest rates rise.
Property market-related stocks have been strong performers on the London Stock Exchange over the last year. However, this trend went into reverse following the FLS decision as Barratt Developments lost more than 5% and Taylor Wimpey and Persimmon almost 7% on the last two days of the week. However, the ‘big three’ have gained 69%, 80% and 56% respectively this year. The FTSE 100 index also fell back slightly last week, in part from the falls for house builders, closing down 0.4% over the five-day period to 6,651 points. However, the index over the last year has gained 13%. Goldman Sachs last week forecast the index would hit a fresh high of 7,500 points in 2014, in light of the robust UK economic turnaround.
US equities also continued to edge up further over a trading week shortened by Thanksgiving Day. The S&P 500 index reached a record 1,814 points on Friday, although it fell back just before close to 1,806 points, closing the five-day period up by 0.1%. Retail stocks were the focus of activity for Wall Street, with the early signs of strong consumer demand fading before the early close for the seasonal shopping day Black Friday. However, the S&P 500 has gained a further 2.8% during November and 28% over the last 12 months.
Positive US housing data also buoyed market sentiment. However, the improved economic conditions are also fuelling market speculation that the Fed could start to taper its $85 billion a month bond-purchasing scheme before Janet Yellen takes over as chair of the Federal Reserve at the start of next year, while crucial employment figures are due out this week. With Goldman Sachs forecasting growth of 3% next year, the Fed’s challenge remains how to taper quantitative easing without causing financial conditions to tighten and bring a sudden end to the economic growth story.
In Europe, banking stocks continued to make gains last week, helping to lift the FTSEurofirst 300 index by 0.6% over the week to 1,305 points. The European index is up 16% over the last year. Equities also continued to rally in Tokyo, with the Nikkei 225 Average up 1.8% over the week and resting at 15,662 points at close on Friday. The index gained 9.3% in November, reflecting gains for its exporters as they benefit from a weak yen. The Nikkei 225 is up 67% over the last year as markets benefit from ultra-loose monetary policy.
Chancellor George Osborne will approach Christmas with extra cheer. Despite the earlier doubts over the reports of economic recovery, Britain is approaching what the Bank of England governor Mark Carney has referred to as its “escape velocity”. The third quarter was marked by a 0.8% expansion of the economy with further growth expected in 2014.
Osborne will unveil his Autumn Statement to parliament this week against this backdrop of growing confidence, with the UK markets also reflecting this positive mood. Sterling rose last week against the dollar, euro and yen, while the stock market continues its steady climb. However, concern still lingers around UK government bonds, with yields edging towards the 3% level since the middle of the year.
The challenge for Osborne and Carney is to generate economic growth while keeping interest rates, yields and inflation low. Fund manager PIMCO’s head of sterling Mike Amey says that the Bank will not lift interest rates until 2015 and possibly 2016. “The economy is not strong enough to withstand higher rates,” he argues. “Anchored interest rates will help support most of the market.”
The Lady’s for turning
Threadneedle Street’s U-turn on FLS is welcome news for Britain’s hard-pressed savers. Although interest rates have remained at 0.5% since 2009, the launch of FLS is widely accepted as having helped send savings rates to historic lows. The scheme made available £80 billion for banks and building societies to lend as mortgage loans, reducing the incentive to attract savers’ deposits to fund mortgage borrowing.
Banks no longer needed to compete to attract consumers’ cash and turned their backs on savers. Subsequently, cash accounts have struggled to beat inflation. The move may prompt lenders to raise money for the mortgage market through traditional methods and take notice of savers again.
With the banks now sitting on a pile of FLS money, an increase in mortgage rates is not expected immediately. Although some pressure is expected, this is not expected to stifle the property market. With Help to Buy supporting purchases, the housing market is expected to continue to strengthen. Carney said the FLS decision would keep the housing market on a sustainable path and ensure the broader economy continues to receive “the stimulus it needs to sustain the UK recovery”.
St. Andrew’s Day came and went as, perhaps, the more enquiring members of the UK digested the detail of a 667-page plan for Scottish independence. Alex Salmond, Scotland’s nationalist first minister, unveiled the document, Scotland’s Future, with much of the focus on the question of future prosperity and the wealth of the Scottish nation in or out of the 307-year-old political union.
The debate has centred on the moot issues from the continuation of monetary union to the carve-up of assets (in particular North Sea oil) and liabilities (the UK’s estimated £1.6 trillion national debt in 2015/16). But the white paper also commits to more generous pension benefits than the rest of the UK, and abandoning the increase in the State Pension age. (Although these measures will come at an extra cost to the Scottish electorate, the expense is offset by the earlier average age of death in Scotland.) The manifesto also proposes to create a separate Scottish regulator, which could require financial services to duplicate efforts for two regimes.
Nationalists want a sovereign wealth fund for oil revenues with a view across the North Sea to Norway. The Oslo government has reinvested North Sea oil revenues since 1996 into a fund that is now worth £470 billion (or equivalent to around £90,000 per Norwegian citizen). The long-term political vision behind the Government Pension Fund Global, which is Europe’s biggest investor in equities, is a salutary lesson to politicians on both sides of the border in the benefits that prudent and committed investing can bring in the long term.
Scots have a reputation, rightly or wrongly, for their parsimony. But it would seem that it is the German people who have kept alive this once admired virtue. OECD figures indicate that Germans save 9.9% of their income compared with just 5.8% for Britons. However, a recent Association of German Banks survey identifies national saving patterns eschew wealth creation – from property to equities and bonds – for ‘safe’ low interest rate savings.
Many want the Autumn Statement to do more for British savers. There have been mounting calls on government to provide more incentives to save to offset the parlous returns available from record low interest rates. Some argue that there should not be a limit on sums that can be put aside in a Cash ISA, while the British Bankers’ Association wants savers to be allowed to hold all of the current annual ISA allowance in a Cash ISA. With interest rates so low, this seems a questionable use of this valuable tax shelter. However, BlackRock’s head of UK retail Tony Stenning points out that the British also hold too much cash, focus on short-term performance and do not diversify investments sufficiently.
Although UK citizens are allowed to save in an ISA up to £11,520 each year, the average ISA subscription is just under £4,000, according to HM Revenue & Customs. Perhaps the British have shed old habits and learnt to spend, or just no longer feel they have spare money. Or much of our savings activity goes into property, the ownership of which marks us off from Germany. And, since the 1980s, home ownership has been a very politically driven British affair. Politics and politicians are never far from markets…