Help to Buy scheme is central to the UK government’s economic strategy

In this week’s bulletin:

  • Debate focuses on the UK economy and its recovery
  • The UK business secretary says Bank of England is operating a “capital Taliban”
  • Help to Buy scheme is central to the UK government’s economic strategy
  • Investors enjoy record quarterly dividends from UK companies.

 

Buoyed: by George not the Taliban

A baby boy named George was born. Britain’s business secretary launched war on the Taliban in the Bank of England for not doing enough to buoy the economy (while the archbishop of Canterbury picked a fight with payday lenders Wonga). And Chancellor George Osborne declared the UK was in recovery.

As Britain, a year on from its Olympic reverie, basked in summer and the royal birth, debate continues to circle around the state of the UK economy, its health and how best to aid its recovery. Britain’s economic turnaround, as for the rest of the developed world, hinges on central bank policy. Meanwhile, equity markets are enjoying strong growth on the back of loose monetary policy. And questions remain over whether lenders are doing enough to support business in the UK, as elsewhere.

Equity markets last week were buoyed by signs of economic recovery for the UK, Europe and the US. However, a survey of Chinese manufacturing activity provided further evidence of a slowdown for the world’s second-largest economy. As growth in China and emerging markets loses pace, the developed economies are improving. The northern hemisphere’s central bankers will have time in their August retreats to ponder what policy can harness or stifle these new cries of life.

Despite an uplift from promising official figures for the UK economy, the FTSE 100 was down 1.14% over the week to 6,555, declining for the five-day period for the first time in a month. Although below its May peak of 6,875, the FTSE 100 is still up by more than 14% from the start of 2013.

In Europe, the FTSEurofirst 300 index fell 0.3% over the five-day period to 1,205. Disappointing second-quarter corporate results over the week knocked European exchanges, after the index reached a seven-week high earlier on 22 July. The Eurozone’s purchasing managers’ index suggested a return to growth for the region in July for the first time since the start of 2012.

The S&P 500 was also hit by mixed corporate results, which reversed the recent strong rise of the US equities index towards the 1,700 level, resulting in a 0.62% fall over the week. Markets this week will again look to a Federal Reserve policy meeting and further US economic data for further signs of whether a scaling back of the quantitative easing (QE) programme will start as early as September.

In Tokyo, the Nikkei 225 dropped 3.15% last week, following five weeks of gains. However, Japan’s consumer price inflation index showed a 0.4% rise in June, which is the fourth monthly rise in a row and its highest level since November 2008. Japan’s re-elected government and central bankers are looking to haul the economy towards a 2% rate of inflation and away from the state of deflation that has stifled growth for most of the last 15 years.

World markets this week will edge nearer to the August lull in confident spirits, despite the Chinese slowdown and what are still early recovery signs for the developed economies. Bank of America Merrill Lynch has reported that more than half (52%) of fund managers surveyed expect the global economy to strengthen over the coming year, compared with 48% in May, despite 65% of participants expecting China’s economy to weaken. The growing appetite for equities reflects investor conviction that developed economies will achieve growth, the survey concludes.

 

It’s a recovery!

Britain’s business secretary Vince Cable last week rounded on Bank of England for operating a “capital Taliban” in Threadneedle Street. By this, Cable and supporters in the Treasury meant that capital requirements for banks are curbing lending to UK business. However, Britain’s economic recovery is looking more like a fact. The Office for National Statistics released figures showing that the UK economy grew by 0.6% in the second quarter, double the 0.3% growth in the first three months of the year.

Chancellor George Osborne said the growth reading showed the economy is “back on track”. The quarterly rise is still slight and comes as pay levels continue to fall and bank lending is flat. UK exports and manufacturing levels are low, while service sector output, which makes up three-quarters of the economy, grew by 0.6%.

However, the Goldman Sachs UK Current Activity Indicator, which is designed to distil business survey and labour market data, rose in June to a level equal to 1.7% annual growth, from 0.5% at the start of 2013. A recent Confederation of British Industry survey pointed to a pick-up in new domestic and export orders, while inward investment is the strongest in Europe. Although the UK growth rate is 3.3% below its peak level in 2008 before the crisis, a rise of 0.6% is a firmer sign of this recovery.

Britain’s economy does face challenges. The UK banking sector has shrunk after the financial crisis and seems unwilling to lend to help stimulate the economy. Many households and companies remain burdened by debt, with some only functioning because of record-low interest rates. Meanwhile, negligible interest rates continue to hamper savers and investors.

Bank of England governor Mark Carney will need a higher growth rate to achieve what he calls an “escape velocity” to power the UK economic recovery. However, Carney has a growth figure to build on. The average annual rate of growth since the 2008–2009 recession has been just 1%, compared to a rate of more than 3% needed for recovery.

Carney at his first Monetary Policy Committee (MPC) at the start of July persuaded his colleagues for now not to engage in further QE. And he has tempered markets, warning them not to anticipate interest rates to rise within the next two years.

The MPC meets again this week, but the crucial gathering for the UK economy will be on 7 August. The new governor at this first quarterly inflation press conference is expected to lay out how the forward guidance strategy he deployed to help Canada’s economy recover will be used to stimulate the UK. The MPC will need to demonstrate what thresholds, such as unemployment levels or GDP growth, it will set to dictate interest rate policy.

An indication of what conditions will be needed to keep borrowing costs low will assist the UK economic recovery and keep a hold on financial market expectations. The minutes of the July MPC meeting also mentioned a “mixed strategy” to boost the economy. In addition to the £375 billion QE programme, this could involve other schemes to encourage business growth, alongside the Funding for Lending Scheme. Despite Cable’s protestations against jihadists on Threadneedle Street, there are signs the Bank is looking to extend rather than restrict its support of lending to help the recovery.

A beneficiary of economic growth and an increase in lending is likely to be the middle-tier companies of market capitalisation less than £3 billion and more than £250 million. UK mid-cap equities have performed well in 2013, with the FTSE 250 up around 20% compared with a 14% rise for the FTSE 100. The FTSE SmallCap index is also up 17%.

 

Buy-to-elect?

The UK government is pressing on with its Help to Buy scheme. The policy sets housing at the centre of government plans for economic recovery. Although the latest package is not aimed at the wealthy elite, it will add stimulus to the UK housing market.

Last week Osborne revealed detail of the mortgage guarantee scheme due to start in January. This builds on the Help to Buy equity scheme launched in April, which provides a loan of up to 20% of the value of a new-build to buyers with a 5% deposit. The new £12 billion scheme will allow buyers of all properties to borrow on those terms.

The new Help to Buy scheme starts on 1 January 2014 for households with an income of less than £150,000 on a property of up to £600,000 in value. Existing owners will also be allowed to use the scheme to remortgage. The lending rules exclude buy-to-let landlords, second homeowners and buyers with no UK credit history.

The Help to Buy scheme is driving a housing-market and house-building boom. Estate agents say last week’s measure will buoy the market for homes priced between £450,000 and £600,000. The scheme transmits the effects of loose monetary policy to the wider economy. However, there is concern the scheme will fuel a housing bubble, with business secretary Cable voicing his misgivings over the project at the weekend.

The year-old Funding for Lending Scheme has also helped lower mortgage rates. George Osborne’s policy is creating an environment for house prices to rise, which may encourage a feel-good factor for voters. However, both schemes have pushed saving rates down sharply across the market as banks, with access to cheap government loans, do not need to attract savers’ money to lend out.

 

King Compound

Investors looking for income above inflation will be cheered by the news that British firms have recently paid out a record level of quarterly dividends. Capita Registrars’ latest UK dividend-monitoring figures show British companies handed back £25.3 billion in gross dividends to shareholders during the second quarter. The dividend payments are 7.6%, or £1.8 billion, more than the same period in 2012.

The second quarter brought a series of special dividend payments, which contributed to the quarterly total. However, these were short of the £1.5 billion total over the same period last year. Capita reported a lower rate of special dividend pay-outs compared with the first six months of last year.

The mining sector paid the highest level of dividends over the second quarter, while the pharmaceutical sector paid the lowest. A total of 246 companies paid a dividend in the second quarter, while 193 increased or started payments and only 33 cut or cancelled them.

Dividend growth reflects underlying economic growth. Many British companies also generate global revenues and profits, which reflects growth in other regions. Capita said that the outlook for pay-outs from sectors such as financial services looked positive.

Recent UK equity market research from Société Générale analysing performance over the last 30 years to the end of 2010 has shown that the market delivered an average annual return of 12%. The majority of this return (11.3%) came from dividend yield and growth.

Capita suggests there will be a slight slowdown for dividend growth. However, opportunities for rising income should not be overlooked, following Carney’s hint that interest rates are likely to remain unchanged over the next two years. Also those investing for income need to remember that share prices and dividends do not always move in the same direction.

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