More positive news on the UK economy raises hopes that the tide may be turning

In this week’s bulletin:

  • Disappointing US payroll figures give markets a jolt
  • Central bank formalises a two-year timeframe for meeting its 2% inflation target and kick-starting the Japanese economy
  • As UK households continue to reduce their debt burden, more positive news on the UK economy raises hopes that the tide may be turning

 

Market eye

  • Disappointing US payroll figures give markets a jolt

The front page headlines this week have been dominated by two deeply worrying stories: the bellicose threats coming from the new leadership in North Korea and, closer to home, the Philpott family tragedy. On the economic front, the financial pages have similarly led with two stories: Thursday’s announcement by the Bank of Japan (BoJ) of increased monetary easing and Friday’s poorer-than-expected US non-farm payroll data which, so far at least, have had significantly opposing short-term impacts on the markets.

After several months of improvements in US employment statistics, Friday’s news that US employers added only 88,000 jobs in March (half the expected level and the lowest increase for nine months) triggered fresh concerns that the world’s leading economy may be slowing and was enough to send most of the world’s markets sharply lower. The FTSE 100 Index ended the week down 2.5% and the S&P 500 Index finished down a fraction over 1%. However, to put these into context, the two markets are up 13.4% and 16.4% over the past 12 months, including dividends, and a very healthy 7.1% and 15.8% respectively year to date (source: Financial Express, data to 5 April 2013). With the global economy taking two steps forward and one back, the insurance policy provided to investors by gilts was highlighted as yields on both UK and US government bonds fell to multi-week lows as demand increased. Perhaps surprisingly, another vaunted safe haven – gold – continued its disappointing run, falling another $30 to $1,567 per troy ounce. From an all-time high of $1,912 in September 2011 at the height of the eurozone crisis, gold has fallen by over 15% as investors’ risk appetite has increased.

In sharp contrast, the news that the BoJ is to embark on a massive round of quantitative easing sparked a huge rally in Japanese equities, with the Nikkei 225 jumping over 400 points to 12,833, a level last seen in 2008.

 

Bank of Japan follows the Fed

  • Central bank formalises a two-year timeframe for meeting its 2% inflation target and kick-starting the Japanese economy

Since the bursting of the post-war economic miracle in the late 1980s, Japan has suffered from two decades of falling wages and prices. On Thursday the new governor of the BoJ, Haruhiko Kuroda, announced a series of measures aimed at breaking free of this deflationary cycle, suggesting that the Bank is deadly serious this time. Previous attempts have always been accompanied by rhetoric attributing the deflationary environment to a range of factors other than the BoJ’s own actions: demographics, economic competition and the demand for credit being just three of them.

On a scale to rival anything introduced by the US Federal Reserve since the start of the financial crisis in 2008, the BoJ is to double the size of its balance sheet over the next two years in the hope that the purchase of government bonds will increase the level of cash in the financial system, boost equity prices and inflationary expectations and weaken the yen, creating the environment for a sharp improvement in the Japanese economy. This represents a significant step up in the QE programme; previously the BoJ was committed to buying just 10 trillion yen of additional government bonds next year, but that has now jumped to 70 trillion yen.

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The thinking goes that it will pay off to remove the expectation that deflation means deferring spending for another day, encouraging Japanese consumers to start saving less and spending more, helping domestic firms. Meanwhile, a devalued yen would provide further help to the world-renowned exports on which the country has relied for so long. Of course, the policy is not without significant risk of introducing too much inflationary pressure (notoriously difficult to rein in) and trigger a wave of similar devaluations by Japan’s rivals. The key to beating deflation will be the reaction of the labour market and the need for wages to rise commensurate to rising prices. Failure to achieve this will put a real income squeeze on consumers and more than likely precipitate a sharp consumer-led recession. Whilst central banks in most of the rest of the world have spent 30 years trying to prevent wage-price spirals, Japan is in the unusual position of needing to generate one. The two-year timescale over which the policy is to be enacted means that either way we won’t have too long to wait to find out if the plans have the desired effect.

 

 

Closer to home…

  • As UK households continue to reduce their debt burden, more positive news on the UK economy raises hopes that the tide may be turning

The start of the new tax year has triggered a series of changes to the tax and welfare systems in the UK that many regard as historic. Whether one agrees with the changes or not, behind all the headlines is the uncomfortable truth that the UK debt level will continue to rise for the next few years; and, as the Daily Telegraph reported, whilst Standard and Poor’s (one of the three ratings agencies) has reaffirmed the UK’s AAA status, it stressed that “we could lower the ratings if we were to conclude that the pace and extent of fiscal consolidation has slowed beyond what we currently expect”.

Debate over the continued need for austerity measures set against the competing voices calling for more steps to stimulate growth will continue over the course of this Parliament and beyond.

However, just as the start of the new tax year has, finally, been accompanied by a gradual thawing in Britain’s arctic weather conditions, so there are renewed signs that the economy is showing signs of springing (or limping?) back to life. The newspapers were full of good news stories about the continued renaissance in the UK car industry. Figures from the Society of Motor Manufacturers and Traders show that vehicle sales have now risen every month since last January, as healthy orders put paid to fears that superstitious motorists would be reluctant to buy ‘13’ plates. And at the top end of the market, Indian-owned Land Rover reported its highest monthly sales ever – perhaps the snow has increased our appetite for a 4-wheel drive.

The other traditional barometer of the UK economy – house prices – is showing a more mixed picture depending upon which indices are followed. House prices do appear to be increasing slowly although, with the exception of London and the South-East, they still remain below their 2007 peak. Of course, the flipside of any improvement is that rising prices make it increasingly difficult for first-time buyers to step onto the ladder. In a sign that investors believe that a lack of affordability will increase the numbers renting, the Prudential was amongst insurers and pension funds increasing its stake in the property rental sector.

On a similar theme, the Sunday Times noted that, whilst the government debt continues to rise despite (or because of) austerity measures, UK households have taken advantage of the opportunity brought about by record-low interest rates to pay down debt. According to the Office for National Statistics, debt when measured against income has fallen from a peak of 167% in 2008 to 141% at the end of last year. What level is sustainable is the question, given that further paying down of debt deprives the economy of much-needed demand. As always, it is a fine line between too much debt and insufficient demand.

And finally, as we see in the new tax year, investors are reminded of the benefits of using their various allowances – pensions, ISAs etc. – early, rather than leaving it until the dying days of March 2014. As a halfway house for these investors nervous of committing a lump sum and mindful of the potential for increased volatility in markets, drip-feeding money into the markets over the course of the year may be a route worth considering to gain additional peace of mind.

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