Statistics suggest that the UK economy is showing early signs of recovery

In this week’s bulletin:

  • Global markets grasp on to positive US employment data
  • Japan’s $1.1 trillion pension fund shifts to equities prior to central bank policy meeting
  • Statistics suggest that the UK economy is showing early signs of recovery
  • Government sale of Lloyds Banking Group stake would inject £17 billion into public finances


Watching Washington

·         Global markets grasp onto positive US employment data

Volatile price swings continued to ricochet across global equity markets last week, although US employment numbers brought a late upward lift to each of the main markets apart from Japan. Investors grasped at Friday’s US monthly official figures that showed a moderate rise in employment during May. The positive influence of the US Labor Department report on global equity markets again highlighted investors’ preoccupation with Federal Reserve policy and the future of its $85 billion-a-month asset purchase scheme.

The S&P 500 Index registered a 0.55% gain on the news, building on a 0.3% rise the previous week. The market-friendly US jobs data also triggered a 1.3% rise for the Eurofirst 300 Index on Friday, although the lift did not keep the index from a third successive weekly decline, with a drop of 1.8%. London’s FTSE 100 registered a 1.2% day rally on the US workforce statistics, but the index still took its biggest weekly dip since November, with a 2.6% fall.

In Tokyo, the Nikkei 225 underwent another week of turbulence, losing 6.51% over the week, but has still risen 9% since 4 April when Japan unveiled it stimulus measures, and 30% year to date. At one point on Friday morning the index was 20.5% down from its five-year peak in late May, although Japan’s Government Pension Investment Fund (GPIF) move to take on more equity exposure prevented the index closing with a 20% decline that would indicate a ‘bear market’. The GPIF said it would lift its domestic stock allocation to 12% from 11% and lower Japanese government bond holdings to 60% from 67%.

Monetary policy and quantitative easing (QE) programmes in the US and Japan, together with the UK and Europe, remain the dominant factor in global markets. Investors are reacting to the slightest nuance or indication of what governments and central bankers intend to do next. With Federal Reserve policymakers scheduled to next meet on 18 June, and a Bank of Japan policy meeting this week, equity markets are expected to remain prone to volatility.

Full employment, together with an inflation target of 2%, makes up the dual mandate that underpins the US stimulus programme.  Although there is no official US target figure for full employment, Federal Reserve chairman Ben Bernanke launched the third round of the QE package in September 2012 with a pledge to continue the scheme until the jobless rate is 6.5%. The health of the US labour market is a key indicator of how much, and for how long, its central bankers will sustain this latest round of bond repurchasing also known as ‘QE infinity’.

The actual growth of 175,000 in the US official non-farm payroll, that animated global markets at the end of last week, was ahead of forecasts of 163,000 new jobs. However, this was not enough to prevent the unemployment rate in the US growing to 7.6% from 7.5%. Although the inching up of the official number of US citizens that are out-of-work spells bad news for the underlying health of the world’s largest economy, it means Washington policymakers have edged further away from the triggers that could bring the end or gradual decrease of its liquidity programme.

Market commentators have labelled the US Labor Department’s May unemployment figure a ‘Goldilocks’ number. “US job growth is neither too hot nor too cold – and the market’s fears about QE tapering have dissolved like sugar in a bowl of warm oatmeal,” explained Marcus Bullus at MB Capital. Investors have ringing in their ears Bernanke’s statement last month that the central bank will maintain a “highly accommodative” monetary policy, with a possible scale-back of the bond purchase scheme if job data improves in coming months.


Rising Japan

·         Japan’s $1.1 trillion pension fund shifts to equities prior to central bank policy

Global markets have turned their attention this week to the Bank of Japan’s June policy board meeting that concludes tomorrow (Tuesday 11 June), with debate expected to centre on responses to market volatility including money market operations and asset purchases.

The policy meeting follows the move on Friday by Japan’s public pension fund GPIF, which is the world’s largest, valued at $1.1 trillion, to make its most significant asset allocation shift since 2006. The GPIF has taken on more risk and more stocks and moved away from Japanese government bonds. The initiative came after a draft strategy document last week showed Prime Minister Shinzo Abe is considering a push for public funds to increase returns to revive the economy.

Despite the reweighting away from government bonds, these remain the fund’s staple investment, while other global public funds have adopted more equities. For example, Canada’s $183 billion asset Pension Plan Investment Board, and Norway’s $686 billion Government Pension Fund Global have allocated most of their money to equities. Although GPIF has hit return target averages of 2.4% a year, the Norwegian government oil revenue pension fund has delivered almost 6% a year over the past decade.

Prime Minister Shinzo Abe last week outlined his growth strategy for public savings to fight deflation and sluggish economic growth. GPIF and other Japanese public funds have a total of $2 trillion in assets. His ‘Abenomics’ QE programme has pushed through $100 billion in government spending, with the Bank of Japan behind a $1.4 trillion stimulus effort to achieve 2% inflation within two years.

Japanese government data released this morning also showed the world’s third-largest economy grew 1% in January-March on improved global growth and Abe’s stimulus policies. Other data released today showed Japan’s current account surplus doubled in April from a year earlier, while bank lending rose to its highest level in over three years. Eyes are now on the Bank of Japan measures to reduce volatility in the bond market at its two-day policy meeting.


Green shoots?

·         Statistics suggest that the UK economy is showing early signs of recovery

UK Chancellor of the Exchequer George Osborne declared in April that the UK economy is ‘healing’, since when there is evidence of rising house prices, increased car sales and improved consumer confidence. And April UK trade figures also give further substance to the claims, with the overall trade balance narrowing to £2.6 billion from £3.2 billion. The narrowing in the deficit suggests that net trade might be playing a role in the apparent acceleration in economic growth. However, exports are still mediocre and the eurozone still faces recession, which will dampen any significant trade contribution to any UK recovery.

Recent surveys suggest that economic growth will have picked up in the second quarter to reach 0.5%, after 0.3% in the previous three-month period. Data from the construction sector shows that its activity rose in May for the first time, if marginally, since October last year. The pick-up in housebuilding follows the government’s Funding for Lending Scheme (FLS), which has cut mortgage costs, and the Help to Buy loan scheme introduced in April, with the second bringing Treasury guarantees to £130 billion of new mortgages from 2014. Halifax reported that house prices rose by 2.6% in the three months to May, which is the biggest increase since September 2010. Morgan Stanley, the investment bank, anticipates a growth in prices of 8% by the end of 2014.

The developments come as Sir Mervyn King steps down from the Bank of England, with his wish to expand the QE programme unrealised.  Incoming governor Mark Carney is due to start on 1 July, and any new stimulus package the Canadian central banker has in mind will have to take account of the positive new data.

Meanwhile, British manufacturers are increasingly turning away from external funding to grow their businesses, despite signs that the cost of credit is easing, according to an Engineering Employers’ Federation (EEF) survey, relying instead on internal funds to support investment because of the banks’ criteria for fresh borrowing.  A record high of 52% of companies polled by the manufacturers’ organisation on credit conditions said they had no need to borrow to support their business. The EEF survey comes as the UK government and the Bank of England attempt to increase credit to small businesses through the FLS.

The organisation suggested that an improvement in lending may be starting to emerge in the second quarter, although this is largely to big business. The balance of companies who said the cost of credit was rising rather than falling sank to 2%, the lowest since the survey began in 2007.

EEF called on the government to consider ways of doing more to stimulate banking competition for smaller companies. Options include making it easier for firms to switch banks and lowering the set-up costs for new banks. Banks are drawing down funds from the FLS but cutting net lending as they run down pre-crisis loans.


Lloyds unleashed?

·         Government sale of Lloyds Banking Group stake would inject £17 billion into public finances

The weekend saw reports that UK Chancellor of the Exchequer George Osborne is poised to launch an early sale of shares in bailed-out lender Lloyds Banking Group. The UK government is also understood to have plans to sell-off shares at a later date in the Royal Bank of Scotland (RBS). The sale of the state’s 39% stake in Lloyds would raise up to £17 billion for the Exchequer.

Osborne is expected to use his annual policy speech to London’s business community at Mansion House on June 19 to detail the sell-off, with an eye on the looming 2015 election, although UK Financial Investments, which manages the government’s bank stakes, has opposed a quick sale. The sell-off is likely to take the form of an offer to the public to buy shares at a discount to the price available to pension funds and money managers. There would be an incentive for investors to hold on to shares for several years. It is not clear if all the shares would be sold in one or a number of tranches.

In this morning’s news were reports that the UK Treasury is considering selling a first 10% stake in Lloyds before the end of the year. The process is expected to be executed via a placement with institutions, although a significant offering to retail investors at a discounted price is also feasible. Osborne aides say he is in “no particular rush” to sell down the government’s 82% RBS stake.

The UK’s Policy Exchange think-tank today published a report supporting the sale in both Lloyds and RBS. However, the group, which is close to Conservative Party decision-makers, argues for a radical pre-election share distribution to the public, giving up to 30 million UK citizens shares in the two banks. The scheme would involve a transfer of shares worth £1,100 to £1,650 without upfront payment to members of the public, who would keep any profits and return the original cost to the government when they were sold on.

The Parliamentary Commission on Banking Standards is also expected to publish its final report this week, which will include suggestions that RBS is divided into a ‘good’ and a ‘bad’ bank to ring-fence toxic assets, and allow the former to lend more freely. The lender underwent restructuring after the government used £45.8 billion in 2008 to keep it afloat, with UK taxpayers holding an 81% stake.

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