In this week’s bulletin:
- Eurozone and US debt ceiling take centre-stage again as political uncertainty sets the tone for markets
- Sterling slides further as a drop in UK manufacturing activity prompts renewed triple-dip fears
- EU plans to cap bankers’ bonuses put Chancellor George Osborne on the back foot
- Talk of negative interest rates sends out a message to savers.
Here we go again
· Italian (non-) election result puts eurozone back at the top of the agenda
Inevitably, and somewhat tiresomely, the ‘boomerang’ stories came back again last week to dominate both the headlines and the market mood. The eurozone and US debt resumed centre-stage and bankers’ bonuses even got in on the act. The week had begun with a sanguine response by markets to news of Moody’s downgrade of UK government debt. It was, after all, hardly a bolt from the blue, as the UK had been on negative watch since February last year, and the muted reaction seemed to confirm that markets had already priced in the loss of the AAA rating – the first time it has happened since the 1970s.
However, as news of the Italian election deadlock hit news wires on Monday afternoon, markets reacted negatively to the signs of renewed troubles in Europe. By the end of the day, stocks had suffered their steepest daily slide since early November, erasing the gains made by major benchmarks in February. What was notable, and for some perturbing, was that the non-result did not cause bigger waves in the markets. Although Italy’s FTSE MIB Index was down 3.5% on the week, the wider FTSEurofirst 300 Index was flat. After rising sharply in the immediate aftermath of the inconclusive election result, Italian government bond yields fell as the week progressed and the shock continued to fade; the 10-year bond yield was still hovering around 4.8% by the end of the week.
The fear is that, in their eagerness to downplay the risks, markets may be lulling Italian and eurozone leaders into complacency and inaction. Giving them more time to fix their problems is one thing, but it gives them more time to procrastinate as well. It was on 9 March last year that insistent investors pushed the yield on 10-year Greek bonds to 43.9%, and that worked. The European Central Bank’s offer of support was and is conditional on the need to repent. At €1.6 trillion, Italy is the third most indebted country in the world (behind the US and Japan); a fact that the country’s electorate appeared to have overlooked in delivering its anti-austerity message and handing 25% of its votes to a comedian.
“Mr Draghi never offered a solution to the eurozone crisis. He bought time for politicians to deal with the underlying causes of the crisis. The Italian electorate does not seem to want to use the time bought to do what is necessary. There is an argument that the Italian electorate needs to get up close and personal with the consequences of voting against austerity. It is certain that ECB intervention would come if Italy posed a systemic threat to the euro.”
Paul Mortimer-Lee, BNP Paribas
While another general election is a distinct possibility, it is far from clear whether any cobbled-together alliance of parties would continue Monti’s reform process. Some easing of the austerity programme imposed by Monti could reduce the depth of the recession; but if it was accompanied by a scaling back or reversal of the structural reform programmes, this would inevitably raise doubts about the government’s willingness and ability to deal with the economy’s fundamental economic problems.
Political uncertainty is well and truly back on the agenda; and having enjoyed relatively serene progress since Mario Draghi made his famous commitment, investors might be wise to anticipate higher volatility as more weight is placed on political news flow.
· Unexpected drop in UK manufacturing sparks more triple-dip fears
Back in the UK, the FTSE 100 Index extended its run of monthly gains to nine – the best winning streak since 1997 – as it advanced 1.3% in February and registered a gain of 7.9% since the beginning of the year.
At the end of the week, sterling slid below $1.50 for the first time in more than two and a half years on news of an unexpectedly sharp drop in UK manufacturing activity in February. Sterling has now fallen 8% against the dollar already in 2013. If the fallout from Moody’s downgrade was less dramatic than Chancellor George Osborne had feared, although it may well add further downward pressure to the exchange rate, news of the contraction in manufacturing came as a grim reminder of the task he faces in returning the UK to sustainable growth. Although the manufacturing activity is just one piece of data – next week’s purchasing managers’ index for the services sector will provide another useful clue – the news added to evidence that it is touch and go whether the UK economy will avoid a triple-dip recession.
“Even if the economy grows in the first quarter, it will still be miserable. Clearly, the MPC are talking the pound down at every opportunity. The UK needs to get export-led growth, and getting the pound down is probably a necessary precondition for that.”
Michael Saunders, Chief Economist, Citigroup
The evidence strengthens the case of those on the Bank of England’s (BoE) Monetary Policy Committee (MPC) who are arguing for more printing of money. It emerged last week that three of the nine members, including Governor Mervyn King, voted for more quantitative easing in February. Whilst it is expected that the MPC will keep policy on hold when it meets on Thursday, the case for further QE appears to have some extra momentum, and it should not come as a complete surprise if a further round of £25 billion is voted in this week. The manufacturing news and the increased chance of more asset buying by the BoE pushed 10-year gilt yields down to 1.89%.
Congress shoots itself in the foot
· No last-minute deal this time as US spending cuts come into force
The end of February marked another ‘line in the sand’ in the long-running political battle over US fiscal policy and, true to form, congressional leaders failed to arrive at any last-minute agreement to stop ‘sequestration’ – cuts totalling $85 billion to the end of September and $1.2 trillion over a decade. The ‘sequester’ decision was merely postponed from the ‘fiscal cliff’ negotiations at the end of 2012, when President Obama succeeded in raising taxes for the rich. This time, though, the Republicans refused to give ground on the deep cuts they were after. Economists anticipate the cuts could shave more than 0.5% off US growth this year and cost 750,000 jobs.
“We shouldn’t be making a series of dumb, arbitrary cuts to things that businesses depend on and workers depend on,” opined a frustrated President Obama. The next deadline for Congress is 27 March when a temporary federal budget that has kept the federal government running since 2012 is due to expire. What is clear is that the political uncertainty that looks set to pre-occupy markets in the weeks to come will not just come from the eurozone.
As if to underline the folly of the political brinkmanship on Capitol Hill, the US provided most of last week’s few bright spots in the global economy. Fourth-quarter US GDP data were revised to show growth of 0.1% on an annualised basis, compared with an initial estimate of a 0.1% contraction. In contrast to the UK’s numbers, manufacturing grew faster than expected in February, well ahead of expectations and suggesting that the economy had some momentum to help absorb the aforementioned spending cuts. US consumer confidence rebounded, reversing three months of declines as Americans began to adjust to the higher social security payroll taxes. US new home sales also reached a post-2008 high, surging 15.6% to 437,000 from 378,000 the previous month, helped by record low mortgage rates and a slowly increasing jobs market. With news that China’s manufacturing sector grew more slowly in February, it seems there is little strength elsewhere in the world if the US stumbles.
Bankers back in the spotlight
· EU plans to cap bankers’ bonuses puts Chancellor George Osborne on the back foot
In the week that RBS announced pre-tax losses of £5.2 billion after a “chastening” 2012 and Lloyds Banking Group a narrowed loss of £570 million (and a reduced bonus pool of £365 million), the banks’ position in the headlines was further secured by news that EU ministers had agreed to impose a bonus cap on Europe’s bankers, restricting them to a 1:1 bonus-to-salary ratio which could be raised to 2:1 with the approval of a super-majority of shareholders. The industry was quick to react angrily to the EU’s plans, pointing out that banks were at risk of losing key staff to US and other international rivals and/or that salaries would rise substantially to compensate, increasing their fixed costs, weakening the link between pay and performance and reducing the bank’s flexibility to reduce or claw back bonuses.
The proposed legislation poses a significant threat to London’s competitiveness as a financial centre but the UK is likely to be short of sympathisers in the European Parliament. Chancellor George Osborne will have a last chance to overturn what Britain views as the most damaging parts of the bonus cap at a meeting of EU finance ministers tomorrow but has a difficult tap-dancing act to pull off, balancing the fight against the bonus crackdown with continuing voter anger over City excess.
Ever to be relied on for an exquisite quote, Boris Johnson, Major of London, offered his opinion on the EU’s move, calling the bonus cap “possibly the most deluded measure to come from Europe since Diocletian tried to fix the price of groceries across the Roman Empire”.
Negative interest rates
· Bank of England’s muses put savers on alert
Paul Tucker, the BoE’s deputy governor, brought the plight of savers back into the spotlight last week when he floated the idea of introducing negative interest rates as a way of encouraging banks to lend and so kick-start Britain’s recovery. Whilst his colleague Charlie Bean was quick to point out that it was just “blue sky thinking”, the suggestion sent out a strong message that savers should not expect an improvement in their fortunes anytime soon. All banks keep their reserves with the central bank and are paid a rate of 0.5% – the Bank Rate – which has now been at this historically low level for four years. The BoE appears to have ruled out a further cut in this rate, but could instead levy a charge on some of the cash that banks deposit in reserve accounts. The theory is that the banks would then feel more compelled to lend out the money.
Such a move would almost certainly lead to lower savings rates; but whether or not it comes to pass, the implication of such a suggestion is that interest rates are unlikely to rise in the near future. Money markets are not pricing in a 0.25% rise until 2017, and a Reuters poll of economists carried out last week found that 45 out of 51 did not expect a rate rise before 2015. What does it mean for savers? According to Moneyfacts (Source: The Sunday Times 3 March 2013), the average easy access account currently pays 0.8% and with rates being withdrawn and changed so frequently there is currently just one Cash ISA paying a rate which just beats inflation. There is no easy fix and cash remains the right home for money that might be needed in the short term, but faced with the prospect of potentially four more years of historically low rates, savers need to strike the right balance between short-term needs and longer-term financial goals.
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