The Great Debate UK

Thank you, Gordon Brown

–Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.–

If the economics profession has sunk in public estimation in the last two or three years, it would hardly be surprising. Our failure to predict the crisis is something which cannot be simply brushed aside lightly, as some of my colleagues would love to do.

To ordinary folk, claiming to be quite good at explaining and even forecasting events in normal conditions, but admitting we simply can’t handle crises makes us about as much use as a doctor who knows how to treat ingrowing toenails and flatulence, but hasn’t a clue about how to deal with heart attacks or cancer.

Nor is that the only charge which could be levelled at the British profession. One could forgive any politician who felt bewildered by the sheer fluidity of the positions taken by the hordes of macro-economists offering advice, solicited and unsolicited, on the direction policy should take. After all, the overwhelming majority of the profession appears to be in favour of expansionary monetary policy (aka QE2) with an eye on keeping sterling weak against the euro and, if possible, the dollar (hence also against the yuan). Yet most of the same people were enthusiastic advocates of Britain joining the euro zone, in spite of the fact that the option of driving down our exchange rate in the way they advise is only open to us because we have stayed out of the single currency.

Likewise, many colleagues are equally confident in opposing too rapid a reduction of our budget deficit  – “After all, we aren’t Ireland/Greece/Spain/Portugal……” they snort, whenever anyone points to the possible risk of delaying the cuts, as they  would like us to do.

On this point, they are right, of course – we are in a very different situation from Ireland and the sunkissed PIGS. But why are we so different?

It’s certainly not because we have been running a tighter ship – in 2009, our deficit was 11.5% of GDP, compared to 14% in Ireland and Greece, 11% in Spain and a mere 9% in Portugal, and by election time, in May this year, our deficit was estimated to be running at 12% of GDP, compared with only 9% for Greece and less for every other EU member. Moreover, our accumulated debt, although less than many other European countries, still stood at 68% of GDP last year, 4% higher than Ireland, which is under intense pressure these days.

Bank of England Inflation report offers markets a reality check

-Mark Bolsom is Head of the UK Trading Desk at Travelex Global Business Payments. The opinions expressed are his own.-

Sterling tumbled to a one week low against the dollar in trading this morning, after the Bank of England delivered its latest quarterly inflation and growth forecasts today.

In his speech, Bank of England Governor Mervyn King downgraded his economic growth forecasts and raised inflation expectations, saying he expected inflation would fall well below its 2 per cent target in two years, even if interest rates stay low.

While markets had expected growth forecasts to be lowered, the Quarterly Inflation Report has been a bit of a reality check. The preliminary reading of Quarter 2’s GDP figure had put the markets in a good mood, as it looked like the economy was back on track.

But King was unequivocal in his belief today that the bias of policy was leaning towards additional quantitative easing, rather than monetary tightening.

This confirms the view that the economy is not out of the woods yet, and we’re not in a position to withdraw stimulus or even tighten monetary policy.

King was also very defensive about the Bank’s record of inflation, but they have overshot their inflation target for 42 out of the past 51 months. January’s VAT rise is definitely not going to help either – and they have been forced to increase their inflation forecast.

Sluggish U.S. economy may threaten UK business development

- Paddy Earnshaw is the Director of Customer Relations at Travelex Global Business Payments. The opinions expressed are his own.-

British importers and exporters’ confidence in the economy leapt in July, as positive economic data fuelled hopes for a return to strong economic growth. According to the Travelex Confidence Index (TCI), which jumped 12 points in July to 116, from 104 in June, strong gains were driven by quarter 2′s GDP figure, as it showed the UK grew at its fastest pace in four years.

Momentum seems to be building in the UK economy – only 6 weeks ago, we feared the worst for Europe, as the sovereign debt crisis unfolded. Now it is the U.S. which seems to face the steepest challenge. Certainly, we expect the deteriorating picture in the U.S. to crimp importer and exporter confidence in the upcoming months, as 8 out of 10 respondents (84 percent) feel the threat to business development comes from the health of the global economy.

U.S. employment data was worse than expected on Friday, revealing that the U.S economy shed 131,000 jobs in July – roughly double what had been expected by economists. The poor set of unemployment results has only heightened the sense of dread from across the Atlantic – is this the clearest indication that the U.S recovery, in contrast to the UK, is running out of steam?

Despite importers and exporters renewed confidence in the UK economy, I think it is too early to say whether their optimism has been accurately placed, as many uncertainties remain for British importers and exporters. Even as the UK recovery broadens, June’s dip in confidence suggested businesses are fearful of the upcoming austerity measures and the impact they will have on consumer buying power.

So, in the short-term, I would expect to see continued support for the pound as UK data continues to out-perform that in the U.S.

Eerie calm before Britain’s election

– James Saft is a Reuters columnist. The opinions expressed are his own –

To look at sterling and gilts, you would hardly know that Britain is sailing into a general election which will likely deliver a weaker government with a diminished ability, if not will, to grapple with high debts, an uncertain role in the global economy and an aging population.

It is impossible to say what will be the result on Thursday, nor what deals may be made between the surging Liberal Democrats, a bedraggled Labour party which will still have a significant wodge of votes and the Conservatives, who must be both hoping that their hour has arrived and that that hour does not prove to be Monday morning at 8 a.m., pouring with rain and all the trains are late.

There is a huge range of scenarios — a weak minority or majority government or a coalition of some form — but the common denominator across almost all likely outcomes is that all raise the risk of a weak government unable or unwilling to push through aggressive deficit-reduction measures.

And an aggressive, credible and clearly enunciated plan is exactly what is needed. Even before the horse trading and compromising begins, all three parties’ plans lack either scope or specificity. Specificity about what will be cut or who will be made to pay more may well arrive, but it is likely to be at the expense of scope. Unless of course, Britain gets a sharp goading, as did Greece and the euro zone, from the financial markets.

Although pat comparisons between Greece and Britain cannot be made — Britain can devalue the pound and set its own interest rates — on some significant measures Britain is in a worse situation than Greece’s. Britain’s fiscal deficit is forecast at 13.3 percent of GDP in 2010, according to the Bank for International Settlements, worse than Greece, Ireland or any other major country you care to name.

Investors are reassured by the fact that Britain has an average debt maturity of 14 years, and appear to be betting it has time enough to work its way through its issues. Unusually, uncertainty this time does not seem to be unsettling investors. It is not hard to see that changing once the results are in.

Better public finance data may be sterling Trojan horse

- Jane Foley is research director at Forex.com. The opinions expressed are her own.-

Finally UK monthly public finance data has brought better than expected news.  Not only was the net borrowing figure for February  better than expected but the January data was revised lower from 4.3 billion pounds to just 43 million pounds, taking the total for the fiscal year to date 131.9 billion pounds.

The better numbers mean that Chancellor Alistair Darling is on course for meeting, or perhaps even undershooting, his forecast of 178 billion pounds for the full fiscal year to April.

In essence this appears to be good news, but it requires qualification.  Firstly, these may be better than expected data but they are a far cry from good data.  At this stage last year the borrowing requirement was around half the size at 66.5 billion pounds; meaning that public finances are very much still in a shockingly poor position.

Not only that but there is risk that Darling will use the news that the borrowing requirement is set to come in under his (very high) target to announce some pre-election sweeteners during the March 24 budget.

The huge UK budget deficit (around 12.9 percent of GDP) is already a nasty thorn in the side of sterling and UK financial market sentiment, additional spending would not be welcomed by investors.

The recent falls in the value of the pound vs the dollar are correlated with the fear that the general election (expected to be called early May) will provide a hung parliament.

Cable: parity is still a long way off but $1.40 beckons

Since 1982, cable has been contained by the 1985 low of GBP/USD1.0790 and the 2007 high of USD2.0798.  The bulk of this time cable has remained within a narrower 1.40 to 1.80 trading range.

These statistics illustrate how significant it would be if the pound were to slip to parity with the dollar this year.  They have not, however, stopped some commentators speculating about such an event.

The problems affecting the pound are well documented.  The appalling truth is that a combination of low growth expectations for the UK economy and a crippling budget deficit have opened the risks of a funding crisis (if the government does not get the budget in order) or a double dip recession (if too much austerity is introduced too soon).

There may exist a narrow policy path the government could steer that would allow for improved fiscal management and moderate growth but, since the chances of a hung parliament are failing to disperse with just 2 months to go before the favoured election date, it appears likely the new government will lack the backing to take difficult decisions.

The size of the budgetary problems facing the US and UK governments are not vastly different.  According to the Bloomberg survey, economists are forecasting a UK budget deficit at 8.7 percent of GDP in 2009 rising to 11.6 percent in 2010.  The US budget deficit is forecast at 10.20 percent of GDP in 2010 but a fall to 9.4 percent of GDP is forecast for 2011.

The first constraint on budget reform in the UK comes from lacklustre economic activity.  Admittedly Q4 GDP was revised higher to 0.3 percent q/q.

However, this was largely due to government spending, a course which will should go into reverse this year.  The risk that the UK could fall back into double dip recession this year not yet been fully averted and the fragile nature of the UK recovery will make aggressive fiscal reform harder to implement.

Can inflation be controlled by raising interest rates?

- Mark Bolsom is the Head of the UK Trading Desk at Travelex, the world’s largest non-bank FX payments specialist. The opinions expressed are his own.-

One of the Bank of England’s Monetary Policy Committee members, Andrew Sentance, was quoted this morning suggesting that the Bank of England will need to consider raising interest rates this year if a “recovering economy poses a threat to inflation.”

Sentance’s view that inflation will rise is consistent with our forecast and is also backed up by the recent upwards trend in the UK’s CPI Manufacturing data. A rise in inflation is unsurprising, given the Bank of England’s asset purchasing scheme, which aims to boost liquidity through printing more money. Inflation has also been bolstered by a weak pound, rising oil and commodity prices, as well as the return of VAT to 17.5 percent.

However, whether rising inflation can be controlled by raising interest rates, as Sentance suggests, is debatable. Historically, central banks have used interest rates to combat inflation, as they act as a brake on credit consumption – as rates become higher, credit becomes more expensive. Hiking up rates therefore offers the consumer an incentive to save, and reduces liquidity in the economy.

However, the current problem faced by the Bank of England is that raising rates above their current level of 0.5 percent will not have a positive impact on liquidity, because credit remains relatively tight. Although billions have been injected into the financial system, it seems that, thus far, this is still being used to build up balance sheets and asset prices. Relatively little has filtered through to consumers, and borrowing remains both restricted and difficult.

Similarly, increasing interest rates will not curb rising input prices in the manufacturing industry and eventually this sector will be forced to pass on these rising costs as they feel the squeeze.

It is also unlikely that the Bank will want to raise interest rates whilst Britain faces a period of extensive fiscal tightening. Due to the UK’s ballooning budget deficit, taxes are expected to rise and government spending is to fall. I think it would be far too premature for the Bank to raise rates against this backdrop of government spending cuts and higher taxes.

A tough spring in store for the pound

- Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The pound has started the year on a negative note.  Ongoing concerns over the budget deficit, an impending general election, the prospect that the Bank of England (BoE) may yet increase quantitative easing (QE) and a drop in consumer confidence are all clouding the outlook.

That said, sterling has already paid a high price for its weak fundamentals.  In 2009 EUR/GBP averaged 0.8909, this is 17 percent higher than its average in the 12 months leading to the Northern Rock crisis and 35 percent above the average rate between 2000-07.

A lot of bad news is in the price but a sustained sterling recovery is unlikely until there are concrete signs of resolution to the UK’s deficit problem.

In the midst of the deficit concerns, the government is still too uncertain about the prospects for economic growth to stiffen its commitment to austerity and, according to opinion polls, the opposition is not enjoying a decent enough lead to ensure it of election success.

This has left the pound worried by the possibility that this spring’s general election may produce a hung parliament and sensitive to the brutal suggestion from Pimco that if Labour return to power the UK may suffer a credit downgrade.

On a more positive note, the UK most likely emerged from recession in Q4.  This is hardly a cause for celebration, however, since most major economies emerged in Q2 or in Q3.

Has the Bank of England helped stem economic decline?

-Mark Bolsom is the Head of the UK Trading Desk at Travelex, the world’s largest non-bank FX payments specialist. The opinions expressed are his own.-

The onset of 2009 saw the pound well and truly on the back foot against both the dollar and euro, at one stage hitting a six-year low against the greenback (falling to $1.3751) and an all-time low versus the single currency. In one week in January, the pound fell 4.5 percent against the euro, 5.7 percent against the yen and 6 percent against the dollar.

The pound’s weakness at that stage was clearly a direct consequence of the credit crunch and resulting global economic slowdown. Nevertheless, as the both the government and the Bank of England opted for policies of aggressive fiscal and monetary stimulus, sterling recovered, to a degree, even as the economy slid into the deepest recession for generations. In response, the Bank of England took positive and decisive action, slashing interest rates to a record low of 0.5 pc and pumping 200 billion pounds into the economy through its asset purchasing scheme.

How successful this has been is debatable. House prices have stabilised and have been slowly rising. The threat of deflation also appears to have receded with November’s data showing inflation more or less in line with the Bank’s 2 percent target. Similarly unemployment has not risen by as much as had been feared. However, as 2009 draws to an end, the government has been forced to revise its own growth forecasts for 2009 downwards, now stating that by year end the UK economy will have contracted by 4.75%. Similarly, some commentators have argued that unemployment data is misleading. True, the number of claimants is still below expectations, but many employees have been forced to accept pay cuts and shorter working weeks.

Worryingly, at the time of writing, Britain also remains the only major economy not to have emerged from recession. The final Q3 GDP number revealed that the economy still contracted by 0.2 percent in the three months to September. Furthermore, significant question marks remain over the long-term sustainability of Britain’s debt, as the government and taxpayer now have to cope with the cost of successive bank bailouts.

Therefore, sterling’s prospects for 2010 look decidedly mixed. Given the level of economic uncertainty we certainly expect interest rates to stay at their current level of 0.5 percent – at least until 2011- as both the Bank of England and the government will want to stimulate economic growth. Traditionally, this could be expected to lead to a further weakening of the pound as demand diminishes. Mervyn King, governor of the Bank of England, has consistently argued that this is needed in order to rebalance the economy and stimulate the UK’s export sector, although such a move is likely to be unpalatable to the UK consumer.

Low interest rates could also be expected to lead to a higher rate of inflation as money supply increases and imports, upon which the UK relies heavily, become relatively more expensive. We could very well see consumer price inflation hitting the 3 percent mark early next year.

Don’t scapegoat the Germans for crisis

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

A revisionist theory on the causes of the global financial crisis blames surplus countries like China, Japan and Germany as much as highly-leveraged, deregulated finance in the United States and Britain.

Making Germany a scapegoat may be tempting, especially in Britain, where memories of sterling’s humiliating exit from the European Exchange Rate Mechanism in 1992 still rankle, but it is unfair and dishonest.

The revisionists contend that the meltdown was due not just to the Americans and British who borrowed, traded and lived beyond their means but also to the Chinese, Japanese and Germans who sold them the goods and lent them the money.

It follows that responsibility for digging the global economy out of its current hole lies disproportionately with the surplus countries, which must spend their reserves or go deeper into debt to boost demand and give the world a fiscal stimulus.

Seen from Berlin, this interpretation of global imbalances looks like a brazen attempt to punish German fiscal and economic virtue and divert attention from the irresponsibility of “Anglo-Saxon” financial capitalism.

Finance Minister Peer Steinbrueck has a 10-second summary of the origins of the crisis.