UK News

from Breakingviews:

The real UK plan B: protecting against euro chaos

By Hugo Dixon and George Hay The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Pundits say Britain needs a plan B to boost growth. What it really needs is a contingency scheme to handle a euro explosion. The central planks should be for the government to keep adequate fiscal firepower in reserve to handle a crisis and to shore up the country’s banks.

The two points are linked. If the government used all its fiscal headroom now in an attempt to prevent a double-dip recession, it might find it had no capacity to react if things go from bad to worse across the English Channel. Debt is already forecast to peak at 78 percent of GDP in 2014/2015, according to the Office for Budget Responsibility. But that assumes the euro zone finds a solution to its problems. If not, the UK will be dragged into a deep recession and its debt will balloon: the tax take would fall, social expenditure would rise and money would be pumped into the banks.

If the single currency breaks up, there will probably be banking panics across the euro zone. Britain’s lenders would also be vulnerable. That’s partly because they hold 15 billion pounds of the sovereign debt of Greece, Portugal, Italy, Spain and Ireland. But the main problem would be their 144 billion pound exposure to those countries’ private sectors. A euro collapse would turn many good loans bad. Royal Bank of Scotland, Barclays and Lloyds Banking Group would be the three banks most in the firing line.

Extra capital alone wouldn’t stop these banks running out of cash in the aftermath of a breakup. The government and Bank of England would also need to provide them with a liquidity backstop, as they did in 2008. As then, support could have two elements: the Treasury could guarantee new issues of wholesale bank debt; and the BoE could restart its Special Liquidity Scheme, which allowed lenders to swap illiquid assets for government bonds for a period of three years.

One option would be to wait until a breakup before doing any of this. But the UK might then find itself on the back foot, having to fight a full-blown panic. It would be better to get at least part of the contingency plan moving now.

from Breakingviews:

Becalmed UK in danger of double dip

By Ian Campbell The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The UK economy looks dangerously becalmed. While GDP did increase a good-looking 0.5 percent in the third quarter, the number was flattered by a catch up from a royal wedding-distracted spring. Besides, there has only been a 0.5 percent rise over the full year. And now a euro zone storm is brewing. That Tuesday's UK manufacturing survey for October dropped to the lowest level for over two years is no coincidence -- but is alarming.

It was always going to be tough for the British recovery to pick up pace. It has to deal with many adverse currents: tighter fiscal policy, depressed wages and high global commodity prices. Strong export demand would have helped. But now recession threatens the euro zone, the UK's largest trading partner. The single currency zone has to deal with financial sector stress and fiscal tightening, and its central bank has been less accommodating than the Bank of England.

British policymakers will come under pressure to do more. The Bank of England has already responded to the European threat, and more promptly than the European Central Bank, by launching a 75 billion pound QE2 lifeboat. George Osborne, the Chancellor, promises more help on what he calls "credit easing" later this month. But it is hard to be optimistic that either policy will achieve much. Mervyn King thought QE2 would help avert worse credit tightening.

Another dip into recession will be hard to avoid. That will be arduous -- above all for the 2.6 million unemployed Britons. The malaise will put political pressure on the government to take a risk on fiscal policy. A fiscal U-turn, a tax cut or additional government spending in employment-generating capital projects, would be more likely to get the economy moving again.

The government is understandably reluctant. The fiscal deficit is obscenely big and its opponents will say "we told you so". But, as in any emergency, plans change when things go bad. The risk for the UK government is that things will get considerably worse.

from Breakingviews:

UK will get QE2 – but may need fiscal help too

The odds are moving rapidly towards a launch of QE2 in the UK. A second bout of quantitative easing - printing money - would be controversial. But a fragile economy needs extreme treatment - monetarily, and probably fiscally, too.

Britain's substantial home-grown problems are being exacerbated by crisis in the euro zone. UK unemployment crossed 2.5 million in the three months to July. Activity in services, the bulk of the economy, almost contracted in August. Wages, up just 1.7 percent in the past year, are falling fast in real terms, impoverishing consumers and threatening deflation. And exports are stalling: the euro zone is the UK's main trade partner.

Inflation, 4.5 percent now and likely to go higher in September, is the obvious obstacle to still looser money. But in January it should drop to about 3.5 percent as this year's sales-tax increase drops out of the equation. In any case, it is not inflation but the threat of renewed recession that is now the Bank of England's foremost terror. GDP growth may already be negative.

Policymakers will have to do more. Adam Posen, the BoE's chief dove, has suggested a new public bank. This quick and unfashionable Fannie Mae-like step seems unlikely. QE2, probably to the tune of about 50 billion pounds, is the obvious emergency remedy.

But there are big doubts over how much money printing can achieve. It may bolster bank confidence, and could drive 10-year gilt yields well below 2 percent. But whether it will stimulate mortgage or business lending is questionable - especially if banks continue to struggle with the euro zone crisis. The BoE risks pushing on a string, as the economist Keynes warned.

That leaves fiscal policy. The UK has been right to focus on reducing an intolerable deficit. But a fiscal rejig, as Barack Obama is pursuing in the United States, may also be necessary. The government could stick to departmental spending cuts while also cutting taxes for the low-paid to stimulate spending, and investing in infrastructure and social housing to spur employment.

Europe's negative forces are strong. Counteracting them is likely to necessitate more policy activism.

Ignore the data, Royal Wedding and sunshine give Britain Plc a Q2 kickstart

A lot of the economic data in recent days has made for pretty grim reading, reinforcing expectations that interest rates will remain at record lows for some months yet.

But a string of bullish updates from British retailers and manufacturers suggest that the second quarter could have got off to a flying start, with fine weather, the Easter holiday and the Royal Wedding all improving the national mood.

Anybody who ignores such signals from within the real economy does so at their peril. In January the pound tumbled when it emerged that the British economy had suffered a shock contraction in the final three months of 2010. The market was caught off guard again a month later when revisions painted an even bleaker picture.

Those of us who had been following closely the steady stream of profit warnings from UK retailers, travel groups and builders were not quite so surprised, particularly as we churned out long lists of companies hit by December’s big freeze and predicted a looming standstill in the construction industry.

The big question now is whether the glow left by a month of unusually sunny weather and two holidays in swift succession for Easter and the Royal Wedding will translate into a sustainable recovery, or at the very least be enough to dull some of the pain of government cutbacks and job losses.

Supermarket group Morrison is sounding very cautious this morning. In common with a growing pack of retailers it has reported stronger than expected sales thanks to a bumper April but has not raised its forecasts for 2011 as a whole, citing falling disposable incomes and economic uncertainty.

from The Great Debate UK:

Waiting for the other shoe to drop

-Laurence Copeland is professor of finance at Cardiff University Business School. The opinions expressed are his own and do not constitute investment advice. -

The unemployed and the terminal insomniacs who have nothing better to do than read my blogs will know that I have long been gloomy about most of the Western economies. How can you fail to be pessimistic when the world economy is still dominated by the U.S. - a basket case, becoming weaker every day, with a political class too blind or too scared to admit in public the obvious fact that the country cannot carry on living beyond its means?

Now house prices are plunging again and, with the dollar still strong, the prospects for an export-led recovery look bleak. In fact, a return to recession is far more likely, and the markets are starting to show signs of that sickening here-we-go-again feeling.

How will it all end?

Anyone who claims to know how this will all play out is on no account to be trusted, but there’s nothing wrong with trying to guess – in fact, that’s exactly what we have to do before we can decide what assets to invest in, or whether to invest at all rather than simply blowing it all on a long bankruptcy binge.

So here goes. I start from the observation that the bond and currency markets, in their infinite lack of wisdom, seem to have divided the whole membership of the United Nations into two classes, high-risk countries and low- (or no-) risk countries.

from MacroScope:

How uncertain exactly is the uncertain BoE?

For a central bank that looks certain to bust its 2 percent inflation target for most of the time between now and the London 2012 Olympics, there is still a lot of uncertainty out there.

Bank of England Governor Mervyn King referred to "uncertain" or "uncertainty" about the outlook five times at the May quarterly Inflation Report press conference according to the bank's transcript, and the latest one didn't seem much more confident in tone.

"There is great uncertainty about the outlook for both the United States and our most important trading partner, the euro area," King said in his opening remarks before taking questions from reporters.

Later on, he proclaimed that the recovery period "will take several years before we adjust back to anything we can call remotely normal."

But just how uncertain is the BoE?

George Buckley, chief UK economist at Deutsche Bank, has come up with a revealing graph measuring the width of the BoE's "fan charts", which identify the distribution of probable outcomes in their quarterly GDP forecast, against the market's main volatility measure, the VIX. They appear to track each other rather closely.

The spread on the fan chart between the weakest probable path for GDP growth and the strongest blew out to 7.5 percentage points  in early 2009 from just over 2.5 percentage points before the financial crisis set in three years ago.

from The Great Debate UK:

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.

from The Great Debate UK:

Rubbish rates – what is a saver to do?

-Rachel Mason is PR manager at Fair Investment Company. The opinions expressed are her own.-

The base rate is going to be stuck at 0.5 percent for years to come, according to experts, so where does that leave savers?

Yes, the base rate needs to be low for any real economic recovery, and many mortgage holders can't believe their luck, with many seeing their payments plummet. But there is always a flipside, and with a low base rate comes low savings rates.

With inflation up at 5 percent (as measured by the Retail Prices Index) it is impossible to get a savings account that even maintains the value of your money, let alone increases it, so what should savers do in such a low rate environment?

Well, unfortunately, since National Savings and Investment's withdrawal of its tax-free index-linked certificates, virtually all savings accounts are paying interest rates below RPI inflation.

So what can you do? Well, if you are looking for a purely cash account, realistically, the only way of securing a relatively reasonable rate on your savings is to go for a fixed rate savings account - the best ones at the moment are offering around 3.15 percent, when fixed for one year, and 4.90 percent when fixed for five years.

With a fixed rate, you know where you are for the entire term, whereas often with variable rate accounts, providers offer what seems like a good deal but they can pull the rate at any point, so you may only get the advertised rate for a few months. If you can afford to leave your money alone for a few years, it may be well worth fixing for a longer period of time, because analysts are predicting interest rates to stay low for some time.

from The Great Debate UK:

EU stress tests: for banks or governments?

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

Worries about Europe’s banking system go back at least to 2007, but whereas the U.S. (and UK) banks appear to have weathered the storm, there are fears that for European banks the worst may lie ahead.  Concerns centre on four areas.

First, there are obvious worries about Greece and the other small countries facing debt problems, notably Portugal and Ireland, where the local banks have lent heavily to their governments and in addition may need to make provision for a substantial build-up in the level of bad debts in their respective corporate sectors as their economies struggle through the recession.

Second, there are worries about the small-to-medium banking sector in Germany, where some of the first signs of the oncoming crisis appeared early in 2007. It is hard to tell how seriously we should treat these concerns, because the Landesbanken are closely linked to their regional (“Land”) governments, so the question is unusually sensitive. Third, there are worries about the European giants, especially the big French and German banks.

Not only is it still unclear (to me, at least) how badly hit they were by Lehman and its aftermath, it is still a matter of conjecture how much sovereign debt they are holding.

Fourth, there is the enigma of Spain, worth a blog on its own. The bald facts about Spain are frightening – 20 percent unemployment (and nearly as much even before the credit crunch), the economy most dependent on construction of any in Europe, a large budget deficit, tourism suffering from the strong Euro.

from MacroScope:

The octopus and the economists

What do an eight-legged creature in an aquarium in Germany and 74 economists have in common? The consensus view that Spain would claim the World Cup -- until the economists, as they so often do, changed their minds.

If World Cup 2010 goes down as one of the most unpredictable and exciting competitions in recent history, bringing underdogs Holland and Spain to the final showdown, what was hopelessly routine was watching so-called expert opinion converge around the safest bet. At least among financial professionals, who have done so well of late predicting the future.

When Reuters first surveyed economists and forecasters in May on which team would be kissing the golden grail on July 11, 2010  in South Africa, it made for interesting reading. Spain would take it -- by a narrow margin, it has to be said -- followed by Brazil, Argentina and England. Improbable probability analysis, perhaps, but not boring.

Then as various teams got knocked out of the competition -- former champions Italy, France, and England -- in a miserable and well-deserved defeat to Germany, Reuters re-polled these same economists and a few more for good measure. And that's when they fell flat. Those brave forecasters slipped back to the easy choice, and as a group they picked Brazil. We all know what happened to them.

It's hard enough to accurately predict where GDP growth is headed, where a currency will trade, or where interest rates will go, let alone who's going to win a major sporting tournament. But what the economists should have done was go with their gut and hang on to their convictions instead of revising their views with each little new development, as they so often do.

But for all those last-minute changes, it has to be said the economists were better at it this time around than in 2006. Back then, fewer than 10 percent of them predicted Italy would win -- about the same proportion who managed to predict the biggest financial crisis in generations.