What is the outlook for the UK economy? Also the Basel 111 agreement disappoints

Friday was a day with no great new insight into the state of the US economy and we saw the Dow Jones Industrial Average edge some 47 points higher to 10462. This has been followed by rallies this morning with the Japanese Nikkei 225 rising some 82 points to 9321 and the Hang Seng in Hong Kong rising by nearly 2%. The recent strength in equity markets has had a corollary of weakness in government bond markets and if we take a look at the US long bond or thirty-year stock it is at a price of 100.1 to yield 3.87% which is a fair setback from the heights of 106 when yields were challenging 3.5%. To give an idea of the speed of the move the price high was as recent as the 31st August and this followed a sharp rise from the 10th August when yields dropped below 4%. Quite a whipsaw when looked at with a little historical perspective. Other government bond markets have followed a similar pattern the ten-year yield on the UK gilt has retreated from 2.82% to 3.12%.

Greece backtracks on her austerity programme and Irish developments

The peripheral nations in the euro zone have had government bond markets which have followed a weaker pattern than many others and news did emerge to perhaps influence them. Allied Irish Bank sold its Polish operations for 3.1 billion Euros which is much better than the book value of 1.4 billion and this will take a little of the current strain of Irish taxpayers,even if it leaves the discomforting thought that as time goes by AIB may regret selling one of its better sections. Greece is also undertaking a roadshow to encourage others to buy its government debt and to this her Finance Minister is issuing quotes stating that Greece will not default or undertake a debt restructuring. If we move from hyperbole to reality her rate of economic growth was revised down to -1.8% in the second quarter of this year  making an annual rate of -3.7%. On a more hopeful trend her unemployment rate edged lower to 11.6% according to the most recent labour market survey.

Adding to a recent trend for measures which appear to go against the recent austerity programme Greece has announced a  cut in taxes on retained earnings for companies to 20 percent in 2011 from 24 percent. In addition the Prime Minister has given the Finance Minister permission to consider alternatives to planned rises the amount of Value Added Tax collected for next year amounting to some one billion Euros. As revenues are falling short of forecasts and targets these look a risky moves to me. According to Reuters Greek ten-year government bond yields ended the week at 11.96% and this remember is after the European Central Bank resuming its buying programme last week. I will be checking her website as the week develops to see the scale of her announced actions, I doubt I will be the only one!

The Basel 111 Accord

Last night saw an agreement on this issue. For those who have not followed the situation this is where officials and central bankers from around the world have met to new international standards for how much capital banks need to hold. This is in response to the credit crunch where many banks hit trouble and some collapsed and is part of an official response to this.Unfortunately a chance for real reform has been missed and our officials and central bankers have again let us down. Those who do not believe this might like to take a look at the performance of bank shares this morning as they have rallied.

What is planned?

1. Banks will be forced to hold a minimum capital of 7% which includes a 2.5% conservation buffer

2. Regulators will have the power to make them hold a further 2.5% of capital as a counter-cyclical buffer should they feel this necessary.

3 Systematically important banks may be forced to hold more capital.

3. This will be in full operation from the 1st January 2019.

Comment

The first point for those looking at this is that there has been a Basel 1 and a Basel 11 in the past and yet we had a banking crisis. Also the delay in full implementation which is going to take over eight years shows a flaw in the current banking model. Having bailed out many weak banks governments are faced with a problem which is that making them hold more capital weakens their profits and hence delays any return to the private-sector. Also it tends to weaken the underlying economy as it would reduce bank lending which in many places is already weak.

One of the stronger parts of the agreement in theory the counter-cyclical buffer will in practice rely on bureaucrats to enforce it. In many case this will be the same bureaucrats who failed to use the powers they had in the run-up to 2007 for the others I am afraid that human nature is again likely to be influenced by economic growth at the time. Remember in the run-up to 2007 one of the architects of the financial crisis (Sir) Fred Goodwin was advising the UK government.The same UK government which ended up having to save his bank with taxpayers money.

The banking model is unchanged and will presumably break again as time progresses. As financial crises appear to be becoming more frequent the next one looks likely to occur before this Basel 111 agreement is even in full operation. I would imagine that the lunch-rooms of the worlds banks may even have a toast to this agreement today as risng share prices are positively associated with higher executive bonuses.

The UK economy

UK Economic Growth

There has been a recurrence of worries over the UK economy recently. However according to the statistics we are in fact doing quite well in terms of growth. For example we grew by 1.2% in the second quarter of this year according to the Office for National Statistics which followed 0.3% and 0.5% in the previous two quarters. A rather different pattern to that of the United States,for example, and if we were to go back to the beginning of this year we have already achieved the amount of growth many though we would get for the whole year and this includes me.

If we try to look forwards then the National Institute for Economic and Social Research or NIESR gives us monthly growth estimate updates and its numbers up to the end of August give an estimated growth rate of 0.7% for the previous three months. So slowing but from a level we did not expect to achieve anyway.The Organisation for Economic Co-operation and Development (OECD) has  lowered its growth forecast for 2010 for the G7 leading economies to 1.5%, down from 1.75%,which is worrying.However set against this it feels that the UK will grow by 0.65% in the third quarter of this year and 0.4% in the fourth. If you added the OECD forecast to what has already happened then UK economic growth for this year would be around 2.5%.

Comment

At a time when there is a considerable amount of uncertainty the UK economy looks as though it may put in a solid growth performance in 2010 and one which is better than was thought at the beginning of the year. There are worries about a world slowdown but recoveries from recessions often go through this phase so we need more information and data to see is this is a normal response or something worse.

The problems for us at this time come in two main areas. The first is our inflation problem which has persisted in spite of a severe recession in late 2008 and early 2009. We will get our retail price inflation figures tomorrow but our latest economic growth figures had some disturbing implications in them for our inflation trends. I reported at the time of the figures that the GDP  implied deflator had risen to 4.1% and that this is an indicator which is superior to all consumer or retail price indices because it covers the whole economy rather than a sub-section. As it covers the whole economy one can use it to look at inflation taking out the impact of the indirect tax (VAT) rises, and if you do so you end up with inflation estimated at 3.2% annualised over the past six months. Actually to exclude indirect tax rises you end up excluding import price rises too and as they look like they have been positive then the picture is if anything worse than that.So far from our inflation problem being “temporary”” as the Bank of England keeps telling us it is looking more and more permanent.

Trade Figures

These feel like they have been a perennial problem for the UK and it is a continual frustration that this problem appears has persisted. I say appears because trade figures are often revised heavily years after the event so they are a very poor quality data source. When I was at university in the 1980s the numbers were revised for 1967 which meant that on the basis of the revised numbers that the devaluation of that year was not necessary. As this was an epoch-making development in UK economic history this should have led to more wailing and gnashing of teeth than it did in my view. Indeed a recent speech which covers UK economic history in an attempt to explain an individual’s policy prescriptions appears to be unaware of this fact amongst other historical errors. I say this because the speech has been reviewed favourably in many quarters which means that they do not understand our economic history either. I am being deliberately vague as I do not wish to be involved in politics only economics.

With these caveats in place our trade performance looks somewhat dismal. According to the Office for National Statistics the UK’s deficit on trade in goods and services was £4.9 billion in July, compared with a deficit of £3.9 billion in June (which was revised up from a deficit of £3.3 billion). As usual I try to look at trends and sadly they too look troubling. Of course we may not be much the wiser as even looking back a year or eighteen months may not be a reliable guide.

So we are left with an economy which appears to be having a good 2010 but we have sadly retained one or two unwelcome old friends on our journey. The future is particularly uncertain but at least we are going into it with some momentum.

Fiscal Stimulus Debate

Thank you to those who put their views forward. I will read them again today and would like to make clear that I enjoy the points put forward on the comments section to this blog where there is often a very high standard of debate.If there are any “lurkers” who feel like contributing please do as  I feel  the standard of debate is one of the strengths of this blog. Also as my title indicates there is by no means any compunction to agree with me as such an edict would be rather at contrast with the title of the blog would it not?

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8 thoughts on “What is the outlook for the UK economy? Also the Basel 111 agreement disappoints

  1. Hi Shaun,

    Did you notice that the OECD report has within standard error expects growth in the last two quarters for the UK. I read this as they think it is highly unlikely the UK will have negative growth this year.

    Not today admittedly but you often mention the UK housing market should be improving under the circumstances, i.e. low BoE base rate. This without mentioning that banks demand huge deposits and so not making mortgages any easier to obtain and the fact that average house price is something like 8 times average income so it is natural for prices to fall to an ‘affordable’ level.

    On the fiscal debate is there any doubt that the Keynesian policies of FDR helped the US get out of the great depression. In certain circumstances mild socialism can work.

    On the subject of debates: Can you mention Robert Peston at some point to give me a place to debate the role of the news editors for the BBC? Also there has been lack of football references recently, I just wanted to mention that if you play positively than you deserve the success of Blackpool.

    Regards,

    Fletch

    • Hi Fletch
      I know one or two surveys are trying to grab headlines by predicting a quarter or more of negative growth but no serious data predicts that at this time.
      As to the UK property and commercial markets I have lots of concerns. Our banks invested a lot in Ireland and Irish banks invested here a lot but the implications do not seem to have struck our commercial property market. As to residential property considering the recession we have just been through then prices have not adjusted enough in my view. Your examples of banks reducing mortgage availability and provision are true but because liquidity and volume have dropped prices have drifted rather than fallen. In the near to central London bubble in which I live then prices have gone back to 2007 levels which seems plain wrong to me as they have risen rather than fallen but the fall in the pound led to London looking cheap to buyers in Euros for example and they did buy…
      I have followed Ian Holloway as I found him both amusing and interesting when he wrote article for the BBC website,however he may well find playing 4-3-3 successfully a bit harder this upcoming Sunday.

    • Hi Fletch
      I meant to ask before about your views on the BBC. It is not quite on your subject but yesterday and today their economics blog did not mention either the inflation figures or the unemployment ones. This is a shame I think.

  2. Basel 111 : I am not sure there are great huge sighs of relief are there- if capital regulation is considered alongside liquidity and leverage ratios,exit of sovereign support measures, refinancing of wholesale funding,levies,break-ups and possible transaction taxes,new Bank of England Policy committees directing lending and behaviour, I might , if I were a banker ( which I am not) of a too-big-to-fail, be thinking of accumulating more capital, tightening my balance sheet further and looking to emerging markets for growth. If I were UKFI I might also be thinking of selling well before the end of the lead-in period if returns on that capital will deplete. The point here being that taxpayer’s capital in UK banks is now facing risk on an elevating path rather than in one hit?

    • Basel 3 is a bureaucrats fudge I think and like the fudges the euro zone has tried this year it may yet have unexpected consequences. Does anybody really believe that it will be fully in operation in 2019?. Either the world economy will be doing well and those concerned with such issues will be a small number who are likely to be ignored again,or we will be in trouble economically and it will be delayed.

      Anyway as someone pointed out to me today Basel 2 was hardly a triumph was it? As to issuance I guess Deutsche Banks share issuance will be watched by UKFI closely as it is a sizeable sum. But banks have a lot of bonds to refinance and capital to raise as of course do their sovereigns so UKFI may find it hard to get a timetable slot even if an issue becomes viable because of rising share prices.

      • I agree there is fudge, but I think politicians are involved. The bureacrats in Basel wanted to see implementation by end of 2012.The G20 Leaders declaration in Toronto started waffling about different national starting points and the need for convergence over time. In the EU a new directive will need to be approved by “Member States” and the Commission, so more chance for the politicians to waffle and promote national agendas. So, I agree its right to wonder whether we’ll see any of this fully in place but I put that risk down in large measure to bank lobbyists and weak politicians.

  3. If you want to know whats propping up property prices there are a number of ways to look at it.
    – For large, luxury properties, you might want to get yourself some figures on the amount of cash being pulled from small private pension funds. Imagine if people living in ‘million pound houses’ were drawing down their pensions to pay the council tax?
    – Secondly, valuations on ‘normal’ houses have to be high, dont they; Banks gave out billions in mortgages and valuations have to remain high so the banks dont go totally under.

    Compare this (house valuations) http://www.home.co.uk/guides/asking_prices_report.htm?location=altrincham&all=1
    with this (ok, its from the Sun 😦 ) http://www.thesun.co.uk/sol/homepage/news/3130945/Altrincham-identified-as-having-the-worst-store-vacancy-rates-in-Britain.html

    Why the disconnect?
    Well, to put it bluntly, these people cannot sell their houses at inflated valuations, their investments have gone to hell in a handcart and they are clearing out their savings to keep a roof over their heads.
    No numbers to ‘prove’ it but its obvious on the ground.
    Like they say; if you dont know who the mug is, its you.

    • Hi Passing by
      Welcome to my blog and thanks for the links. To my mind there are quite a few problems with the current state of our housing market as I wrote yesterday and I suspect that some of them will unravel as time goes by. There are many implications from a fall in house prices and not all of them are bad as for example first time buyers would be pleased but there is little doubt that it could easily cause more trouble for our banks particularly those who were involved in the 125% of equity mortgages.

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