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.
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%.
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.
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?