After yesterday’s surprisingly good economic figures for the UK where GDP rose by 0.8% in the third quarter following on from 1.2% in the second quarter you might have expected some mea culpa from the economists who follow the UK as if you look back over the past couple of year’s then their predictive powers have been poor. Perhaps it was in an effort to hide this that most immediately forecast that growth would slow in the next quarter! Either way growth so far in 2010 has been much stronger than expected including by me. As ever I am always cautious about the use of a spot number for these figures (particularly for a preliminary estimate which has only 40% of the data) but even if you published a range from say 0.5% to 1.1% for growth all of the range would have been better than expected.
Whilst the Chancellor was probably still doing a little jig he had started when he heard the news the response of financial markets was mixed to say the least. The only positive response was from the UK pound which rallied by over a cent against the US dollar nearly touching 1.59 at one point and by nearly two cents against the Euro to 1.14. Equities ignored the figures with the UK Ftse 100 falling some 44 points or 0.78%.
However the main impact was on the UK gilt or government bond market which fell heavily. Why? We are back to our recent theme of markets front-running expected central bank moves. Any move towards further monetary easing or what has been called QE2 moved into the distance and the market lost the support provided by an expectation of further gilt purchases by the Bank of England to reinforce the nearly £200 billion it has already made. For example in what now looks to be a particularly ill-timed move Adam Posen voted for an extra £50 billion of purchases last month. Added to this other government bond markets fell too yesterday.
The effect of this is that five-year gilt yields rose to 1.65% and the ten-year benchmark fell by 1.2 points as its yield rose by 0.14% to 3.06%. The longest-dated gilt we have Treasury 4% 2060 fell by 1.37 points to now yield 4.12%. Even index-linked or inflation proof gilts fell and the longest dated of these which matures in 2055 fell by 2.24 points to 123.81.
The market reaction immediately showed to my mind the danger of markets “front-running” expected central bank action. After good figures our equity and bond markets fell. I hope that someone records the figures and posts them to the Bank of England with a section explaining that the distortions on markets caused by their actions are becoming more frequent and severe.
The most curious move was the fall in index-linked gilts which I do find odd. I have to introduce the caveat that it can be volatile as a market even though theoretically it should not be, as it deals in real rather than nominal yields and real yields should be more stable. If you consider that we are growing more strongly than expected and inflation is already well above target then you might reasonably expect inflationary trends to be stronger going forwards. Accordingly you might have expected index-linked gilts to rise. Indeed if you factor in the fact that the CRB spot index rose to a new recent high of 493.89 driven by foodstuffs, fats and oils and livestock components you might need to scratch your head a little harder!
More bad fiscal news from Ireland
Ireland’s government has made a statement which is another blow to her.
The Government has today decided that an overall adjustment of €15 billion over the next four years is warranted in order to achieve the target deficit of 3% of GDP by 2014. The key reasons for the significant increase from the figure announced in Budget 2010 are lower growth prospects both at home and abroad and higher debt interest costs.
I have stopped the quote there because it goes on to use the word “credible” and if any government with its cronyism and delays does not deserve this word then it is a race between Ireland and Greece I feel.
What does this mean?
In essence it means a doubling of the dose of fiscal austerity over the period of the four-year plan, as the expected adjustment was half this size when the target of a fiscal deficit of 3% of GDP was originally introduced. Also it means that the Irish government is still dissembling as over this period the IMF has in fact raised its forecast for world economic growth in 2010 from below 2% to 4.8%, whereas the statement talks of lower growth prospects abroad . Indeed there was poignancy I thought in the way UK growth exceeded forecasts by such a wide margin on the same day as this statement was released.
A problem for Ireland the saga of Google
One of the themes of the Celtic Tiger image of Ireland was the way that she cut her Corporation Tax rate to 12.5% and thereby attracted many multinational companies to her shores. Her plan was to collect the 12.5% tax. However the tale of Google has emerged over the last week to question and maybe even disabuse this notion. According to the Irish Independent.
Internet giant Google slashed its tax bill by $3.1bn (€2.6bn) over the past three years — by moving a lot of its profits through Ireland, it has emerged……….The company ended up cutting its corporate tax bill to just 2.4pc, and tax experts are amazed at how little tax the company has managed to pay overall…….Google used methods that take advantage of Irish tax laws to legally move profits in and out of companies here, escaping Ireland’s 12.5pc corporate tax rate.
I guess if you play the low tax game you run the danger of attracting those who intend to avoid it completely.
The Bank of Greece
The Bank of Greece gave an update on its monetary policy yesterday to the Greek Parliament and considering it was written by a central banker it makes some interesting points. Please remember that central bankers usually analyse their own country through rose-tinted spectacles.
In the first half of 2010, GDP fell by 3% compared with the corresponding period of 2009, while for the year as a whole it is expected to decline by about 4%. Unemployment is projected to exceed 12%; average real wages, partly reflecting high inflation, will decline by 8% in the total economy and by 17% in the public sector……Recession was of course expected for this year; it is also expected to continue in 2011, albeit at a weaker pace.
So we start with a very downbeat estimate and if you factor in the expected falls in real wages I remain of the view that the forecast it makes for Greek GDP over this year and the next remains too optimistic. I have a section on this blog devoted to Greece and wrote on Friday about how her economic figures are likely to be revised yet again and on the 19th of October I discussed my views on her likely insolvency. However we then get something more revealing.
A first, sine qua non, condition for the success of the Programme is the adequacy and effectiveness of the mechanism needed to implement it, namely public administration.In this respect, important changes are already under way and must be carried through rigorously and without delays. However, these are not enough.What we need now is a comprehensive and complete rebuilding of the state on new foundations, so that its operation will encourage rather than hinder creative initiative
So the Bank of Greece does not think much of the Greek state as it stands. It then adds to this with its view on the tax system.
there is no room for further increases in tax rates for businesses and individuals; policies to achieve the necessary increase in public revenues should be geared towards broadening the tax base and combating tax evasion…..The settlement of tax arrears is not the ideal option for increasing revenue.
Indeed the Bank of Greece also has criticism for Greece’s private-sector and entrepreneurs.
However, adjustments are also required on the part of enterprises, which must become far-sighted, expand their time horizons and immediately take investment initiatives. The pursuit of maximum possible gains in the shortest possible time is no longer an option.
Whilst much of this report in couched in what I call central banker speak the underlying message is plain. The government needs to improve its administration and also needs to do a lot more work in combating tax evasion. The Private-sector does not escape criticism either and it too needs to shape up. In its own way this is a very similar summary to that given by Michael Lewis in Vanity Fair albeit couched in more neutral language. I see nothing that changes my view that Greece is in effect insolvent and if anything reading between the lines of this report only confirms it.
The Bank of Greece also issued a statement on volumes in the Greek government bond market. This confirmed that very small amounts of buying by either the European Central Bank,Norway or China may well have had a disproportionate effect on Greek yields recently.
Trading volume on HDAT in September was EUR 1.8 billion, compared to EUR 819 million in the previous month and EUR 51.8 billion in September 2009.
So volume is only 3.5% of what it was a year ago and I think that it speaks for itself. The yield on the ten-year benchmark government bond has risen by around 1% in the last week or so to 9.75% so the improvement is starting to look short-lived.
A playlist for November 3rd 2010
As we approach this date and the expected announcement by the FOMC of more Quantitative Easing my mind has turned to a possible musical accompaniement to it to play during the usually dull build up to it. So far I have come up with the following.
For Ben Bernanke
Start Me Up by the Rolling Stones
Pump it Up by Elvis Costello
More,More, More by Andrea True Connectuon
Bennie and the Jets by Elton John ( or perhaps that should be Bennie and the Inkjets…. as suggested by Mr.K)
Coming Around Again by Carly Simon
and as an exhortation to the economy from Ben
Jump by Van Halen.
For those opposed perhaps
Never Going Back Again by Fleetwood Mac
I can’t go for that by Hall and Oates (sorry Sean).