Market Watch Redmayne Bentley

This week’s election budget will be far less important than the post-election budget that is likely to be presented in July, as only in this one will politicians clearly tell the electorate of the cuts that will be undertaken in the public sector, in order to help re-balance the country’s finances.  The pre-election budget, however, will be important as it will signal to markets and international investors how serious the Government is about clearing up the mess that are our country’s finances.  At one end of the spectrum, electoral bribes could create panic in already nervous markets, triggering a crisis in sterling, even before the country has had the opportunity to elect a new Government.  At the other extreme, a prudent and responsible budget from the Labour Government could set the tone for the election campaign.  Whilst the opposition Conservatives have portrayed themselves as being sounder with public finances than the Government such a course of action, which I believe is the most likely outcome, will put the government under pressure to spell out how they will contain borrowing which is running at nearly 13 per cent of GDP.  Whilst Gordon Brown undoubtedly has the biggest say within the Labour Party on the budget, Alastair Darling finds himself in an interesting position and one that he will undoubtedly use to his advantage.  Whilst nobody expects Gordon Brown to encourage massive electoral bribes, it is largely acknowledged that he is more free spending than the Chancellor.  For Mr Darling, he will be aware that this is probably his last budget, because if the Government loses the election then he is certainly out.  If Labour wins, however, a revitalised Gordon Brown would remove Mr Darling, as he wanted to only a few months ago, when had he been strong enough, he would have replaced him with Ed Balls.  Mr Darling therefore knows that he is writing his obituary and if history is to be kind to him then he knows he must position himself as a man who helped to restore the public finances, after the worst financial crash in many generations.  By portraying himself as a prudent Chancellor, Mr Darling will also know that this is the best opportunity he has for hanging on to his job, as another possible outcome is for a hung Parliament, with Labour being marginally the largest Party.  If this were to occur a weakened Gordon Brown would almost certainly not have the power to replace Mr Darling, who would be revelling in the Party praise as having been instrumental in securing a record fourth term.

In the week the European Commission demanded that Britain produce a plan to cut its budget deficit to below 3 per cent of GDP. The UK Government’s current prediction is to cut it to 4.6 per cent by 2014/15, which is looking increasingly unlikely. The pressure to do so was slightly eased by the news that public finances were in a much stronger position, although still terrible, than had been forecast.  The budget deficit for the month was £12.4 billion compared with £8.8 billion a year earlier, below the £14 billion that had been predicted by City economists.  The February deficit of £12.4 billion was still a record for the month, taking the country’s total debt up to £857 billion or 60.5 per cent of GDP, less than the peak of 61.4 per cent hit in December.  The Government is forecasting that debt levels in 2014 will peak at 80 per cent of GDP.  Also easing the situation January’s figure was revised sharply down, showing the Government borrowed £43 million, down from a previous estimate of £4.3 billion.  So unless March is particularly gruesome, then the deficit will come in under the Government’s December budget forecast of £178 billion. Whilst this is clearly encouraging, one must remember that the Government will be borrowing significantly more than the budget deficit, as it also has to borrow to pay back borrowings that are maturing,   £52bn of gilts will mature during 2010-11, more than three times this year's total. In 2009/10 the Government is expected to sell some £225 billion worth of Government bonds and next year is likely to sell a further £170 billion worth and on  current estimates, the country must raise £703bn of debt finance between now and 2013-14. One of the main drivers for the better monthly figures was better tax receipt, which climbed 3.6 per cent in the month. This was the sharpest rise since April 2008, as the amount generated by VAT jumped by almost a third, compared with February 2009.  The Government projections for borrowing next year are highly sensitive to growth projections and, once more, the Government appears to be being very optimistic in the rate of growth that the economy will grow by.  In the pre-budget report in December Alastair Darling suggested that the economy would contract by around 4.75 per cent due to the recession and this is likely to be revised up to 5 per cent on Wednesday.  He also looks likely to stick with his 1 per cent to 1.5 per cent growth forecast for 2010 and 3.25 per cent to 3.75 per cent growth in 2011.  The City forecast for growth in 2010/11 is for a more modest 2.5 per cent and even these numbers are now being revised back as commentators fear that recovery is not taking hold and that the snow battered economy in the first quarter may have contracted and we will know this only a few days before the expected election date. I continue to remain highly concerned that we will in fact report negative growth next year as the economy dips back into recession as stimulus programmes are removed, not only from the UK economy but, more importantly, the European and American economies. Lending to British business fell at a record annual rate in January, in a sign that the economy’s recovery is far from assured.  The Bank of England figures report highlighted the risk to the recovery at a time when both the banking sector and Government are trying to repair stretched finances.  The level of net lending fell by £6.5 billion in January, nearly twice as fast as December, the Bank reported in its Trends in Lending report.  This produced an annual rate of decline to 9.3 per cent, the biggest fall since monthly records began in 1999.  Lenders reported that businesses were looking to reduce debt levels and demand for credit remained subdued.  The report highlighted that there had also been no significant change in loan availability over the month. According to the Council of Mortgage Lenders, mortgage lending made a surprise recovery in February, increasing by 6 per cent, compared to the previous month.  Gross mortgage lending, which ignores loan redemptions, increased at an estimated £9.2 billion last month, compared to £8.7 billion in January, which was the lowest figure in ten years.  The CML said an increase in lending in the shortest month of the year was unusual but unsurprising this year, given the end of the Stamp Duty holiday in December, as this had distorted lending figures considerably in the month of January. Lending in February was down 6 per cent compared to the same month last year, when borrowers accessed £9.7 billion in mortgages. The CML said that the first two months of the year were broadly in line with its forecast for lending of £150 billion during 2010.  The number of borrowers behind with mortgage repayments fell by 4 per cent in the last quarter of 2009, according to the Financial Services Authority.  By the end of last year 378,000 mortgage accounts were in arrears, defined as owing at least 1.5 per cent of their outstanding loan.  The number of new arrears cases registered during that period was down 9 per cent on the previous quarter at 41,000.  The FSA said the number of such cases had fallen each quarter of last year and the figures for the final quarter were 39 per cent lower than the same period in 2008.  The number of new repossession cases was also down, falling by 15 per cent quarter on quarter to 11,800, the lowest figure since the summer of 2008.  Overall, the FSA believes that this year 54,000 homes will be taken into repossession.  The property website, Rightmove, announced in the week that house prices were up by 0.1 per cent in March compared to its February forecast, the smallest margin ever recorded at this time of the year, when prices have never fallen month on month. With an Election imminent the government has announced a shake-up of the credit card industry that it claims will save consumers millions of pounds. Five new 'rights' have been secured in an agreement between the government and the industry, which will save consumers almost £300m a year, according to government estimates. Under the deal, repayments to credit and store card firms must be used to pay off the most expensive debt first, reversing the current practice. Consumers will have the right to tell their providers never to increase their credit limit, and the right to reduce their limit at any time. Lenders will not be allowed to raise interest charges on existing loans for customers without giving customers 60 days to switch provider and Consumers will have an annual statement that allows easy cost comparison with other providers. In addition, consumers at risk of financial difficulties will be given guidance on the consequences of paying off too little. The industry will introduce the key changes by the end of this year, the government says.

In a very encouraging and upbeat move at the end of last week the British motor industry, with Government assistance, confirmed that it is looking to expand via £2.6 billion worth of investment that is set to safeguard and create thousands of new jobs.  Nissan is to start the mass production of electric vehicles in Sunderland and Ford plants in Dagenham, Southampton and Bridgend will build the next generation of cleaner diesel and petrol engines for its cars, McLaren is also to build super cars in Woking to rival Ferrari and Lamborghini in the retail market.  The news follows investments commitments following the opening of Lord Mandelson’s £2.3 billion fund to support the car industry, under which £270 million loan guarantees have been committed to Vauxhall.  The news comes as new statistics reveal that production in Britain’s car factories rose by 62 per cent year on year in February.  Commercial vehicle production also rose, increasing by 74.2 per cent.  Whilst one must remember these comparisons are against terrible numbers last year, it is very encouraging and I believe it is central to re-balancing our economy away from one that has been consumer spending (i.e shopping) led to one that is export focused.  This will help reduce our deficiencies in manufacturing and ultimately help create the wealth in the economy that is so desperately needed. The CBI in its latest snapshot on industry said that export orders are at their strongest for 18 months, which are helping Britain’s struggling manufacturers compensate for weak, poor demand at home.  A quarter of firms reported that they expected to increase production over the next three months, whilst one fifth said they would reduce output.  The CBI’s Industrial Trend survey also reported a pick up in price pressures, which are at their strongest since September 2008.  This theme of increasing price pressure was also discussed at the last Bank of England rate setting meeting, where minutes released in the week showed a unanimous vote to retain rates at the same level, whilst leaving quantitative easing on hold also.  One of the reasons for growing worries on inflation, revolve around sterling’s recent sharp decline and the impact that this is having on petrol at the pump.  AA in the week warned that petrol is heading for £5.40 a gallon with the Chancellor likely to proceed with the postponed introduction of a planned 3p hike in duty due on April 1st.  The average petrol price is currently around £1.15 a litre and this looks set to increase to over £1.20 in the coming weeks.  If sterling falls sharply then this will add to the upward pressure on the price at the pump.

 

Employment numbers in the week on the surface looked very encouraging, with the numbers of people claiming benefit in February falling at its sharpest rate since November 1997, just after Labour came into power.  The Office of National Statistics said that the number of Briton’s claiming job seekers allowance fell by 32,300 in February to 1.59 million, against analysts’ predictions of an 8,000 rise.  However, if one digs into the numbers, the surprise drop in unemployment was largely down to the fact that 149,000 people over the last quarter have been re-categorised as ‘inactive’ taking the number of those not working to an all time high of 8.16 million. The number of people in employment in the month actually fell by 54,000, giving an employment rate that is at a 13 year low, suggesting that an increasing number of people are giving up on the labour market.  The figures also reveal that public sector employment rose by 7,000 in the final quarter of last year, to 6.1 million, whilst private sector employment fell by 61,000.  Compared with a year ago, the NHS is now employing 62,000 more people, taking its head-count to 1.62 million, an all time high.  Overall, the unemployment rate fell 0.1 per cent to 7.8 per cent of the workforce, compared with 9.9 per cent in the Euro zone and 9.7 per cent in the US.  The UK’s more flexible labour market is enabling people to retain their jobs. They are doing shorter hours and are prepared to take short-term pay cuts in order to ensure the survival of their employers in the private sector.  I cannot emphasise enough how important I believe the flexible UK labour market is and how it has enabled us to keep unemployment numbers much lower than our main European competitors.  It also means that specialist skills are not lost and we can respond more quickly to an upturn in overall aggregate demand when it eventually occurs – as it will.  Of course, one of the other reason why our numbers are not as poor as our main economic rivals is, of course, the fact that the Government has been using a significant proportion of the borrowed money in order to grow public sector employment, which will stop next year when the squeeze on public sector employment will see a reversal of 13 years of Government policy.  Long-term unemployment, measured by the total of people out of work for more than 12 months rose by 61,000 to 687,000, the highest level since 1997, suggesting that there are serious structural issues to be addressed.  The number of 16 to 24 year olds out of work was down 28,000 to 915,000, or 19.6 per cent of the workforce in that age group.  The number of economically inactive people at 8.16 million is the highest since the Office of National Statistics started recording this measure in 1971.  The ONS said that of the 8.16 million people deemed to be economically inactive, it thought that 2.3 million would like to have a job.  If this number were therefore added to the number of unemployed and then the 2 million on the long term sick, then the numbers very quickly grow. According to the Government funded National Skills Council’s new report on Britain’s most rapidly growing jobs, its audit reveals that in the past 8 years Britain has become a nation of beauticians, town planners and psychologists.  The first national Strategic Skills audit reveals a country using its higher income to, what the Financial Times described as “naval gazing” rather than building the industries of the future.  Rapid growth has been in conservation and environmental protection officers whose numbers have increased by 124 per cent between the second quarter of 2001 and the second quarter of 2009.  The number of town planners has also doubled over the same period.  Other big gains have been seen in semi-professional occupations, these are jobs that help highly qualified people - like teaching assistants and paralegals.  Meanwhile, off shoring has taken its toll on heavy manufacturing and factory floor jobs.  The number of electrical product assemblers has tumbled by 69 per cent, whilst metal workers have also been in steep decline.  The audit reveals that the UK is pretty poor at creating the sort of jobs that will be needed to build a world-beating manufacturing led economy.  As the FT notes “the UK’s growth in highly skilled jobs has been one of the lowest in the Organisation of Economic and Corporation and Development since 2001”.  Chris Humphries, Chief Executive of the Government funded body behind the report said “we are actually getting higher growth in public sector jobs than those ideal in economic terms.  Public sector jobs don’t create wealth, they spend wealth”.

 

Italian prosecutors are probing financial institutions as local and national government agencies face potential losses of €2.5bn on derivatives with lawyers accusing them of misleading the city of Milan on swaps. On Wednesday four banks were charged with fraud linked to the sale of derivatives to the city in a case that could set off a large number of lawsuits by Italian local governments facing potentially billions of dollars of losses on their borrowings. A trial date for, Deutsche Bank, JPMorgan Chase, UBS and Hypo Real Estate Holding’s Depfa Bank, has been scheduled for May 6. Iceland's central bank cut its key policy rate by 0.5 percent on Wednesday as it sought to bolster its economy despite ongoing controversy about Icesave. Sedlabanki said its key lending rate will be lowered to 9.0% from 9.5%, while the deposit rate and overnight lending rate will be cut 0.5 percentage point to 7.5% and 10.5%, respectively. In the fourth quarter, economic growth returned after a severe recession, with seasonally adjusted gross domestic product rising 3.3% after a 7.2% contraction in the third quarter. Sedlabanki's rate move comes despite the ongoing controversy surrounding online savings bank Icesave, a unit of Landsbanki, which collapsed at the height of the global financial crisis in late 2008. The repayment of EUR3.9 billion, which U.K. and Dutch governments spent to cover the savings of their depositors, is still under negotiation. India’s central bank is forecast to increase interest rates again next month as the Reserve Bank of India last week increased the benchmark reverse repurchase rate to 3.5 percent from a record-low 3.25 percent and the repurchase rate to 5 percent from 4.75 percent, saying containing inflation has become “imperative.”

 

Standard & Poor’s gave Greece a vote of confidence on Tuesday as the ratings agency backed away from downgrading the country’s debt in a sign that the Greek budget crisis was easing. The euro area’s 16 finance ministers declared on Monday night that they stood ready to assist Greece with direct loans from individual member-states. But they insisted that the overriding goal remained for Greece to overcome its difficulties was by means of a rigorous austerity programme lasting at least three years. Bullish Investors said S&P’s statement indicated that Athens no longer faces an imminent downgrade because its deficit reduction measures had increased confidence that Greece will be able to borrow again from the markets over coming weeks. Later in the week the euro zone’s united front against involving the International Monetary Fund in a rescue operation for Greece started to breakdown, with at least three of the area's 16 nations openly calling for IMF intervention if needed. Finland, the Netherlands and Italy were clear in there views. The IMF has already provided technical assistance to Greece this year and until now euro zone governments have ruled out IMF financial support on the grounds that the Greek crisis is an internal matter for Europe's monetary union. A number of euro zone governments, as well as the European Commission, regard it as a matter of European prestige and credibility to oppose financial aid from the Washington-based IMF. Germany's perceived hard line stance has also stoked anger. In a thinly disguised reference to Greece, Merkel told her parliament on Wednesday that there should in future be a mechanism to expel countries from the euro zone if, "again and again", they broke its financial rules.Greece's socialist government, dissatisfied with what it sees as the delay in sealing European support stated later in the week that it had not ruled out turning to the IMF as a last resort unless EU leaders come up with an acceptable rescue package at their next summit on March 25.

 

Credit default swap markets need to be better regulated, and introducing a central clearing system for them is a top priority, European Central Bank president Jean-Claude Trichet said on Friday. A CDS offers insurance against a default on corporate or government debt and contracts are mostly privately negotiated, or ‘over-the-counter'. He said CDS that offer protection against debt default should not be misused by speculators and he did not call for a ban on using CDS to bet that a borrower's creditworthiness will deteriorate. A number of politicians have blamed the practice – which involves buying of CDS by speculators who do not own the bond being insured – for adding to Greece's debt woes. On Wednesday Michel Barnier, the European commissioner in charge of financial market regulation, said he would propose rules to control such transactions, also known as naked buying. This I believe is very sensible and the correct course of action. Clearing of CDS trades in the EU and United States began on a voluntary basis last year and market leader ICE said in January its European clearing passed the trillion-euro mark. Clearing ensures that a trade is executed even if one side defaults and provides an electronic data trail for supervisors. The G20 group of leading countries agreed last year that as many contracts as possible in the world's $450-trillion derivatives sector, including CDS, should be standardized, centrally cleared and traded on an exchange where appropriate by the end of 2012. The United States is already debating a bill to turn this pledge into law and the EU is due to come out with similar draft measures in the summer. Those opposed to credit default swaps say that speculators use the contracts to bet against countries for profit, which can lead bond yields higher and make it prohibitively expensive for debt-strapped countries like Greece to refinance their debt. In the week the Bank of Japan voted to hold interest rates at 0.1%, a level maintained since December 2008. It also increased a stimulus measure aimed at encouraging financial institutions to lend more by doubling to 20 trillion yen ($220bn) the amount of cheap short-term loans it is offering banks. The scheme, which lends money at a rate of 0.1%, was introduced in December to try to tackle the deflation that is threatening Japan's economic recovery. The economy expanded by 0.9% between October and December of last year, down from an initial estimate of 1.1%. The continuing problem of deflation is bad for an economy, as it tends to make consumers and businesses delay major purchases in the expectation that prices will fall further in the future. Japan has a history of struggling with deflation with the 1990s referred to as Japan's "lost decade" because of its 10-year struggle with falling prices. This followed a collapse in prices in the housing market and the stock market at the end of the 1980s.

 

US equities closed just off an 18-month high last week, after the Fed reiterated that it would keep rates low for an “extended period” and that has been interpreted by investors as meaning no rate rise for at least the next six months. Meanwhile whilst readings beat economists' expectations on new home construction and building permits, both fell in February showing continual weakness in the economy. Construction of new homes fell to an annual rate of 575,000 during the month, down 5.9% from January's revised rate of 611,000; this was an increase of 0.2% from the 574,000 rate in February 2009. The number of building permits issued during February fell to a seasonally adjusted annual rate of 612,000. This was 1.6% below the revised January rate of 622,000, but up 11.3% from the February 2009 rate of 550,000.Economists had expected building permits would fall to 601,000.

 

China warned the U.S. against imposing sanctions over the value of the Yuan, arguing that the exchange rate issue has been politicised and that a rise in protectionism threatens the global economic recovery. In the US, five senators last week introduced legislation to make it easier for the U.S. to declare currency misalignments and take corrective action. China repeated that it, “won’t turn a blind eye” if the Treasury Department’s April 15th report labels the Asian nation as a currency manipulator and sanctions follow and that he Chinese government  would “deal with” any escalation of the dispute. In the three years to mid 2008 the currency had been allowed to appreciate 21 percent, but since then the Yuan has remained at 6.83 per dollar. This month China will probably record its first deficit since April 2004, with the surplus having already fallen to a one-year low of $7.6 billion in February after a fall of just over a third last year. International Monetary Fund Managing Director Dominique Strauss-Kahn said Wednesday that China's currency remains undervalued. "The opinion of the IMF from this point of view is still that the Renminbi is very much undervalued," he said at a conference at the European Parliament.  Strauss-Kahn said that in economies with persistent current account surpluses -such as China, Germany, and many oil-producing countries - domestic demand must go up. Broadly speaking, this means boosting growth in consumption, and in some cases, exchange rate appreciation would also play an important role, he said. "Some currencies are obviously undervalued, especially in Asia, especially the Renminbi.” The IMF chief also said the global economic recovery was stronger than some had predicted. "The recovery is shaping up to be better than expected, and we are forecasting global growth of 4% this year," The World Bank on Wednesday raised its growth forecast for China this year to 9.5 per cent and warned that tighter monetary policy and a stronger currency were needed to prevent bubbles and rising inflationary expectations. In a generally upbeat assessment of the Chinese economy the bank raised its forecast for 2010 from the 8.7 per cent it predicted in its last quarterly report in November.

 

The Organisation of Oil Exporting Countries (OPEC) has agreed to keep to its existing oil output quota in a decision that was widely expected. The oil producers' cartel is currently exceeding its stated production target of 24.84 million barrels a day, but expects demand to mop up that extra. Crude oil for April delivery closed at $80.68 a barrel. The April contract expires today, with the May contract where the bulk of trading took place, settled at $80.97.

 

The week’s events will be dominated by Wednesday’s budget and whether or not Alastair Darling will be able to present a credible plan to cut borrowing, whilst at the same time offering sufficient electoral bribes to help the Party’s fortunes in the up and coming general election. On Thursday we are expecting official retail sales numbers for February to show a recovery from January’s fall, but they are unlikely to be strong enough to fully offset the decline seen at the start of the year. On Tuesday, UK inflation numbers are likely to show that CPI inflation last month was around 3.5 per cent, as increasing petrol prices help push up overall inflation, although a sharp upturn in food prices last February will drop out of the annual comparison figure, thus neutralising the effect somewhat. In the US the February Existing Home Sales index from the National Association of Realtors is due out on Tuesday when Sales are expected to have fallen to 5 million from the 5.05 million in January.  Durable goods orders, on Wednesday are expected to have risen 0.5% in February after rising 2.6% in the previous month and Durable goods excluding autos are expected to have risen 0.3% after falling 1% in January. February new home sales are forecast to have risen to a 315,000 annualised level from a 305,000 level in January. GDP on Friday is expected to remain at the same 5.9% annualised rate in the government's first revision of fourth-quarter GDP. The final March reading on consumer sentiment from the University of Michigan is due on the same day and is expected to have risen to 73 from 72.5.

 

Investor Jim Rogers and chairman of Singapore-based Rogers Holdings (he co-founded the Quantum Fund with George Soros) says he is shunning sterling because of the UK’s trade deficit.” I cannot imagine buying sterling back unless it gets really cheap.” He also repeated that Greece shouldn’t be bailed out and that allowing the country to go bankrupt would propel the euro “through the roof” as investors concluded it was a “hard currency.” “Why should you support people who’ve been living high on the hog on someone else’s money?” said Rogers, He announced that he has bought euros because the market has “massive amounts of short positions” in the single currency and he expects gold to go “much higher” in the next decade, although he is not purchasing equities, although he may do so when they correct. If the stock market “goes down 20 or 30 percent, that would probably raise my interest,” he said.  “We’re going to have another recession, I guarantee you … by 2012 say, it’s time for another recession,” Rogers told CNBC over the weekend. “The next time it’s going to be worse because we’ve shot all of our bullets,” he added. The difficulties in Greece appear not to have been resolved by the European Community and the prospect of IMF intervention looks an increasing possibility.  The collapse of the Latvian Government in the week, where the economy is expected to have contracted by around 30 per cent since the start of the recession, is also likely to re-focus investors’ attentions on the prospect of a sovereign debt default, which I continue to believe is highly likely and will ultimately pierce the increasingly optimistic mood of equity investors who are misreading current strength in the global economy as a sign of a durable recovery. Emergency interventions have helped boost the global economy but it has not been restructured. These investors are failing to recognise that stimulus programmes will be removed and are being mislead by their distorting effect on aggregate demand. I believe that western economies are unlikely to be powering ahead next year at the break-neck speed that most Western Governments are predicting.  The European Commission on Wednesday warned the euro zone’s four largest countries ; Germany, France, Italy and Spain  that their economic growth forecasts for the next three years are too optimistic, putting at risk their ability to cut their budget deficits in accordance with the European Union’s fiscal rules. I do not believe that the UK economy will grow by 3.5 per cent next year, which the Chancellor is going to comically predict in the budget.  This is not merely fanciful, but an outright lie, but one which he needs to adhered to. If he does not then the public spending projections would shoot up to levels that would be unpalatable for both investors and an electorate about to vote in the up and coming general election. The fact that these projections will prove ridiculous will be part of the reason why the forth coming public sector cuts will be much more severe than the electorate are being told by all sides of the political spectrum.  "People are not ready for this," Vince Cable said at the weekend. "The political classes haven't spelt out what's involved”. That is that there is a fearsome fiscal squeeze is on the way.

 

 Leeds Financial