Market Watch from www.legalandfinancial100.co.uk

The Chairman of the US Federal Reserve warned in the week that the US economic outlook remained “unusually uncertain, but offered no new plans to stimulate it, as a number of commentators had hoped.  The Fed has now held its benchmark lending rate at zero to 0.25 per cent since December 2008 to encourage borrowing, but recent economic data has shown that the recovery is faltering as employment remains high and the housing market starts to deteriorate.  Against this, consumer confidence has recently fallen sharply.  In his speech to the Congressional Committee, the Chairman believes that the US economy will grow by between 3 per cent and 3.5 per cent this year and 3.5 per cent to 4.5 per cent next year.  If this is true then the US economy is clearly not heading for a double-dip recession, as I and a number of commentators believe will inevitably happen in the US.  Earlier in the week, Greece, Ireland and Spain managed to get debt issues away, with reasonable yields and cover, although all were relatively short dated.  Hungary, however, is increasingly in dispute with the International Monetary Fund over its deficit reduction plans.  Hungary is in the fifth year of an austerity programme and the IMF has put in doubt a $25 billion loan to the country, citing the fact that the Government is not being austere enough in its current plans in order to stabilise the country’s finances, as the new Government is increasingly reflecting the public mood that enough is enough.

According to Jean-Claude Trichet, President of the European Central Bank, public spending cuts and tax increases should be imposed immediately across the industrial world, as evidence of a healthy European recovery is seen.  The view of Europe’s most senior economic policy maker contrasts with continued US demands for fiscal tightening to be delayed until at least 2011 and suggests there is little agreement between Europe and the US over the best way to help the global economy.  The world’s leading economic watchdog, the International Monetary Fund said in the week that Europe faces a prolonged period of stagnation, unless it puts its house in order.  The report pained a picture of an unruly economic confederation which lacks the necessary controls to reign in excessively spending members.  The report described a patchy and uncertain recovery as the most likely outcome, unless measures were undertaken to bring down private and public debt.  Without such action the IMF has warned of years of ‘anaemic’ growth.  Speaking in the week, Spencer Dale, the Bank of England’s chief economist and member of the Monetary Policy Committee delivered a warning of low UK growth, soaring unemployment and high inflation.  He believes that demand in the economy will remain “”incredibly anaemic” for up to five years and that the economy will not return to normal “for an awfully long time”.  He sees one of the main drivers for inflation being the recent VAT hike, which takes effect in January.

The U.K. economy grew at its fastest pace in more than four years in the second quarter, the Office for National Statistics said on Friday. In its preliminary growth data, the ONS said the economy expanded 1.1% on the quarter and 1.6% on the year between April and June, meaning that the U.K. has now expanded for three straight quarters the recession. In the first quarter, the economy expanded 0.3% on the quarter and declined 0.2% on the year. The last time quarterly growth matched 1.1% was in the first quarter of 2006. Quarterly growth hasn't been higher since the third quarter of 1999.  UK retail sales were stronger than expected in June, boosted by promotions and the World Cup, the Office of National Statistics said in the week.  Retail volumes were up 0.7 per cent in June from May and rose 1.3 per cent on the year.  Economist had been expecting sales to rise by 0.4 per cent on the month and 1.3 per cent on the year.  On another positive front, British manufacturing is continuing to recover, with production rising at its fastest pace in 15 years according to the Confederation of British Industry.  In its monthly industrial trend survey, total orders hit a 23 month high, whilst a separate quarterly poll showed production rose at its fastest rate since April 1995 in the three months to July.  According to the Society of Motor Manufacturers and Traders, UK car production increased sharply in June, rising 28.6 per cent on the same month last year.  Almost 118,000 cars were produced and this was the eighth month in a row that production increased. 

The Budget deficit was slightly larger than expected in June, and this was before the £6 billion additional cuts planned by the coalition have taken effect.  Public sector net borrowing rose from £14.9 billion a year ago to £15.2 billion and was up 2.4 per cent in the second quarter in the year compared with the same period in 2009.  Tax receipts rose by 4 per cent compared to a year ago, after rising 10 per cent or more in the previous three quarters of the year.  The Budget forecast for the whole of 2010/11 is for tax receipts to increase by slightly over 6 per cent.  Current spending was up 4.6 per cent in June compared to a year ago and 5.6 per cent so far this fiscal year, in line with the Budget forecast.  Government borrowing, as measured by the public sector net cash requirement, climbed to £20.9 billion in June, the highest since records began in April 1984 and up slightly against last month’s £20.2 billion for the same month last year.  The rise is significantly more than market expectations of an improvement to a deficit of £15 billion for the month.  Britain’s total sector net debt is now £926.9 billion, equivalent to 63.9 per cent of GDP when the bank bailout costs are involved. The National Audit Office in the week warned that targets to cut Government department spending by £35 billion by 2011 are unlikely to be met.  Gordon Brown had asked the Treasury to seek annual savings of £35 billion from departments across Whitehall by 2011, as he sought to curb back official spending without affecting front line services provided.  Within the report published the National Audit Office found that many savings identified were either dubious or would be detrimental to public services.  It also questioned some of the £10.8 billion in savings already reported by Government departments, arguing that many of them are unsustainable. In its monthly trends in lending report, the Bank of England said that bank lending to UK businesses shrank again in May, with corporate balance sheets helped by a very strong month of new share sales.  The Bank said that the total stock of loans to British businesses dropped by £2.3 billion in May, after a fall of £1.1 billion in April.  The report also stated that rather than the banks being unwilling to lend, that there was muted demand for lending and that the corporate market expected this to remain that way for some time to come.  Meanwhile, gross net mortgage lending, i.e. new loans minus repayments, fell in June compared with May, whilst the figure of 48,000 mortgage approvals for house purchases was down from 51,000 in May according to data from the Council of Mortgage Lenders, which, unlike the Bank of England, does not seasonally adjust its monthly numbers.  A total of £13.1 billion was advanced during the month, 15 per cent more than in May and the highest level since December last year.  For the second month running Andrew Sentence was the one lone voice of the Monetary Policy Committee calling for a rate rise, the minutes of the last MPC meeting revealed in the week.  He argued that inflation, which has fallen by 0.5 per cent in the past two months to 3.2 per cent, is still above the Bank’s 2 per cent target and likely to remain that way for some time.  The balance of the Committee, however, expect inflation to fall over the nearer term and even discussed the prospect of embarking on another bout of quantitative easing, having already issued £200 billion of new money.   I believe there will be further quantitative easing, although this is probably not going to occur until the latter part of this year and will likely be a coordinated push by both Europe and the US to try to boost flagging Western economies.

According to new data from the International Energy Agency, China has removed the US as the global top energy user, with China consuming 2.2 billion tonnes of oil equivalent last year, compared to the US, whose consumption was 2.17 billion tonnes of oil equivalent.  Whilst the figures were questioned by China, they clearly show its increasing and insatiable appetite for energy, as it continues to expand its industrial base.  A decade ago China’s total energy consumption was about half that of the US.

Markets rallied in the week and have read poorer news as a positive, which is always a worrying trend.  It is generally believed that the poorer news will require policy makers to act to counteract the downward pressure and a growing number of commentators are suggesting that further bouts of quantitative easing are inevitable. After the downbeat comments from the US Federal Reserve Chairman, Mr Bernanke and his comments were interpreted as a sign that further stimulus probably through more quantitative easing will be required in the US.  Such market optimism makes me very nervous and if this additional stimulus is not forthcoming in the weeks ahead then valuations will look stretched and markets could react very violently to bad news.  I believe there is significant bad news yet to be revealed and whilst the stress tests on the European banks is seen as a way of trying to appease market participants, unlike in the US, European banks are not the core problem, as they were when the US banks were tested.  The core problem in Europe is sovereign debt and however the authorities fudge the results of the bank stress tests, the sovereign debt issues are not going away quickly.