Market View from www.LegalandFinancial100.co.uk

During the past week and ahead of the coalition’s Emergency Budget on June 22nd, the UK’s Deputy Prime Minister, Nick Clegg, gave the clearest sign yet that the new government will be looking for savings from public sector pay and pensions as it looks to reduce a £156 billion Budget deficit.  Whilst acknowledging that nobody wants to see a drop in real public sector incomes and the government was committed to protecting those on low wages, Mr Clegg said that the public sector pay bill, which now costs the country £160 billion a year, had to be tamed and that pain would be felt throughout the economy.  His comments came just hours after the government’s new Office for Budget Responsibility downgraded the official growth forecasts from 2011 onwards, as expected, and said that the current situation with public sector pensions was simply not fair.  Clegg said that expenditure on public sector pensions would rise to more than £9 billion in 2014/15 from £4 billion in the fiscal year 2011 as a result of the previous government’s inaction.  In 2015, therefore, the cost of public pensions will be around £4,000 a year per household.  Mr Clegg also hinted at big increases in employee contributions to public sector pensions for NHS staff, teachers, civil servants and others to close this gap.  From 2011, the large majority post war baby boom generation starts reaching 65.  This section of the population were huge contributors to growth in the past decade, with falling birth rates they had more spending power and increased female participation in the labour market added significantly to spending and output.  This demographic boost, however, has been wasted as the previous government failed to ensure that the baby boomers set aside sufficient savings to sustain themselves in retirement.  It has been argued that Gordon Brown’s raid on pension funds, early on in the first Labour Administration, turned what was largely regarded as one of the best pension provision of any country, into one which became one of the poorer.  Rather than encouraging these baby boomers to save for retirement, government policy actually discouraged it and encouraged borrowing, just at the time when the opposite was required. 

 

The new independent fiscal watchdog, the Office for Budget Responsibility, has predicted growth of 2.6 per cent next year and 2.8 per cent in 2012, below Alistair’s predictions of 3.2 per cent and 3.5 per cent respectively.  This, therefore, leaves Britain’s structural deficit, bigger than feared over the next five years.  The structural deficit is the gap between what the government gets in taxes and what it spends in a year and whilst we expect the government to overspend in hard times, because taxes fall and benefit payments rise, it cannot continue for an extended period. It is estimated that it will hit 8.8 per cent of GDP or £123.7 billion this year, compared with Alistair Darling’s forecast of 8.4 per cent of GDP.  By 2014/15 it will have fallen only to 2.8 per cent of GDP the Budget Office said, rather than the 2.5 per cent anticipated by Labour.  Continually running a structural deficit is a clear sign of living beyond our means and means that over the five year period our overall level of debt will increase from the current £870 billion to nearer £1.4 trillion.  The Office of Budget Responsibility suggests that debt interest will be £67.2 billion by 2014/15, slightly lower than the £70 billion David Cameron warned of a few weeks ago.  In the previous government figures for net borrowing over the five year period to 2014/15 were forecast to hit £567 billion, although the Office of Budget Responsibility now forecasts this at around £544 billion. 

 

Of particular note to me was the fact that the Report said that there was less spare capacity in the economy at the end of 2009 than the Treasury assumed three months ago.  The previous government assumed that six quarters of falling output meant that the economy could grow for a protracted period without reigniting inflation.  The numbers produced in the week, however, suggest that spare capacity amounted to 4 per cent of national output, rather than the 6.25 per cent the former Chancellor has forecast.  The relevance of this is that there is less scope for the economy to expand at above its long term trend rate without igniting inflation. The conclusion from the Report by the Independent Watchdog is that in the short term our outlook is slightly less poor, although the longer term outlook is worse.  So, on the inflation front, one of the main questions arising from the report is whether or not the Bank of England’s Monetary Policy Committee will stay unworried about inflation, which is already high at 3.7 per cent.  If it does start becoming worried about inflation then interest rates will have to rise sooner rather than later.  As I have said before, I believe that in the nearer term inflation is likely to fall back sharply as the deflationary forces emanating, not only from the government spending cuts but also Europe, push it significantly lower.  It will be the fear of deflation taking hold that will encourage authorities to create more inflation within the system and, ultimately, I believe this will be achieved by more quantitative easing or the printing of money, not only in the UK but also in Europe. The higher structural deficit means that the government is likely to impose more dramatic and fiscal tightening in coming years to meet its goal of eliminating the bulk of the structural deficit by the spring of 2015.  Growth this year was unchanged at 1.3 per cent.  The OBR sees growth of 2.6 per cent in 2011, 2.8 per cent in 2012/13 and 2.6 per cent in 2014.  Ahead of the Emergency Budget the UK Treasury said it was axing twelve projects worth some £2 billion and suspended a further twelve schemes with a cost of £8.5 billion, arguing that these were unfunded schemes by the previous government in its attempt to bribe the electorate. The numbers also reveal the unpalatable truth that is that Britain now has to cut back, whether or not we like it.  Other economies like Greece, Portugal and even Germany are trimming their deficits and, if we do not follow suit, we will be targeted by investors worrying about our continued solvency.  Whilst many argue that it is not possible to cut government spending and achieve reasonable growth, one should look at the history books.  This has been done twice before in Britain in the last 30 years in the early 1980s and the mid 1990s.  From a budget deficit of 8 per cent of GDP in 1993 Britain managed to achieve a surplus of 3.7 per cent in 2000.  This was done under Chancellors Norman Lamont, Kenneth Clarke and the early version of Gordon Brown; when he earned the reputation as a prudent Chancellor before he threw it all away in his spend thrift days. Canada managed to turn a budget deficit of 9.1 per cent of Gross Domestic Product in 1992 and turned it into a surplus of 2.9 per cent in 2000.  Spending cuts and tax rises planned by the government, according to former Monetary Policy Committee member, David Blanchflower, risks plunging the UK into another ‘great depression’.  Echoing other commentators, Blanchflower said economic growth only comes from bank lending or government spending.  “The point is if you have no government spending and no bank lending there is no show in town” he said. 

 

A sensible approach to raising money from the population through tax is to tax what you want to discourage, not what you want to encourage.  This principle has long guided policy around the world and is the reason why alcohol and cigarettes, for example, are generally taxed quite harshly but, in the UK’s case, the balance between taxes on labour and consumption is skewed in the wrong direction.  The taxes paid on working account for 49 per cent of the total tax, while the taxes on consumption provide around 32 per cent according to analysts.  Mr Osborne’s up and coming budget looks a good opportunity to improve this mix and is one of the reasons why I believe that it is inevitable that VAT will increase.  Currently there is little need to support consumption with lower taxes and whilst we talk about poverty, there is not widespread real poverty in the UK, Britons continue to consume in abundance and this is clearly seen in our official basket of inflationary measured consumer goods, which includes garlic break, foreign holidays and blue ray disc players.  The forthcoming slowdown is already being flagged by a number of companies, with W S Atkins, the construction and engineering company, warning that the need to cut the UK’s budget deficit would result in a raft of delayed and cancelled projects during the next few years, which would have an impact upon it. Mouchel warned that its order pipeline since March has fallen away as public sector contracts have shown a decided turn for the worst. 

 

The UK’s finances were in better shape in May than economists had forecast, according to official data released on Friday, leaving Chancellor George Osborne with somewhat more headroom than first thought. According to the Office for National Statistics, public sector net borrowing was £16.0bn, below the £18.0bn consensus forecast and lower than that seen in May 2009, when it totaled £17.4bn. Net borrowing for April was also revised down by £1.6bn, to £8.3bn and the public sector net cash requirement totaled £12.0bn, significantly below the £19.1bn in May 2009. The nation’s current budget deficit was £14.1bn in May while net debt, at £903.0bn, was 62.2 per cent of gross domestic product, up from 55.4% a year earlier, the fifth-highest month of borrowing in history. Meanwhile, there was evidence of how the debt burden will weigh on the U.K. government with debt interest payments rocketing 45% in May from a year earlier, to GBP4.3 billion. Net social benefits, which include unemployment benefits and other welfare costs, were up 3.7%. The latest data continues a message of improving finances delivered over the past few months. In May, total receipts were boosted relative to those of May 2009 with the reintroduction of the 17.5 per cent rate of value added tax as well as the introduction of a 50 per cent tax band for those earning annual incomes of £150,000 or more. Taxes on income and capital gains were £9.3bn, roughly 9 per cent above levels in May 2009. VAT receipts, at £7.3bn, were about 19 per cent above those in the previous May.

 

Draconian cuts in spending are inevitable and Osborne is likely to announce that the coalition intends to eliminate the deficit by cutting £4 in spending for every £1 raised in tax, arguing that is the best way to ensure robust future growth. George Osborne will likely announce plans for the biggest-ever assault on welfare benefits in Tuesday's emergency budget as part of an estimated £85bn package of savings and tax rises to reduce Britain's unprecedented peacetime deficit. The coalition also believes that, by slashing the £180bn-a-year welfare bill, it can help protect spending in other areas, such as education, defense and transport, as well as safeguarding capital projects vital to the economy. The focus on welfare and benefit reform is likely to include cuts in tax credits for wealthier families and could see the end of child benefit payment to higher earners. Other measures aimed at business are likely to include cuts in corporation tax, with Osborne setting out a five-year road map to reducing rates. These are steps in the right direction, but whether they will be enough to shield vulnerable regions remains to be seen. A National Insurance contribution holiday for employers in depressed regions is likely to be the centerpiece of the coalition government's efforts to avoid being seen as callous slash-and-burn merchants, with the idea being to stimulate private sector employment and small business growth in areas dominated by the state. Economists expect the chancellor to increase VAT and CGT, raising billions of pounds for the Treasury. This will be softened with an increase in tax thresholds, possibly up to £10000 over the course of the parliament, taking many families out of the income tax net as he also dramatically reduces tax credits to the better off recipients. A fat tax that is higher taxes on high sugar and fat foods is also a likely possibility. Changes to aviation taxes will provoke protests from airlines as Osborne is expected to replace air passenger duty with a “per-plane” duty. The Chancellor is understood to have rejected pleas from banks for a profits tax and will on Tuesday announce a £3 billion tax targeted at the banks capital position, very similar to what is being proposed in America. The Institute for Fiscal Studies estimates that £85bn will have to be found in cuts and tax rises over the course of this parliament to balance the books, this is £34bn more than there would have been under Labour.

 

UK industrial output growth slowed in June as export orders slipped from May’s levels the Confederation of British Industry said on Thursday.  The industrial output balance dipped to +15 compared with +17 in the May survey and was weaker than expected. Business confidence amongst UK firms has seen its biggest drop since 1995 due to concerns over government spending according to the Business Trend survey from accountant BDO.  Their index fell to 97 in May from 103 the previous month, the largest drop since the survey began. UK retail sales raised more than expected in May as food stores and electrical goods sales picked up ahead of the World Cut.  The volume of retail sales rose 0.6 per cent on the month and 2.2 per cent on the year in May.  The year on year increase was the strongest since November 2009, with the month on month forecast double that which analysts had predicted.  The squeeze on public sector jobs has begun, with official figures on Wednesday showing unemployment in the UK rising 23,000 to 2.47 million in the three months to April.  The numbers also revealed that public sector employment fell by 7,000 to 6.1 million in the first quarter, ending a long period of growth in the sector, whilst private sector employment increased by 12,000 to 22.8 million.  On a positive note for the labour market, the number of people claiming job seekers allowance fell by a more than expected 30,900 in May to 1.48 million or 4.6 per cent of the workforce, the lowest for more than a year.  Unemployment has risen in the past three months, whilst the claimant count has fallen for six months out of seven and Officials were unable to explain the growing divergence between overall unemployment, a survey based measure, and the number of people claiming job seekers allowance. The biggest gap appears to be in the number of people who have been out of work for more than twelve months and who are now not seeking job seekers allowance.  The number of people classed as economically inactive rose by 29,000 to a record 8.19 million in the three months to April or 21.5 per cent of the workforce, boosted by a rise of 58,000 people who were long term sick.  Unemployment amongst the 16 to 24 year olds rose by 11,000 to 926,000, or 19.6 per cent of the workforce in that age group. UK inflation decline more than expected last month as food prices dropped and the rise in petrol prices eased off.  Consumer price inflation rose 3.4 per cent on the year, down from a 17 month high of 3.7 per cent in the previous month, slightly below forecast of 3.5 per cent, but still above the Bank of England’s target of 2 per cent.  The broader measure, the RPI fell to 5.1 per cent from 5.3 per cent in April. 

 

In a largely expected move George Osborne in the week moved to radically restructure the UK’s regulatory regime, describing what he saw as a spectacular failing to regulate the city properly by the tripartite regime established by Gordon Brown.  The move will see the abolition of the Financial Services Authority and increased powers for the Bank of England.  Mervyn King, the Governor will become one of the most powerful central bankers in the world, with a new remit to prevent the build-up of risk in the financial system, in addition to his Monetary Policy role.  The FSA will lose much of its powers to a new Consumer Protection and Markets Authority, charged with regulating the conduct of every bank and policing the City.  The structure of the Organisation will be focused on a prudential regulator, yet to be named, in charge of insuring that individual banks, building societies and insurance companies are operating safely.  The Bank of England will still retain the power to set interest rates, which was given to it by Gordon Brown in one of his first acts in government, as well as controlling the money supply and being the lender of last resort.  It also shifts power from Canary Wharf, where the FSA is located, to the heart of the square mile, the traditional home of London’s banks.  Speaking for the first time since the announcement, Chief Executive of the Financial Services Sector, Hector Sants said that Banks were not practicing what they preached.  Mr Sants had been due to step down as Head of the FSA this summer but has now been put in charge of overseeing the transfer of the FSA’s core regulatory powers to the Bank of England, as the government begins to dismantle the tripartite system. Before the Chancellor’s announcement, the Future of Banking Commission released its report, suggesting investment bankers should be forced to wait ten years to cash in their bonuses in full under radical proposals tabled by a cross party commission set up in the wake of the banking crisis.  The Commission, which was chaired by David Davis, the Conservative MP, said that dramatic changes were needed and that even remuneration proposals set out by the G20’s Financial Stability Board did not go far enough in eliminating rewards for taking short term risks.  Other members included the Business Secretary, Vince Cable and Peter Vicar-Smith, Chief Executive of Which. 

 

According to the Royal Institute of Chartered Surveyors, the abolition of Home Information Packs last month has provided a boost to the property market, with an increase in the number of homes being put up for sale.  However, according to the Council of Mortgage lenders in the week, the number of loans to first time buyers fell to 17 per cent in April, the lowest proportion of total home purchases since September 2007.  The CML said that 40,000 loans for house purchases in April were 9 per cent down on March, whilst the number of first time home loans fell to 14,300.  Loans to home owners fell 5 per cent to 26,100, whilst remortgaging numbers were down 16 per cent to 24,000.  The government had announced in the previous week that around 150 social housing projects were under threat because of a £610 million black hole inherited from the last government and announced a £100 million cut from the National Affordable Housing Programme, which will see plans to build 1,453 social homes axed.  Housing Associations typically fund 60 per cent of the cost of affordable houses, with the remainder met by grants.  Many associations have invested heavily in developing sites and now face the prospect of promised money being withheld.  Bellway, the large UK house builder commented in the week that these moves will have a very marked effect upon its performance in the coming year.

 

Euro zone industrial output surged in April increasing for the eleventh consecutive month and signaling that economic recovery could be gathering pace. The rise in April was greater compared with the same month last year than in any month in almost two decades, data showed on Monday. The European Union's statistics office Eurostat said industrial production in the 16 countries using the euro rose 0.8 per cent month-on-month for a 9.5 per cent year-on-year gain. The annual jump is the highest since measurements for the euro zone began in January 1991, Eurostat said. Despite the rise, production of consumer goods fell month-on-month; indicating demand among consumers was still fragile Eurostat also revised upwards production data for March to a 1.5 per cent monthly rise and a 7.7 per cent year-on-year gain from 1.3 per cent and 6.9 per cent respectively. Spain is increasingly coming into focus as the international markets are virtually closed to Spanish banks and corporations, because investors are becoming more nervous about their exposure both to potentially suspect government debt and also to bad domestic property debts. Spain's banks are heavily exposed to the country's property sector, which has been badly hit by the slump in the market. Evidence shows that the banks are getting funding from the European Central Bank. They borrowed €85.6bn from the ECB last month double the amount lent to them before the collapse of Lehman Brothers in September. Without this support, many of the savings banks [cajas], which make up 50% of the country's financial sector, would likely collapse. Whilst the Spanish government is still able to borrow in the markets, it raised €5.2bn from two short-dated auctions in the week it had to pay significantly more for the money paying 2.84% to borrow over 18 months, when last month it only had to pay investors 1.95%. The big fear is that Spain may end up being forced to resort to the Europe-wide emergency fund set up in the wake of the Greek crisis and that would undermine the already poor confidence of investors. Whilst Spain is not Greece, as its debt is 55 per cent of GDP, where as Greece debt is over 100 per cent, Spain still needs to issue a bout €97 billion of debt in 2010.  In July it must raise €40 billion, including redemptions, coupon payments and deficit financing, according to analysts.  Added to the complication, many of Spain’s banks are currently finding wholesale international money markets closed to them.  Therefore, the next six weeks are crucial to Spain and if it has to rely on the European Central Bank to buy its debt then there are question marks as to whether or not the Commission’s new €440 billion rescue fund will be sufficient to stop market nerves intensifying significantly.  By the end of 2011, Spain must refinance around 30 per cent of its outstanding debt and this is likely to occur at a time when the countries weakest banks also need recapitalizing.  But, according to analysts, this could push the country’s debt ratio to around 65 per cent of GDP and, whilst still manageable, for nervous investors it is heading in the wrong direction. Spain’s central bank, in an attempt to ease concerns, says it plans to publish the results of “stress tests” on the country’s financial institutions in the near future to clear up doubts about Spain’s banking system. Spanish officials and bankers believe that international investors and speculators have exaggerated fears about the potential problems of Spanish banks. However several of the 45 unlisted savings banks or cajas have proved vulnerable to the collapse of the domestic property market and are being forced into mergers to cut costs and the rationalise operations. The Bank of Spain has seized control of two small, struggling cajas, one in the centre of the country and one in the south. Spanish financial officials have denied suggestions that the Fund for Orderly Bank Restructuring, known as the Frob from its Spanish acronym, will need to raise tens of billions of Euros to recapitalise the country’s lenders. Some analysts say that the Frob was likely to pay out €11bn in loans to support mergers among the cajas, including €4.5bn for the merger among seven lenders led by Caja Madrid. To cover this, the Frob has €12bn of funds available – €9bn from its initial capital and a further €3bn from a bond issue last November. In the week the EU denied a report that it was setting up a special €250 billion plan to help Spain should it get into difficulties and also revealed that the result of stress testing of European banks in the 27 EU countries will be revealed next month, in a sign that it hopes to help stem market concerns.  Whilst Britain and Washington have been arguing for such disclosure for some time, it appears that France has now changed its mind, helping Germany push through the results, which it sees as central because the lack of transparency has only added to greater fear.  The blue print for the stress tests comes from the United States where, in April 2009, the Federal Reserve took charge of a rigorous health check of the 19 largest American banks.  After the stress tests a number of banks were forced into capital raising exercises, though some critics suggested that the tests were not harsh enough and should have extended across the whole banking system, where the number of smaller banking failures continues to rise at a worryingly high rate.

 

According to a report from the Bank of International Settlements on Monday, banks in France and Germany have nearly €1 trillion worth of exposure to the economies of Southern Europe, with the bankers bank saying that Germany banks have 12 per cent of their capital in government bonds, issued by the three hardest hit southern countries, whilst France is not far behind with 8 per cent of capital exposed in the three stressed nations.  All told, banks in the 16 country euro zone had €1.57 trillion of exposure as of 31st March to four countries facing what the report delicately calls ‘market pressures’.  The report also warns that European banks have €727 billion of exposure to Spain, more than €2 billion to Ireland and €244 billion to Portugal and €206 billion to Greece.  The report defines exposure as loans, loan commitments and derivative contracts.  The Organisation also acknowledges that the big fear is that a default somewhere in Europe would lead to another round of bank insolvencies further stressing markets and complicating the fiscal picture with another round of bailouts. During the week, in its regular check on the French economy the International Monetary Fund warned the French Government that it should not rely on independent economic forecasts when drawing up its public deficit reduction plans and warned Paris against over-optimistic growth predictions.   France has promised its EU partners that it would use its budget deficit expected to reach 8 per cent of gross domestic product this year, to 3 per cent in 2013.   This relies on average growth of 2.5 per cent a year from 2011 to 2013 – a rate not seen for at least a decade after 1.4 per cent last year.   In the week Paris said that it needed to find €100 billion of extra revenues and savings a year to reach a budget deficit of 3 per cent in 2013.   Of this, some €35 billion are expected to come from higher growth.   The German population is, on the whole, against the recent European bail-out, as they see themselves funding more spendthrift nations and this has been reflected in political backlash and a lack of confidence in the German Government.   Less than eight months after it took office, the coalition is given only a narrow chance of running to a full term by the majority of Germans, 53 per cent of whom said in a poll that they expected it to fall.   This may happen sooner rather than later, as on 30th June German politicians will vote for the new President, either the Merkel-backed candidate, Christine Wolf, State Premier of Lower Saxony, or the opposition-backed former East German and human rights activist, Joachim Gauck.   With a growing number of politicians pledging to support the opposition-backed candidate,  a  Merkel loss would be seen as a lack of confidence in the Germany Chancellor and the common consensus is that the Chancellor’s position would be untenable, leading to a collapse of the German coalition. Following this she would likely face a vote of no confidence in Parliament, an event that has only happened three times since 1949.   The last coalition Government to collapse before completing its elected term was the Social Democratic Green Alliance, which collapsed in 2005. The ZEW index, which gauges expectations about German economic growth in the next six months and offers an early warning about possible changes in trends showed that German investor confidence tumbled this month at a rate not seen since the collapse of Lehman Brother’s investment bank as Europe’s largest economy was hit by fears over the euro zone debt crisis. The Mannheim-based ZEW institute said its economic sentiment indicator dropped by 17.1 points in June – the sharpest fall since October 2008 – taking the index to its lowest level since April last year. The ZEW blamed the fall on uncertainty about how the debt crisis would unfold and over the impact of fiscal austerity packages across Europe.

 

Foreign investors flocked to US assets in April, as instability in Europe spurred a flight to safety, official figures showed on Tuesday. Purchases of US long-term securities totaled $83bn, down from a record $140.5bn in March, with China, Japan and the UK all increasing their holdings, according to the Treasury department’s international capital flows data, known as Tic. China remained the biggest foreign holder of US assets. Overseas demand was strongest for US Treasuries, with private investors buying $61.2bn of bonds and notes. Foreign central banks, anxious from the European debt crisis, bought $14.5bn of bonds and notes. Foreign governments and investors bought $10.1bn in US equities and $10.1bn in corporate debt in April. U.S. states are facing shortfalls totaling nearly $300-billion in 2010 and 2011 as they struggle with trying to balance budgets. California is looking at a gap of $19-billion this year and $37-billion next year on a budget of about $125-billion-a-year.  As virtually all other states are barred by legislation from running operating deficits, forcing them to balance their budgets annually by slashing spending, raising taxes or both. Typically, states can only borrow short-term funds, or for capital projects and commentators believe that the U.S. government will inevitably have to come to the rescue, using its borrowing clout to save some states from near-bankruptcy or devastating service cuts. If the administration does nothing then the entire U.S. economy could be put at risk. California, like the country’s banks, may be too big to fail. Billionaire Warren Buffett, who advised U.S. President Barack Obama during his White House run, suggested recently that a Washington bailout of California and other troubled states is inevitable. How, he wondered, can Washington deny California after saying yes to General Motors, AIG and dozens of banks. “I don’t know how you would tell a state you’re going to stiff-arm them with all the bailouts of corporations,” Mr. Buffett said. The alternative for many state and local governments may be default. Mr. Buffett said many state and municipal bonds are only triple-A rated because investors assume there’s a federal backstop. “If the federal government won’t step in to help them, who knows what the bonds are,” he said. Former Federal Reserve Chairman Alan Greenspan said the U.S. may soon face higher borrowing costs on its swelling debt and called for a “tectonic shift” in fiscal policy to contain borrowing.” Perceptions of a large U.S. borrowing capacity are misleading,” and current long-term bond yields are masking America’s debt challenge, Greenspan wrote in an opinion piece posted on the Wall Street Journal’s website. “Long-term rate increases can emerge with unexpected suddenness,” such as the 4 percentage point surge over four months in 1979-80, he said. Greenspan dismissed “misplaced” concern that reducing the deficit would put the economic recovery in danger, entering a debate among global policy makers about how quickly to exit from stimulus measures adopted during the financial crisis. U.S. Treasury Secretary Timothy F. Geithner said this month that while fiscal tightening is needed over the “medium term,” governments must reinforce the recovery in private demand. Barack Obama has warned against cutting national debts too quickly as it would put economic recovery at risk. In a letter to G20 leaders, the US president said that while it was important to put in place "credible plans" to cut deficits, withdrawing economic stimulus early was dangerous. "[In the past] stimulus was too quickly withdrawn and resulted in renewed hardships and recession," he warned. But Mr Obama said the US would still aim to halve is own deficit by 2013 and that the US budget deficit would be cut to 3% of GDP by 2015, the president said. The leaders of the world's 20 leading economies are due to meet in Toronto on 26 June. U.S. consumer prices fell a second straight month during May and underlying inflation rose slightly, leaving the Federal Reserve with room to support the economy with record-low interest rates, with both in line with expectations. The consumer price index dropped 0.2% last month, the Labor Department said Thursday. In April, prices fell an unrevised 0.1%, as economic slack restrains inflation. Underlying consumer prices, which strip out volatile energy and food items and are closely watched by the Fed, rose 0.1% in May. This "core" rate of inflation was unchanged in April. The annual rate of inflation now stands at 2%, meeting the US Federal Reserve's target.

 

Japan's new government has pledged to slash corporation tax and beat deflation to achieve stable economic growth of 2% a year and aims to defeat deflation by April 2011, but revealed few details on how it would achieve this. The government also said it would cut corporate tax from 40% to nearer 25%. Last week, Japan's central bank announced plans for up to 3 trillion yen (£22bn; $33bn) in loans to spur economic growth. This is the first time Japan has set a time frame for tackling deflation, which has plagued the economy for much of the last two decades. It has hampered economic growth, with consumers opting to hold off on making major purchases, expecting prices to fall even further. Japan's growth had averaged just 1.3% a year before the recession brought on by the financial crisis. Like many other developed economies, Japan is also suffering from high levels of sovereign debt and the new Prime Minister Kaoto Kan has made cutting the country's deficit his priority.

 

Economic growth in China will remain robust this year, though activity could slow in 2011, the World Bank said Thursday. China's gross domestic product, the broadest measure of economic activity, will grow at a 9.5% annual rate this year, according to the World Bank's quarterly update. In 2011, the nation's GDP is expected to grow at an 8.5% rate. Although China's economy is expected to remain strong the report said leading indicators suggest the nation's rapid growth could moderate in the second quarter. "Growth should be less investment-driven this year and benefit from more favorable external trade, while consumption is likely to remain supported by a strong labor market," Ardo Hansson, the World Bank's lead economist for China, said in a statement. The World Bank also forecasts "favorable" prospects for the global economy, with growth estimated at 3.2pc for this year and 3.3pc for 2011. But it said risks to that outlook were large because of the debt mountains that some countries are burdened with. The run-up in debt in countries using the euro "could turn into a real and contagious debt crisis" that threatens still fragile economic recoveries in Europe and the US, it said.

 

China announced on Saturday that it will let its currency trade more freely although a large increase in its value is not expected. Since 2008, China has pegged its currency, the Yuan, to the dollar, keeping its value artificially low and making it tougher for U.S. companies to compete, with commentators suggesting the Yuan is undervalued by 25% or more. The move comes one week before President Obama and other world leaders gather in Toronto for the G20 economic summit, at which China's currency policy was set to be a big topic. Representatives of several industrialized nations, including India, Brazil, United States and European countries have asked China to allow its currency to float recently to no avail. Obama praised the move as a "constructive step that can help safeguard the recovery and contribute to a more balanced global economy." Later in the weekend China faced a potential backlash from critics, led by the US, to its exchange rate policy after it appeared to retreat on Sunday on promises to allow its currency to revalue. Beijing's hints on Saturday that it would end a two-year peg to the dollar were initially welcomed as a positive step to redress unfair trading terms and end an approach attacked by many as currency manipulation. Analysts said that the move might also head off a potentially damaging trade row between China and the US at a G20 summit this week. But in a follow-up statement to its "reform" pledge, made today, China ruled out a one-off revaluation and said there were no grounds for a big appreciation of the Yuan.

 

Indian inflation has risen to a two-year-high, raising the possibility of interest rate rises. The wholesale price index rose to 10.16% in May, the highest since 2008. Rising food and fuel costs have pushed the rate well above forecasts, which were nearer 9%. The government says prices will come down soon. The rise in the inflation rate comes after India recorded its fastest growth in manufacturing in at least 15 years in April. Unlike most countries, India calculates inflation on the wholesale price of a basket of 435 basic goods, which means actual prices paid by the consumer are much higher.

 

Crude-oil futures closed higher on Friday and advanced 4.6% on the week. Crude for July delivery the thinly traded front-month contract added 39 cents, or 0.5%, to close at $77.18 a barrel, whilst August crude, the most actively traded, lost 2 cents to close $78.01 a barrel. Oil has gained for two consecutive weeks, and spent four out of five days in positive territory last week. The US Department of Energy has joined the list of critics of West Texas Intermediate, saying the US oil benchmark “does not always exactly follow the broader oil market”. The warning is the first from the US administration and comes after similar concern from the International Energy Agency, the western countries’ oil watchdog and after Saudi Arabia, the world’s largest oil exporter, dropped WTI as its reference last October. Traders and analysts have attributed recent exaggerated decline and subsequent increase in WTI prices to localised supply conditions at the pipeline hub of Cushing, Oklahoma, the delivery point for the New York Mercantile Exchange WTI contract. It was because of erratic price movements in WTI that Saudi Arabia decided to drop the US benchmark as its reference for sales in the US for the first time since 1994. It replaced it with a basket of crudes from the US Gulf of Mexico. Others, including Kuwait and Iraq, have followed Riyadh’s decision. In London on Friday, spot gold surged to an intraday high of $1,260.20 an ounce, up 3.6 per cent on the month. Adjusted for inflation, however, gold is still a long way from its record high above $2,300 an ounce in 1980. Gold closed at $1,256. I remain extremely bullish on gold because I believe that, sooner or later, recent huge monetary expansion around the globe, with probably more to come, will translate into inflation and forecasts of $1,300-$1,500 for the end of the year do not I believe look unreasonable.

Saudi Arabia, the world’s fourth-largest holder of foreign exchange reserves, has more than twice as much gold as previously thought, according to new estimates that point to the revival of bullion as part of emerging economies’ official reserves. The changes in Riyadh’s reserves were revealed by the World Gold Council, the industry-backed body which regularly tracks official bullion holdings. According to the WGC, the Saudi Arabian Monetary Agency, the central bank, has gold reserves of 322.9 tones; more than double the 143 tones it had previously reported. The central bank said in a footnote of its latest quarterly report that “gold data have been modified from first quarter 2008 as a result of the adjustment of the Sama’s gold accounts”. Analysts believe that central banks could be net buyers of gold this year for the first time in nearly two decades. India bought 200 tones of gold from the International Monetary Fund earlier this year, while Russia and others are purchasing bullion from domestic miners on a regular basis, official data show. European central banks, after more than a decade of hefty disposals, have all but stopped selling. Riyadh is now the 16th largest gold holder The US is the world’s largest bullion holder with 8,133.5 tones.

 

The likely UK move to balance the budget over the course of the parliament reflects a new mood of austerity sweeping Europe, which is unsettling Barack Obama. He told world leaders on Friday that their “highest priority” was to safeguard the recovery. Like most western country’s the UK has built an elaborate and costly government machine, tied to a regressive tax system that can’t generate enough revenue to pay for it all and living beyond our means is no longer possibly to the extend it was as lenders are beginning to realize they may not get their money back and are starting to look much more closely at the fundamentals. If the national debt continues to increase then we are living beyond our means and our ability to effect and influence our destiny becomes increasingly less. Whilst the Head of Equities at Henderson, the investment group, last week raised his forecast for the FTSE 100 to 6000 for the end of the year, implying a 15 per cent rise, his bullishness I fear is misplaced and this is not largely due to the up and coming squeeze from government spending as may be assumed. The reason for this is because of the structure of the FTSE 100 Index and that the majority of earnings are received from overseas.  My concern continues to focus on Europe, where the European Central Bank has been buying bonds of high deficit countries such as Greece, Spain and Portugal, to avoid a significant fall in their bond prices and with it a further loss of confidence in the future of the EU.  Ultimately, I believe the European Central Bank is only buying time with this policy, as a default, most probably from Greece, which was downgraded to ‘junk’ status by Moody’s this week, looks an inevitable outcome.  Investors therefore should not be lulled into a false sense of security by the market’s recent strength in the week as the European central bank peddles ever more furiously to keep the weaker economies afloat. The world cut bounce should not be read that all is well and investors moving money into the market may well be scoring an own goal, as the recent run does not look to have legs.

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