Market Watch from www.LegalandFinancial100.co.uk

For the past 42 months out of 51 UK inflation has been ahead of the Bank of England’s target of 2 per cent, so last week’s Quarterly Inflation Report was keenly awaited.  The market was already anticipating that growth forecasts would be cut lower and being brought more in line with those of the Office of Budget Responsibility and for the inflation numbers to be revised up.  Bank of England Governor, Mervin King, stressed that the Monetary Policy Committee has not gone soft on inflation, despite the evidence above.  The Bank is also increasingly coming under criticism for its handling of the economy, with it having failed at the beginning of the credit crisis to appreciate the gravity of the situation and was therefore caught flat-footed. Once the Central Bank grasped the situation however, it moved swiftly and boldly to win back the advantage.  Just before the credit crisis in 2007 the Bank proclaimed that “This is not an international financial crisis” and in August 2008 it said its “central projection” was for “broadly flat GDP over the next year or so” when subsequently the economy shrank by 6 per cent.  Since then the Bank’s forecast on recovery has consistently been too bullish, with the bank stating in August 2009 that inflation was “more likely to be below target in the medium term than above” this has clearly not been the case.  Following the criticism the Bank has acknowledged that its basic model for predicting the economy needs further refinement and it has revealed that it is now spending £3.5 million overhauling its forecast model, due to past policy errors leading from the information obtained from it.  The Bank now expects GDP growth of 1.6 per cent in 2010, down slightly from the 1.7 per cent forecast in May, with the outlook for growth next year being cut dramatically to 2.7 per cent from the 3.4 per cent it anticipated only three months ago.  For 2012, the Bank sees growth of 3.1 per cent, down from 3.5 per cent.  The consensus forecast for private economists is for growth of 1.2 per cent this year to 1.1 per cent next year and 2.4 per cent thereafter.  This therefore, still puts the Bank of England on a much more bullish footing that City economists because it now believes that inflation is likely to rise and remain above 2 per cent over 2012, the Bank has signaled that it is unlikely to toughen monetary policy in response to higher inflation, as it believes that these are temporary factors, like the increase in VAT.  The Bank believes that the planned £113 billion worth of spending cuts and tax rises over the next five years will have a negative impact on economic growth and that this will enable its inflation targets to be achieved.  Friday was Sir Alan Budd's last day as chairman of the Office for Budget Responsibility after what turned out to have been an unexpectedly short period of office. The deadline for applications for his job is 5pm on Wednesday, August 18, and the appointment is expected to be made in September. Robert Chote, the director of the Institute for Fiscal Studies, is considered frontrunner for the role, which pays a salary of up to £142,000.

 

Like the Bank of England, I believe that inflation is a short term worry and that in the very near term we increasingly need to worry about the threat of deflation, which is a significantly more fearful prospect.  I believe it will be the fear of deflation in the shorter term that will lead the authorities to keep policies lax and will, ultimately, in the longer term, lead to an upturn in inflation and this is what investors should be planning for. Inflation is likely to be created by more quantitative easing, which I believe is inevitable and this week we saw the US authorities embark upon the first steps of acknowledging that this is highly likely in the US,  as they confirmed that they are now not withdrawing earlier quantitative easing stimulus, which they had planned to do.  This means that freshly created money will not be withdrawn from the system, but will be ploughed back in as a weapon against the deflationary threat.  I am of the view that the US will embark upon another round of significant quantitative easing soon and that US Federal Reserve Chairman, Ben Bernanke, has won the argument in the Federal Reserve by winning over the majority of its members with the fear that deflation is increasingly stalking US markets.  Mr King pointed out that without the increase of VAT recently, inflation would have been just 1.6 per cent in June, well below the Bank of England’s 2 per cent target. The recent rebound in economic growth is expected to have been even stronger than first estimated after news that Britain's construction industry enjoyed its biggest boost in business for almost half a century in the second quarter. The Office for National Statistics reported that output across the industry jumped 8.6% as new house building took off, and activity recovered following harsh weather at the start of the year. The rise was the strongest rise since the second quarter of 1963 and is likely to increase GDP growth to 1.2% from a previously reported 1.1%, the ONS said. That original GDP estimate had already taken economists by surprise, coming in at almost double the consensus forecast.

 

Expectations of widespread job cuts in the public sector have begun to discourage households from spending and buying big ticket items, evidence revealed in the week.  The Royal Institute of Chartered Surveyors and valuers reported that UK house prices fell in July for the first time since July 2009, with a continuing lack of mortgage finance deterring first time buyers.  The Chartered Society also commented that a number of surveyors and valuers have told them that they have been staggered by the ferocity of the market downturn since the coalition Government’s Emergency Budget in June.  According to the British Retail Consortium and the KPMG Retail Survey, total retail sales were 2.6 per cent lower in July compared with a year earlier, following a 3.4 per cent increase in June.  Like-for-like sales, which strips out the effect of additional floor space, grew by 0.5 per cent compared with 1.2 per cent in June.  The report also highlighted that the worst hit sectors were big ticket items such as big screen flat TVs.  According to the Council of Mortgage Lenders, the number of home owners falling behind in their mortgage payments eased in the second quarter of the year, but the trade body warned of strong headwinds ahead for the housing market, as it downgraded its arrears  forecast for 2010.  It now believes net mortgage lending in 2010 will be £140 billion, roughly the same as 2009, which itself was a post war low.  Earlier it had forecast a modest pick up to £150 billion.  In the boom years 2006-07 this lending was around £250 billion.  On a positive note, the organisation said that the number of mortgage loans that were three months in arrears or more slipped in the three months through to June to 246,400 or 2.17 per cent of loans outstanding.  In the first quarter, the equivalent arrears figure was £252,799 or 2.22 per cent of loans.  Arrears have been steadily falling since they peaked in the second quarter of 2009 at £282,900 or 2.48 per cent of loans outstanding.  Overall, the organisation has downgraded its forecast for both the number of loans in arrears by the year end to 175,000 from an earlier estimate of 205,000 and cut its estimate of the number of home repossessions to 39,000 from 53,000.  There were 9,400 repossessions between April and June, down 4.1 per cent from the £9,800 in the first quarter and 20 per cent less than the 11,800 in the second quarter of last year.  The CML also revealed that there were 52,000 new loans to home buyers in June, 90 per cent more than May and up 14 per cent on the same period a year ago.  Whilst welcoming the 12 consecutive months, in which lending numbers were higher, the lenders organisation said it was still very cautious about the prospects for the housing market over the coming months. Britain's "golden age of home ownership" is coming to an end, and millions of young people face a lifetime of renting instead says The Chartered Institute of Housing. This comes as figures reveal that in the most expensive parts of the country first-time buyers need to save deposits of more than £40,000, almost double the average income, to have any chance of buying a home.  Hometrack, the property analyst, says that in London a single person would need to earn more than £50,000 a year to obtain a mortgage for a two-bedroom flat at the bottom end of the market. Without the first run of the housing market operating normally the whole sector is likely to be dysfunction and under downward price pressure for some time. As the Governor of the Bank of England tries to rebalance the economy away from being driven by consumer spending, Britain’s trade figures for June in the week revealed a surge in exports as they grew at the fastest rate in nearly 30 years in the second quarter of this year, offering hope that the policy may be beginning to bite after sterling’s heavy devaluation.  Underlying export volumes grew by 15.5 per cent in the three months to June, compared to the same period a year earlier.  Not since comparable data began in 1980 have exports of goods, excluding volatile oil and other erratic items, increased so rapidly. Imports grew by 14.6 per cent over the year and have been growing more slowly in recent months compared with exports.  Underlying volumes grew 6.4 per cent in the second quarter, compared with the first quarter, whilst imports grew by 1.6 per cent.  Overall, the UK global goods trade deficit narrowed more than expected in June, with the goods trade deficit shrinking to £7.4 billion in June, from a downwardly revised £8 billion in May.  Economists had been expecting the deficit to shrink to £7.8 billion.  Whilst the trends are encouraging, a deficit of £7.4 billion is still one of significant concern and a sign that we continue to live beyond our means. 

 

There was positive news on the employment front in the week, although I expect this situation to change rapidly following widespread job losses in the public sector.  Official labour market data showed that the employment level enjoyed its biggest jump since 1989 in the three months to June, as the overall economy rebounded.  The number of people employed in the UK increased by 184,000 to 29.02 million in the Second quarter, two thirds of the increase coming from part time workers.  This increase reflected the growth of 1.1 per cent in the economy over the same period.  The unemployment rate fell from 8 per cent to 7.8 per cent, with a 49,000 drop in the number of those classed as unemployed, the biggest fall in three years, taking the jobless figure to 2.46 million.  The unemployment rate also showed that the number of people unemployed for more than 12 months increased by 33,000 over the second quarter, to reach 796,000, the highest number since early 1997.  Further investigation also shows that the number of 18 to 24 year olds out of work for two years or more rose to 72,000 in the three months to June, up 11 per cent on the previous quarter.  At the other end of the age scale, the number of people over the age of 65 and in employment rose by 40,000 in the last three months, this being the highest number in this sector since the Office of National Statistics started keeping these numbers in 1992.  The highest quarterly jump previously had been 26,000.  This now means that one in twelve people over 65 are now working.  The trend for older working and the number of over 65s working has doubled in less than a decade and is a reflection of the better health of many older people, as well as a desire to keep active and the pressure on budgets.  According to the latest survey by the Charted Institute of Personnel and Development, in conjunction with KPMG, George Osborne’s cuts are likely to hit the public sector hardest, but the private sector is also likely to suffer too.  This undermines the Government’s hopes that the private sector will create enough jobs to offset those being lost in the public sector.  Almost a third of employers across the private and state sectors responding to the survey said that they expected to make some workers redundant during the next three months and the number of workers who will lose their jobs has increased.  Redundancies are most likely in the public sector, where 36 per cent of employers plan to shed jobs as budgets come under pressure.  Job insecurity was the biggest factor behind the plunge in the Nationwide’s Confidence Survey in the week.  Its monthly consumer confidence index fell to 56 in July, down sharply from 63 in June and the lowest since the depths of the recession in April 2009.  The index has now fallen for three straight months.  31 per cent of consumers also believe that their household income will be lower in six months time; this was the highest since the index began in May 2004. Tui Travel, owner of Thomson Holidays and Thomas Cook added to fears about weak consumer sentiment they warned delays in holiday purchases meant that profits would be at the lower end of expectations.  Tui Europe’s largest travel firm said it had not been able to claw back losses for the first half in the third quarter, traditionally one of its strongest periods. In the UK, Government advertising spending has been one of the main drivers from growth in commercial radio over the past decade and recently, privately owned Global Radio, which owns Heart, Galaxy and LBC stations, suggested that Government advertising could fall by 75 per cent this year following its decision in May to freeze its £540 million annual advertising budget, of which £193 million is spent on traditional media.  The Cabinet Office has recently confirmed that advertising spending in June fell by 52 per cent to £6.5 million.  Government spending on advertising accounts for around 3 per cent of television advertising revenue and less than 1 per cent for the print industry.  Commercial radio, therefore, appears to be at the forefront of these cuts and I believe we will have to get used to significantly lower advertising revenue, which would see a number fail.

 

The recent banking results season has been acclaimed as a sign of a turnaround in the sector, which I continue to dismiss.  Particularly, for the likes of the Royal Bank of Scotland and Lloyds Bank, as they continue to remain dependent on Government support and this is largely being dished out by the Bank of England’s special liquidity scheme.  The scheme was designed to make good part of the difference between what the banks have leant and what they have on deposit.  This deficit had been funded by the wholesale money markets which shut down at the height of the credit crisis.  This made the banks insolvent to all intents and purposes, as they were unable to refinance themselves.  The special liquidity scheme saw the Bank of England act as buyer of last resort and this enabled the two banks and others to remain solvent.  The scheme is timetabled to be wound down in January and is expected to complete by 2012.  Many City observers believe that the central bank will have no alternative than to extend the scheme as a number of banks and building societies are still finding it very difficult to fund themselves.  The Bank of England, however, is believed to be ignoring these requests, saying that, particularly in the case of Lloyds and the Royal Bank of Scotland, they could face penalties from Brussels if the scheme were extended. This is because an extension could break European State aid rules, as it would primarily help the two State controlled banks, rather than the banking sector.  The present scheme itself was troubled at the beginning and it was only due to the wider credit crisis that Brussels is thought to have allowed it to proceed in April 2008, in the wake of the collapse of Bear Stearns.  The special liquidity scheme offers cheap funding in exchange for collateral made up of high quality mortgages.  Bank of England officials believe that lenders should work harder to solve their funding problems by seeking deposits overseas and shrinking their balance sheets faster.  This is the key dilemma for the banking sector.  Whilst the Government wants them to lend more and encourage economic growth, the banks have lent more than they can provide and are therefore having to scale back their lending capability.  They are also seeing increasing regulatory requirements, which require further capital to protect themselves from a further downturn.  The banks argue that rather than holding back lending, there is little appetite for new lending, with most lending being refinancing at the present time.  Where there is significant demand for new financing, this largely comes from distressed businesses and under more diligent lending practices, the banks are not lending to these businesses for fear of the loans going bad.  Lloyds Bank Chief, Eric Daniels, recently confirmed that his bank needs to refinance £132 billion of its £600 billion loan book and this is the reason why City analysts believe that Lloyds Bank is the biggest user of the special liquidity scheme.  In the UK, the Bank of England calculates that banks still have a gap of £450 billion between what they have lent and what they have in deposits to support their loans.  Whilst this is down from the near $1 trillion at the height of the credit crunch, this also means the banks are having to find new ways to support themselves.  In total, the Bank of England has lent banks £165 billion through the special liquidity scheme and Analysts estimate that around £85 billion of these loans are to Lloyds.  The Royal Bank of Scotland is also reliant on the scheme but to a lesser extent and it is believed to have reduced its loans from £21.4 billion to £16.4 billion in the last six months of the year.  Barclays and HSBC both used the scheme earlier in the crisis, although both are now thought to have paid this money.  With the economy lurching downwards again, further bad losses are likely to be revealed.  With increased regulation and these massive funding problems curtailing lending I remain very negative on the banking sector and I would not rule out further capital calls from the weaker UK banks, should the property market and economy head sharply downwards again. 

 

In its latest report The Population Reference Bureau predicts that Britain will see its population grow from today's 62.2 million to 77 million in the next forty years, an increase of 24 per cent. Making it bigger than France, projected to be 70 million and Germany, which is predicted to have 71.5 million. The predictions forecast that Britain will see its population increase over the next 40 years at the fastest rate than nearly every other European country. The extra 15 million equates to the combined populations of Glasgow, Birmingham, Manchester, Leeds and Liverpool being added to the total national population over the next two generations. France's population will increase at half the level, adding 7 million to its 63 million. While Germany will actually see its population fall sharply from 81.6 million to 71.5 million because of a lack of immigration, and a far lower birth rate than that in Britain. It already has the second oldest population in the world after Japan, with one in five of all Germans over the age of 65. Europe, in total, will see its population dip from 739 million to 720 million, because of its low birth rate. The world's population will increase inexorably, swelling from 6.89 billion to 9.49 billion. India will be responsible for a significant part of this increase, becoming the largest country in the world by overtaking China. The country, which hit 1 billion just a decade ago and now has a population of 1.19 billion, is expected to hit 1.75 billion, adding the equivalent of the entire population of the European Union in 40 years. China's population will increase, but relatively modestly, moving from 1.34 billion to 1.48 billion.

 

Deflation in Japan is causing considerable concern and Japan's central bank kept its benchmark interest rate unchanged in the week, as it tries to boost the country's slow recovery from recession whilst also attempting to tackle deflation. Rates have been held at 0.1% since the end of 2008. The Bank of Japan said there were signs of recovery as Exports and production in the world's second-largest economy were increasing. However, there was a warning that a slowing in Chinese demand for imports, as seen in figures released by Beijing could hurt Japan's exports and global growth. Earlier this month, Japan's prime minister suggested that the country's economy might need additional stimulus spending. Naoto Kan said that while the economy was still growing, there was concern about the level of unemployment and the health of the global economy. Japan in the week talked down its strengthening currency today as concerns grew that companies reliant on exports could be impacted by the yen's strength against the dollar as it hit a 15-year low of ¥84.71. This followed the US news that it would have to inject money into the economy because the pace of recovery in output and employment had slowed. Japanese authorities last intervened in the currency markets in March 2004 and have avoided answering questions about the issue. In 2004 and after a 15-month spree Japan sold 35tn yen ($410.7bn; £263bn) to try to protect exports and fight deflation.

 

The strength of Japan’s economic recovery was questioned on Monday, as second-quarter growth figures came in sharply below economists’ expectations. Growth in the GDP slowed to an annualised, seasonally adjusted rate of 0.4 per cent in the three months ended June 30. This was far lower than the revised 4.4 per cent pace recorded in the first quarter and economists’ expectations of 2.3 per cent for the last period.

 

China’s property prices rose at there slowest pace in six months in July following the government cracked down on speculation. Prices in 70 major cities climbed 10.3 percent from a year earlier, the statistics bureau’s newspaper reported with the value of sales falling 19.3 percent from a year ago. With sales cooling faster than prices it suggests that the government will maintain the current curbs. On a year-on-year basis, the increase in prices in July compared with 11.4 percent in June and a forecast of 10.5 percent. April’s 12.8 percent gain had been a record for the data series, which began in 2005. China’s trade surplus reached an 18- month high as exports rose to a record and import gains slowed, adding pressure to allow faster appreciation of the Yuan. The gap surged 170 percent from a year earlier to $28.7 billion, significantly beating forecasts. Exports increased 38.1 percent to $145.5 billion and imports advanced 22.7 percent to $116.8 billion. The trade surplus was the biggest since January 2009 and compares with $20 billion in June and $10.63 billion in July 2009.The government has limited the Yuan’s rise to less than 1 percent since ending a two-year peg to the dollar, and the report comes three months before mid-term US elections. China’s trade surplus with the U.S. rose 10 percent to $93 billion in the first five months of 2010, according to the American Commerce Department. China's economic growth continued to ease in July, signaling that the world's third-largest economy may need to loosen its policies to avoid a hard landing. But now, concerns that the government's measures could result in a so-called hard landing for the economy are growing. Chinese industrial production in July rose 13.4% from a year ago, but the growth rate declined for fifth straight month, according to data released on Wednesday by China's government. Retail sales in China also weakened in July, the government said. Sales rose 17.9% from a year ago, but that's down from 18.2% annual growth reached during the first half of the year. Meanwhile, China's consumer price index, a key gauge of inflation, spiked 3.3% form a year ago, driven by a 6.8% surge in food prices which have jumped due to severe flooding in the country. Excluding food, prices increased 1.6%.

 

The U.S. trade deficit widened unexpectedly to a record 21-month high in June, as imports from its largest trading partners rose strongly. The deficit grew by 19% to $49.90 billion, the US Commerce Department said on Wednesday. The deficit in May was revised down to $41.98 billion from an initial estimate of $42.27 billion. Economists had expected the deficit to expand to $42.7 billion in June. The U.S. trade gap with China expanded to $26.15 billion in June, the widest level since October 2008 and a 17% gain on the previous month's bilateral deficit of $22.28 billion. Imports expanded $3.83 billion, while exports slowed by $38 million. Earlier in the week, China's trade surplus increased more than market expectations, hitting $28.7 billion as exports grew faster than imports. The figures are likely to continue to give ammunition to US federal lawmakers pressuring the Obama administration to take China to task on its currency policy. Sander Levin, chairman of the US House of Representatives ways and means committee, has called a hearing on the Chinese currency for when Congress reconvenes in September. Although China earlier this year announced a move to a more flexible exchange rate, lawmakers say the Yuan is still artificially low, undermining U.S. competitiveness. Legislators are threatening to pass laws that would hit imports from countries that are deemed to be manipulating their currency. Exports from other large trading partners also hit near two-year highs. The U.S. registered an expanding deficit with Mexico of $6.21 billion while the deficit with the European Union ballooned by 26% to $7.76 billion. The deficit with Japan surged 45% to $5.25 billion while with Canada, it grew to $2.58 billion, up $320 million from the previous month. Sales at U.S. retailers rose less than forecast and consumer confidence held near an eight-month low last month, indicating the economic slowdown will persist into the second half of 2010. U.S. consumer prices rose in July for the first time in four months on the back of higher energy prices, but underlying inflation remained tame amid a weak economy. The seasonally-adjusted consumer price index for July rose by 0.3% from June. Consumer prices had previously fallen by 0.1% in June, 0.2% in May and 0.1% in April. However, the underlying inflation rate that's more closely watched by the Federal Reserve barely rose. Core consumer prices, which strip out changes in volatile energy and food prices, rose by just 0.1%. Compared to July 2009, consumer prices are up 1.2%, only slightly higher than the 1.1% year-on-year rise in June. With The July figures were exactly in line with expectations. The central bank last week said it would resume small purchases of government debt as it attempts to counter the economic slowdown. The U.S. economic recovery is weakening, the Federal Reserve warned at the conclusion of its meeting on Tuesday, its most bearish outlook in more than a year.” The pace of recovery in output and employment has slowed in recent months," the Fed said in its statement and whilst it still expects the economy to grow, the improvement will be "more modest in the near term than had been anticipated." U.S. retail sales rose for the first time in three months during July, but the narrow gain was driven by cars and petrol as demand fell elsewhere. Overall Sales rose 0.4% in line with expectations. Whilst the positive overall number was a sign of hope for the economy, there were only four increases among the 12 retail categories in the Commerce report. June and May sales were revised up, falling 0.3% and 1.0%, respectively. Previously, the government estimated sales fell 0.5% in June and 1.1% during May.

 

The number of U.S. homes lost to foreclosure surged in July, as lenders ceased more properties from homeowners who have been in default for months. Lenders repossessed 92,858 properties last month, up 9 per cent from June and an increase of 6 per cent from July, 2009, foreclosure listing firm Realtytrac Inc. said on Thursday. Banks have stepped up repossessions this year to clear out the backlog of bad loans. July made the eighth month in a row that the speed of homes lost to foreclosure increased on an annual basis. Historically the number of homeowners who have fallen behind on their payments remains high and these borrowers are being allowed to stay in their homes longer. This is partly because lenders are reluctant to add to the glut of foreclosed homes on the market as they have been swamped with an unprecedented number of defaulting properties and have been overwhelmed by the volume. The number of properties receiving an initial default notice, the first step in the foreclosure process,  rose 1 per cent last month from June, but was down 28 per cent versus July last year, Realtytrac said. Main Street may be about to get its own gigantic bailout. Rumours are suggesting that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages, one in five, are in negative equity to a sum of $800 billion. On Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. It is thought that the vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obama's loan-modification program. HARP has just extended through to June 30, 2011. The move, if it happens, would be a stunning political and economic bombshell, less than 100 days before midterm elections in which Democrats are currently expected to see support evaporate with possible historic losses. The key date to watch is August 17, when the Treasury Department holds a much-hyped meeting on the future of Fannie and Freddie.

 

The German economy grew at its fastest pace since the country was reunified in the second quarter, helping the euro zone to outstrip growth in the US. Europe's largest economy powered ahead between April and June, growing by 2.2%, thanks to a recovery in construction and strong foreign demand for German goods. This was well above market expectations of 1.4% growth. Growth in the first quarter was revised higher to 0.5% from 0.2%. German companies have benefited from concern about debt problems in Greece and Spain, this has pushed down the value of the euro against the dollar and made German products cheaper abroad. As I have stated before Germany is sucking the strength out of the weaker European countries. France’s year-old economic expansion accelerated more than economists had estimated in the second quarter as export demand buoyed manufacturing and investment. Gross domestic product increased 0.6 percent in the three months through June, from a revised 0.2 percent in the first quarter. Economists had predicted a gain of 0.5 percent. France’s economy has expanded for five straight quarters after the year long recession that was the worst since World War II. This helped fuel growth in the 16-member euro zone, which expanded by 1%, compared with just 0.2% in the first three months of the year. Spain recorded lackluster growth of 0.2% and the Greek economy shrank by a further 1.5% in the second quarter of the year, This comes after a 0.8% decline in GDP in the first three months of the year, indicating that the decline in the economy is speeding up. Greece's GDP has fallen 3.5% since this time last year. According to both the European Union and the International Monetary Fund GDP is forecast to decline by 4% this year. Earlier in the week it had been reported that European Industrial production had unexpectedly fallen in June, prompting concerns over the strength of the economic recovery. Factory output dropped 0.1 per cent, against forecasts of a 0.6 per cent jump, in line with the trend over the previous three months. The bad news however was weakened by an upward revision of the May figure, from 0.9 per cent to 1.1 per cent growth, according to seasonally-adjusted data from the European Commission. Falls in Germany (-0.5 per cent) and France (-1.6 per cent) accounted for the bulk of the shortfall, though Greece, Spain and Portugal also saw falls in industrial production. Industrial production is known to be a volatile number. Slovakia’s new government came under fire from its euro zone partners, particularly Germany, on Thursday after its parliament voted overwhelmingly to reject taking part in a European Union aid package for the troubled Greek economy. The European Commission and The German government criticised the Slovak parliament’s decision in unusually strong terms but stressed that the loan package to Greece was not put at risk by Slovakia, which was to provide just over 1 per cent of the total needed for the €80bn ($104bn, £66bn) bail-out. Slovakia, which is much poorer than Greece, adopted the euro last year, and as a member of the zone was expected to provide more than €800m, its portion of the rescue package that saved Greece this year. Then Hungarian government has refused to give in to IMF demands for further budget deficit reduction and in response the IMF team has walked out of the country. The Hungarians have already been through nearly four years of austerity in which the deficit was reduced from 9% to 3.8% of GDP. The country's current account which was more than 7% of GDP in 2008 will be less than 1% this year. With unemployment having risen from 7% in 2007 to nearly 12% today, and the economy still barely growing Hungarians are beginning to say enough is enough. Negotiations with the IMF over conditions for further access to IMF funds broke down on 17 July. A new  government led by Viktor Orban, whose party won a landslide with more than two-thirds of the Hungarian parliament in April, has openly attacked the country's central bank, blaming it for keeping interest rates too high and thereby delaying the recovery. The central bank has held interest rates at 5.25%. Last year, Hungary's GDP fell by 6.3%, whilst rates were between 6.25 and 9.5%. The Credit rating agencies Moody's and Standard have put Hungary on review for a possible downgrade due to its failure to reach agreement with the IMF. The New York Times reported recently that the change in Hungary "reflects a larger struggle that is expected to play out over the next year or so as most European politicians… seek to impose fiscal discipline on their increasingly unruly citizens." For Europe's sake we must hope that the governments of Spain and Greece do not buckle under increasingly hostile populations. Hungary is a centre-right government and if the socialist governments of Spain and Greece were to oppose the European authorities and the IMF directions they would almost certainly rally popular support and that would frighten the life out of the creditors that are currently supporting these countries via fresh bond purchases. Their withdrawal would lead to a closure of the capital markets for these countries, similar to what has happened in Greece and lead to a European wide bailout for the countries. The IMF suspended its review of Hungary’s 20 billion-euro ($25.8 billion) emergency bailout because “a range of issues remain open,” the Washington-based lender said in a July 17 statement. The government must make “tough decisions, notably on spending,” to comply with deficit requirements, the EU said. The IMF delegation may return to Budapest in September, and Hungary will eventually reach an agreement with the IMF, Economy Minister Gyorgy Matolcsy said at a news conference in Vienna, after the IMF team withdrew. Hungary is seeking a new “precautionary” loan agreement from next year as the current program expires in October. Problems in Ireland have also came into focus last week with fresh concerns about its banking sector and market rumours that the European Central Bank has been intervening to buy Irish bonds. The deficit will be 18.7pc of GDP this year and if you strip out bail-out costs for Anglo Irish, it is still stuck at around 12pc. The near-doubling in interest rates paid by Ireland within the last three weeks is not a good sign for a nation that had thought it had taken all it's painful medicine. German benchmark market interest rates fell to record lows as investors fled to safe haven assets, in a week that has seen the spreads between Bunds and Greek, Portuguese, Irish, Italian and Spanish debt rise sharply. As I have noted before the euro is not a currency as much as it is an experiment. It is also not an economic currency, but rather a political currency and whether the euro lasts in its present form is a political decision to be made by numerous national players. Events like those in Slovakia and Hungary further reinforce my view that it will not survive in its current form and change is inevitable. I believe that managed change is better than rushed change brought about by market forces.  These forces are brutal and inflict ultimately more pain and hardship than would otherwise have been the case.

 

Gold showed a gain of $10 over the week as investors focused on its safe haven status closing at US$1,215/oz. Investment bank Goldman Sachs also provided support for gold, predicting it will reach $1,300/oz within the next six months due to lingering economy fears in the markets.

Britain is “very likely” to face an oil shock within the next decade, triggering economic volatility as fraught with “nasty surprises” as the 1970s, Chris Huhne the energy secretary has warned. He has told the Financial Times that Britain is in danger of becoming as vulnerable to price spikes as before the discovery of big North Sea oilfields, leaving the economy open to “very severe blows”. His forecast of a looming energy crisis came in an interview where Mr Huhne admitted that “nuclear is going to play a part in the energy mix”, but declined to guarantee state support for low carbon manufacturing. “The world we’re going into isn’t going to be a world where the oil price will be $80 a barrel flat for ever or $150 a barrel flat for ever,” he said. “It will be a world where we will have very substantial oil price spikes, which have an enormous capacity to provide shocks to the domestic economy and to the world economy, exactly as they did in the 1970s and 80s.”

 

On Friday in Vienna, the Organization of the Petroleum Exporting Countries (OPEC) revised higher its forecast for world oil demand growth in 2010 by 100,000 barrels a day to 1 million barrels a day. The growth in demand is expected to be driven by China, India, the Middle East and Latin America. The estimate for 2011 oil demand was unchanged from OPEC's previous report. Earlier in the week, the International Energy Agency had also revised higher its estimates for global oil demand for this year and 2011, citing slightly higher economic assumptions and baseline adjustments. Forecasted global oil demand for 2010 and 2011 was revised up by 80,000 barrels a day and 50,000 barrels a day respectively. Oil demand is thus expected to average 86.6 million barrels a day in 2010 and 87.9 million barrels a day in 2011. Although Crude-oil futures closed slightly lower on Friday, with Crude oil for September delivery falling 35 cents, or 0.5%, to $75.39 a barrel on the New York Mercantile Exchange. Heavier drops in previous sessions created a weekly decline of 6.7%, with a 3% slump on Thursday. Oil has fallen, as global economic worries have increased and last week saw oil's highest weekly loss since late June/early July, when it lost 8.5%. Oil prices are 8.7% off their most recent peak, an Aug. 3 rise to $82.55, a 12-week high.

 

World wheat stockpiles before next year’s Northern Hemisphere harvests will be 6.6 percent smaller than forecast a month ago after adverse weather decimated crops in Russia, Kazakhstan and Ukraine. According to the Department of Agriculture, World output will total 645.7 million metric tons in the year that began June 1, down from 661.1 million forecasted in July and 680.3 million in the previous year? Global inventor will fall to 174.8 million tons from 187.1 million estimated last month and 194 million this year. Wheat prices have surged 70 percent since reaching a three-year-low on June 9 amid dry conditions in Russia, Kazakhstan and the European Union and flooding in Canada. Russia, the world’s third-biggest producer, has banned exports of grain this year to conserve supplies for domestic food production and animal feed. Alexander Morozov, chief economist at HSBC, says that the combined impact of the heat wave on agriculture and general economic activity could reduce Russia’s gross domestic product growth by about 1 per cent this year, a cost to the economy of about $15bn. The USDA cut its production estimate for Russia by 15 percent, to 45 million metric tons from 53 million in July. Ukraine's forecast was cut 15 percent to 17 million tons and Kazakhstan’s estimated production is 11.5 million tons, down 18 percent from last month

 

On Tuesday inflation numbers for July are forecast to show RPI remaining high despite a slight easing weakening last month to 4.8% from 5% in June. The official Consumer Prices Index (CPI) measure of inflation is expected to show little sign of falling back to the Government's 2% target and it is forecast that it could ease back to 3.1% from 3.2%. Minutes of the Bank's rates meeting, due on Wednesday, are likely to show the first three-way split among policymakers for two years as they balance inflation and growth risks. It is forecast that two members of the Monetary Policy Committee (MPC) voted to increase the £200bn quantitative easing programme to aid the stalling recovery in August and that Andrew Sentance continued to call for a quarter point rise in interest rates as he prioritised the need to rein in inflation. Borrowing figures and retail sales data are released on Thursday. With Government spending cuts at the forefront of attention, the latest update on Britain's public finances will be keenly awaited. Public sector net borrowing is expected to have improved further in July, down to £3.8bn from £14.5bn in June, although borrowing is typically lower in July. Retail sales may disappoint, however, with forecasts suggesting a drop in growth to 0.3% last month from 0.7% in June as the Government's austerity measures take their toll on consumer confidence.

 

In the US on Monday, the Empire Manufacturing survey is due before the start of trading. The regional reading on manufacturing is expected to have jumped to 7.50 in August from 5.08 in July. On Tuesday, New home construction is expected to have risen slightly, with housing permits jumping to a 555,000-unit annualised rate in July from a 549,000-unit annualised rate the previous month. The Commerce Department report is also expected to show that building permits, a measure of builder confidence, fell to a 573,000-unit annualised rate in July from a 586,000-rate in the previous month. The Federal Reserve's reading on factory output is due and Industrial output is expected to have risen 0.6% in July. Capacity utilisation is expected to have risen to 74.5% from 74.1% in the previous month. On Wednesday, The Leading Economic Indicators (LEI), from the Conference Board, is expected to have risen 0.2% in July after falling by that same amount in June. The Philadelphia Fed index, a regional reading on manufacturing, is also due.

 

US Stocks had surged 7% in July after a number of major U.S. companies reported better-than-expected results for the quarter. But the March rally has stalled in August, as the corporate reporting period comes to an end and recent more forward looking economic data proves generally to be disappointing, hitting hopes of a US recovery. With unemployment at 9.5%, people in the U.S. are worried about the recovery.  A record run of 22 straight federal government budget deficits has raised fears of higher taxes and Cautioned Americans over their finances. This means higher saving, which restrains spending and hits demand. The bigger-than-anticipated US trade gap suggests second-quarter GDP s is likely to be revised down closer to 1% or 1.5%. Fed officials are increasingly concerned that the U.S. economic recovery is running out of steam. Some fear weak consumer demand could put further downward pressure on prices and lead to deflation. Deflation can become a dangerous spiral in which consumers are encouraged to save more on expectation that they can buy goods and services later at a lower price, thus hurting the economy further. Once established, deflation is very hard to turn. I believe it was the realisation of this that saw the US Federal Reserve begin the process of acknowledging that further quantitative easing looks inevitable in America. The problems in Europe have also not gone away, the cracks have just been papered over and once it reopens after its holiday month, the cracks are likely to be prodded and poked again.  In the UK, the coalition’s honeymoon period will clearly come to an end when the public sector spending review is announced in October and it is rumored that one Senior Minister has compared the mood to August 1914 - that is no one suspects the slaughter to come.