Well you will be pleased to hear today that Alistair Darling has cut duty on bingo in the next budget causing shares in Rank Group to rally initially by 5%, great for those who enjoy a game on a Thursday evening. Unfortunately this pre-budget report does not appear to be a “full house” for the UK economy and sterling is once again experiencing severe pressure in the currency markets. Alistair Darling today announced a super-tax of 50% on the bonuses of tens of thousands of bankers but at the same time raised national insurance contributions and finally admitted what we all know, the UK economy has been harder hit than feared by the recession.
So what’s been happening in the currency markets? Well sterling seemed to be in favour leading up to and during the pre-budget speech, trading as high as 1.1103 against the Euro by 1pm before moving down to its current level of 1.1029. Against the USD the story was very similar with the pound moving away from an overnight low of 1.6167 up to 1.6374 before trading down once again into the low end of 1.62. The market is currently in the process of absorbing the pre-budget report recently delivered by Darling and sentiment is gradually turning sour and less supportive of our currency, highlighted by volatile rate movements.
Concerns persist of the state of UK government debt with many questioning the creditability of Darling’s plan to reduce the UK’s budget deficit in addition to the increased likelihood of the UK losing its AAA credit rating. This is likely to make our economy even less attractive to investors and see a big sterling sell off.
Paul Dawson a friend and economist has kindly written an article below which should explain the current climate in even more detail and answer some of those points you couldn’t quite get your head around.
Between the Devil and the Deep Blue Sea
The party’s over and the hangover symptoms are just getting worse by the minute.
Yesterday, Moodys stated that they might want to review the AAA ratings of the UK soverign debt but, the omens have been around for some time.
It follows in the wake of earlier warnings by Fitch and Standard & Poor.
Those who issued warnings e.g. the late Ian Rushbrook at Personal Assets Trust have been proved right. http://www.patplc.co.uk/documents/quarterly/55.pdf
In addition to the IMF warnings about public expenditure the OECD (Organisation for Economic Co-operation and Development) has issued similar warnings in its latest annual Economic Outlook available here http://www.oecd.org/dataoecd/4/59/43037700.pdf. This was also reported in the Daily Telegraph on 20/11/09 under the title “OECD warns Britain risks debt spiral” by Edmund Conway.
We, that is the UK population have enjoyed (on the back of a policy of cheap money) the fruits of a consumer credit binge accompanied by a bubble in asset prices particularly property.
One can lecture from on high about individual responsibility but, one must not forget the role that governments and central bankers have played in keeping this party on the road.
Blaming international markets, US subprime mortgage debt and irresponsible banks makes for good copy but, the politicians also need to face the music.
In today’s Pre-Budget report we will see how Alistair Darling proposes to respond this side of a general election.
Unfortunately, now that the wheels have come off the UK economy it is reliant on an economic life support system euphemistically known as “quantitative easing” see explanation below.
Thanks to this policy of the Bank of England injecting liquidity into the UK economy the stock market has recovered some of its horrendous losses but, the recovery, anaemic as it is comes with a price attached.
The Bank of England knows that at some point in the not too distant future the international money markets will call its bluff and start selling sterling with renewed vigour.
The UK government has incurred massive debts in propping up the banking sector and these now stand at £175 billion which is equivalent to 12.4% of GDP.
Debt interest on public sector debt now accounted for just 4.2% of public spending in 2007 but, according to the IMF this will increase to 8.3% by 2014 as the UK’s net debt rises from 40% to almost 100% of GDP (source Daily Telegraph 3 November 2009 “UK interest costs equal to entire Transport bill” by Edward Conway).
I have included a link to the IMF document below – see page 18.
http://www.imf.org/external/pubs/ft/spn/2009/spn0925.pdf
The IMF have also separately warned the UK government about the need to cut public expenditure.
http://www.guardian.co.uk/politics/2009/oct/01/nhs-debt-imf-britain
Both the main political parties are now having to confront rather than posture about the level of cuts that will be necessary to restore financial stability.
The Pre-Budget report will be the opening shot in a verbal war that will continue until the next general election and beyond.
The problem is that the politicians do not want to let the cat out of the bag this side of a general election and tell us the stark truth about their past follies and what it will take to turn the situation around.
If they do not however, a currency slide and a run on the foreign exchange reserves could be followed by a request by a beleaguered Chancellor for an IMF bailout as happened in 1976.
New Labour’s reputation for economic competence has disappeared in a cloud of smoke and the political fallout from the expenses scandal has only served to sour the attitude of the voters towards their elected representatives.
David Cameron may have succeeded in alleviating the toxicity of the Conservative Party as a political brand and be gaining popular support but, this does not necessarily translate into votes particularly as one heads further into the north of the country.
Political punditry is a risky game but, three years ago, one of my associates who is a betting man told me that the next election was one for David Cameron to lose rather than Gordon Brown to win.
This may seem strange but, the electorate might decide as in the two elections of 1974 that they do not want to give any of the parties a large majority.
A volatile electorate might not even bother to turn out and vote or, it could chose to vote tactically particularly if certain politicians were considered to have lost their personal credibility over dodgy expense claims.
If that happened and there was a hung parliament, journalists will be digging into their files to recall the less than heady experiences of the LibLab pact from 1977-79.
More importantly, UK financial markets do not like uncertainty and a coalition government struggling to control spiralling borrowing, declining tax receipts, rising social expenditures and the vicissitudes of an unpopular war in Afghanistan will have its work cut out merely to survive let alone implement difficult decisions.
The failure to address these problems in particular the continuing growth in government borrowing will only serve to store up future inflationary pressure for the UK economy and if that comes to pass sterling will decline precipitously (down) unless interest rates are raised dramatically.
A future government will have to control the volume of the UK’s public sector debt and if investors demand a risk premium to compensate for rising inflation and a declining exchange rate then interest rates will have to be raised which will crowd out private sector borrowing and investment. If not, tax increases will have to fill the gap.
All in all an unappealing prospect both for the UK economy and its currency.
History may not repeat itself exactly yet the “nice” decade as Mervyn King once put it is well and truly over. As a consequence, the study of monetary policy and the sterling exchange rate is going to get even more interesting as we appear to be heading rapidly back to the 1970’s.
So, for those of you who were not around at the time and equally, for those of us who want to take a trip down memory lane I will end by attaching two links that will bring that decade back to life.
http://news.bbc.co.uk/1/hi/magazine/6729847.stm