The UK Budget and the Economy

The key to understanding the impact of today’s budget on the real economy is found in the Chancellor’s comment right at its beginning that it would be a ‘fiscally neutral’ budget.  In short, that means that whatever measures he introduced to, say, cut taxes or duties would be exactly offset by others that increased revenues or reduced spending.  On balance, no net direct impact on total demand over the planning horizon of five years up to 2017/18, but perfect for the next election.

If you look at the Treasury table that analyses the net affect of all today’s measures http://www.hm-treasury.gov.uk/budget2013_policy_decisions.htm, you will see that in this year there is actually a net withdrawal of money to the tune of £1.3 billion mainly driven by spending cuts.  Even though he has removed the fuel escalator due in September and given something back to beer drinkers, the Budget for this fiscal year will contract the contribution of government spending on the economy.  In 2014/15 as many of the measures announced today come into effect such as the Employment Allowance of £2000 and various measures for home-buyers this becomes a net input to the economy of £1.6 billion.  In the following year, as the new Child Care scheme starts to be phased in, there is a net injection of some £2.8 billion.  In the following two years we return to withdrawals of £1.7 billion and £1.3 billion per annum.

One objective the Chancellor has achieved is

RBS - the price and everything, the value of nothing

So, the market is continuing to try and work out the value of RBS in light of their results published last week.

The RBS interpretation was that they were on track for re-building the bank.  Their share price had been improving over the last year as they gradually started to address their ills under new CEO, Stephen Hester.  He pointed to the improving 'under-lying' profits of their 'core' business' as an indicator of good things to come.  This seemed to confirm the idea that the bank would be ready to re-privatise over the coming 12 to 18 months.

The fact that there had been a fairly small improvement in operating profits, was not good enough for the markets.  That profit was turned into a huge net loss after adjustment for a variety of fines, provisions and adjustment for market based credit spreads.  And it is this net profit that seems to have driven market sentiment since last Thursday's figures.

The gap between the RBS share price and the target price of £5.00 that most feel would be needed to justify a re-privatisation has been widening.  Last Wednesday's price had been hovering around £3.45 for some time and had actually been rallying in advance of the results.  The disappointment of Thursday saw an immediate down grade as the results were released and have fallen even further threathening to fall back below £3.00.

Their share price needs to surge by 66% over the coming year to make it a real candidate for re-privatisation or at least need to be in sight of that price to announce a sell-off.  If last week's results were meant to show that there was light at the end of the tunnel it must be disappointing to all involved that the market decided to make the size of the task even bigger.

 

RBS - A tale of two banks

Today’s results for RBS were very much a tale of two banks.   Operating profit up from £1.8bn in 2011 to £3.5bn, but net profit showed a huge loss of  £ 5.2bn which was in excess of the expected £3.5bn loss that analysts had been predicting.  CEO Steven Hester will be hoping people will focus on the good news – that under his guidance ‘new RBS’ is improving and moving towards a better future.  But early signs suggest the markets have focused on the losses of ‘old RBS’ – losses created by adjustments to loan values, mis-selling compensation and fines that are the legacy of the pre-crisis world of finance.  In immediate trading after the announcement, their share price fell by more than 3% to some £3.35.

So, what are the issues behind these figures?

The UK grew in Q3 - by 1%

The release of today’s GDP figures will basically allow everyone across the political spectrum to tell the story they wish to tell.

Growth is back.  After 3 quarters of contraction or, as we economists like to call it, ‘negative growth’ we are back on track to expand.  Well, yes and no.  A 1.0% bounce is great news, but not quite enough to completely wipe out the losses of the last year: in Q3 2011, the index of GDP stood at 103.1 and is now 103.  If I were an Olympian having struggled and pushed myself through 12 months of hard training and effort I’d be disappointed not to have improved my performance even if recent training has been ‘going really well’.

The story of the last 12 months is one of flat activity.  Hmmm.  Not so great then.

The winners in the economic race for a turnaround performance

It's my party .....

The Greeks must feel like they have accepted an invitation to a party that nobody wanted them to turn up to.    They have spent a long time getting ready and even brought a bottle of their favourite wine with them, but the host has turned his nose up at the wine (well Retsina is perfect while on holiday on the Aegean but loses its appeal in cooler northern climes) and explains that it’s not a fancy dress party afterall!  Oops!  Nobody is quite sure how to fill the awkward silence that follows.

A year ago it was not an option that Greece should leave the Euro.  The political leaders of the Eurozone

Bad News for the UK from the OECD

The OECD have today warned that the UK economy will contract marginally in Q4 of this year (by some 0.1%) and will further fall in Q1 2012 (by 0.6%) and so enter a second period of recession.  See OECD predicts recession for more details.

Clearly the Ezone crisis will have a decisive role in the OECD downgrade, but it is also clear that the Chancellor has been following a high risk policy approach at a time when high risks are to be avoided.  His main risk is of front loading spending cuts during the Parliament as the central plank of his fiscal consolidation plan.   At a time when the private sector has been finding it hard to regain its growth momentum, the huge cuts in public spending are expecting businesses to find even more ways to expand to make up for the cuts.  Not only do they need to find sales to make up for what they lost in the recession, they have to make good the loss of spending power in the economy driven by spending cuts.

Should this come as a shock that has been brought on by feckless management of the EZone crisis?  Well, not really.

India in transition

I have just returned from a short business trip to Mumbai, India.  The client is a domestic bank with a short history but impressive plans to grow within the Indian retail market.  I must say the relationship has taught be much about what in the West is often described as an emerging market – frequently with little knowledge beyond hearsay behind the realities of the situation of the economic prospects for the country.

I return from this assignment with one major impression of the warmth and energy of the senior management team.  They were open to new ideas and generous in their hospitality.  They are proud in the achievements of their country: proud too of the contribution they can make to its continued growth, development and increasing prosperity.  It is a welcome evidence of pride not just – as they said – in ‘the money’ but in the economic welfare of the economy.  Something that does not seem to pervade the wider global banking industry at present.

A second issue that surprised me was

Bond Market Mayhem - what happens now?

When reflecting on current conditions in the bond markets it is worth remembering two aspects of their behavior.   The first is that traders operate ruthlessly and quickly to changes in sentiment and expectations.  And secondly, these changes may appear to be based on objective assessments of ‘the numbers’ but they embody many subjective views of the prospects for returns on debt.  There is currently quite a divide between the negative mood in bond markets and increasingly positive news in the ‘real’ economy.

 The consequence of the ruthlessness and speed of action of traders is that the markets have become an

Expect the Yuan to rise ….

­­­­­­­­but not for yet a while.

There have two major developments in the last 7 days in relation to the competitiveness of the yuan – or renminbi – the currency of China.  The first was the decision by US Treasury Secretary Tim Geithner to reserve judgement on whether the Chinese are manipulating their currency and keeping it low to maintain its export competitiveness.  The second was the meeting over last  weekend of the Chinese government to discuss its plans for the next 5 years of growth and development.  Unlike western economies the Chinese continue to create 5 year plans to guide the economy.  The one now published – the 12^th - covers the years 2011 to 2016.

Funding Universities in England and Wales

Government policy in the UK has moved decisively towards a more consumerist model for funding higher education.  Traditionally we have taken the view that the wide economic benefits of having a workforce educated beyond age 18 will more than pay for the investment required to get them there.  That is to say that the economic benefit of investing in education will be seen in higher levels of economic activity and growth and therefore more tax income for the government.  On that basis the ‘taxpayer’ is more than able to bear the cost of University and still be ‘quids in’.

The balance of the argument has now moved on.  First we introduced top up fees a decade ago.  This means that currently students pay up to £3290 per year for their courses which they receive as a student loan repayable after graduation.   It is essentially requiring students to pay for a part of their education out of the enhanced lifetime income stream it gives them.  Seems reasonable.  We are now facing the prospect of increasing the top up fees to some £7000 and perhaps more.  We must wait and see the full debate as it passes through the Parliamentary process.

More fundamentally

Growth is on the up as interest rates stay low

This is the time of year when the key global institutions (the OECD, IMF and World Bank) review their forecasts for the year in view of how economic events have developed since they last published reports in the Spring.

The Paris based OECD has been especially busy this month with updates on their Spring assessment for global growth as well as some newly published views on the state of several major economies including the US.  No time to lose after ‘la rentree’.  Both reports make pretty good reading at a time when many headlines are still discussing the likelihood of a double dip in growth. 

Their autumn global update (to be found at: www.oecd.org ) admits to a slower level growth for the second half of the year but with longer term improvements on the cards and a reducing risk of a return to a downturn. 

To Basle or not to Basle....

The agreement reached at the weekend to implement new capital requirements for banks is the next step on the road towards reforming our international financial system.

The key components of the agreement are that:
a) banks will be required to hold capital reserves of up to 7% of their loans as a buffer against bad and under-performing assets.  This is an increase on the 2.5% that has been the norm in the past.  And was the woefully insufficient amount that was the norm in the recent crisis.
b) the new arrangements will be implemented from 1 January 2013 giving banks and regulators plenty of warning and time to make the changes.  Already a number of banks have announced their plans to raise capital to this end.

If fully ratified by the G20 at their meeting in November,

The Budget – a glass half empty or half full?

This week’s emergency budget delivered by George Osborne was both significant and clever.  Significant for the dramatically new direction it has set out for the future of the UK and clever for the way in which funds were found to finance specific new activities.

Depending on the viewpoint you have, you will see the measures announced in quite different ways. 

For the markets – in capital, currency and credit – it has been seen as something of a gamble.  While they liked the clarity of a plan, there are some comments that he may have overdone the size of the deficit reduction.  The facts that the budget will actually lead to lower growth than previously forecast for 2010 with higher unemployment, a higher short term fiscal deficit and will result in a net deficit of well below 3% (the forecast is 1.7%) of GDP in 2015 provide evidence for the size of his additional discretionary fiscal tightening.

If you work in the public sector, the glass contains something of a spiked cocktail or at best some nasty tasting medicine. 

The battle lines are drawn ...

The two great opposing armies of economic thought and analysis are clearly ranged against each other. 

On the one hand are those advocating a positive role for government spending as a stimulus to support the economy out of recession and back to sustainable levels of growth.  On the other is the more market-oriented approach emphasising the inefficiency of government action and the way in which large levels of public spending can crowd-out private sector investment and activity. 

Behind the lines of combat there are some ideological differences...

The economic patient is stirring

If you glance at the breakdown for growth forecasts for the UK this year you will see what an economic system looks like as it starts to climb back out of recession.

If we achieve 1.5% GDP growth this year, it will have been driven mainly by public sector growth - likely to be around 1.7% - with a small contribution by private sector spending - around 0.7% - and some offsetting reductions in investment: investment spending has collapsed over the last two years and appears to be declining at a rate of 2.4% this year.   Oddly, while exports are expected to grow pretty well this year on the back of a more competitive exchange rate (forecasts suggest an expansion of some 4.5%), these are likely to be matched by higher imports so that there is only a very small net contribution to growth from trade.

The most recent estimated figures for UK GDP growth in Q1 make two issues clear.  Firstly, to use the

When governments and the market fails....

The  volcanic ash crisis is unfolding in a fascinating way with business leaders starting to look for someone to blame - and in this case it's 'the government' or even 'governments' of the EU that are to be blamed for not realising how bad the situation was becoming over the weekend.

I was one of those potentially stranded souls without a way to get home - from the Netherlands to the UK.  In the first case I had to change plans at the last minute on Thursday to ensure I could get to a business seminar in Maastricht.  Then as the situation escalated it was a matter of wondering how to get back.

The market system responded quite well to the occasion.  Eurostar found extra capacity it could lay on and its pricing model pushed ticket prices up.  Other alternative travel routes have followed suit.  The telecomms

Commercial Priorities for the Year Ahead

The prospects for growth in the UK over coming year and beyond are becoming clear. The final revisions to Q4 data for the US and UK tell a story that both these economies grew more rapidly in the Christmas quarter than had been thought at first. It is likely that we are out of recession but still in a depressed state when you look at activity levels compared with three years ago. Opinion is somewhat divided over the pace of recovery in 2010 – indeed whether we will slip back into recession in the West if a perfect storm of poor policy plus lack of confidence in ‘the markets’ and in the real economy fails to ignite growth.

We can learn a lot about the potential unfolding of this recession by reflecting on our previous experiences. The National Institute of Social and Economic Research (NIESR) produces a time-line for the UK recession compared with the four main recessions experienced in recent times: in 1930-34, 1973-76, 1979-83 and 1990-93. If you look at the progress of the recession in months since the peak of the cycle and the level of activity in relation to that peak, you see some very clear patterns.

Letters From Economists

The problem at the heart of the argument between the economists that have recently published open letters in the Times and FT is that we all want a level of certainty that is simply not possible. The debate and conclusions that the different groups draw are based partly on what they look at when they assess the strength of the economy and partly on their judgements about what that means.

UK Economy Still Not Growing in Real Terms

Latest figures published today for the UK by the Office for National Statistics, show a decline in GDP for Q3 of 0.3%. This is an upward revision on the first estimate of a month ago, but not enough to take the UK out of a technical recession. At current prices and with a small amount of inflation in the system, GDP grew by 0.1%.

Looking more deeply into the results, we see strong variations in activity.

Latest IMF forecasts revise GDP growth upwards for 2010

Today's IMF Economic Outlook provides some positive news for the global economy. Below is a short overview from Jorgen Elmeskov, Acting Chief Economist at the OECD.



Higher growth than previously expected for next year, but for some the legacy of high unemployment will provide a drag on the speed of the recovery. Is that a hint of a wry smile when he seems to suggest that the US, having shed labour rapidly, will bounce back more quickly than labour hoarding EU companies and countries?

Overall the OECD economies are set to grow over the year, with the exception of Greece who will face a small decline in 2010, and the non OECD world is set to bounce back more rapidly.

Unemployment in the EU is set to hit double digit figures exceeding 10% for the next two years. Eight countries are set to stay above 10% with Spain (19.3%), Turkey (15.2%) and Ireland (14%) likely to struggle for some time yet in returning to strong expansion.

A summary of the forecasts is provided on the OECD website with detailed assessments of individual countries too.