04 - 03 - 08

It is always good to start off with some positive news ...

... so the fact that the three main UK indices are all ahead for February (more details below) makes pleasing reading. But if we scratch beneath the surface of the ‘doom and gloom’ in the financial and economic press, there are signs that matters may not be as bad as some commentators would have us think. (Might they have an eye on seeking to influence this month’s budget?)

Slow-down does not mean a stop

Outlook
According to one major insurance company, while there will be a slowdown in the economy, we are unlikely to see outright recession. This will, however, impact on tax revenues which rely on a steadily growing economy to ‘square the circle’ of offering apparent tax cuts, while spending more money (but not increasing borrowing too much).

A major factor will be that house prices will remain flat and while this is great news for first time buyers (in fact for anyone moving up the ladder, too) household budgets will be hit by higher energy and food prices. The company also expects the economy to start a recovery by the end of next year and while this might be viewed as ‘seeing the world through rose tinted spectacles’ in order to talk up business, it is not inconsistent with the Institute of Directors’ Chief Economist’s views reported last month.

Interest rates
February’s cut in interest rates will, while some may still want more done, be most welcome to businesses, which should see the cost of borrowing ease.It will also weaken sterling against our main trading partners’ currencies (sterling was down 0.13% against the dollar and 2.25% against the euro last month) which makes exports relatively cheaper and competing imports more expensive.

Interestingly, the strong euro is starting to hit jobs in Germany, where BMW is to shed 5,000 workers.

Markets (Data compiled by the Insurance Marketing Department Ltd.)

Oil prices continue to reach new heights

As indicated above, after a somewhat rocky time the FTSE100 managed to end February a very modest 0.8% up. The mid-cap FTSE250, however, did rather better at 1.88% up for the month. Surprisingly for some people, the AIM market rose 5.23%, recovering some of the losses seen during the last three months. In fact, this was probably a ‘correction’ after the worst impact of the Capital Gain Tax Changes, announced in the Pre-Budget Report, were slightly mitigated by the introduction of a modest £1 million lifetime 10% rate for certain qualifying investments. This may have stemmed the expected exodus from AIM shares; but we have yet to see whether this step is enough.

Elsewhere markets did less well, with the Dow Jones losing 3.04%, the NASDAQ100 falling by 4.95% and the EuroStoxx50 shedding 1.8%. On a twelve-month basis, the above indices are all down, although in the case of the Dow Jones, only very slightly so.

Shock of the month was oil, where the price of Brent Crude 1-month futures rose by 8.56% to top US$100 a barrel. What is not clear is the extent to which this is due to the activities of speculators, rather than increasing demand, particularly from the emerging economies.

Interestingly, the OECD has forecast a slowdown in China’s economy, which has previously been a powerhouse for the world, although Brazil, India and Russia are expected to continue growing. In the latter case, one must wonder whether the emerging middle class will actually be the strongest bulwark against increasing centralisation if Dmitry Medvedev, the new Russian President, proves as strong as his predecessor.

Inflation

Credit cards make spending too easy

Rachel Lomax, Deputy Governor of the Bank of England, has warned that we face a real risk of higher inflation, based on soaring commodity prices, which will cut demand for up to two years. If wage demands rise, this will increase costs even more, adding to a possible spiral. One wonders if her comments are intended more to ‘put a shot across wage negotiators’ bows’, than reflecting a real fear of inflation. Certainly the CBI has reported the longest sustained demand for 12 years (measured by orders balanced) which does suggest there is room for manufacturers to raise prices.

Retail sales volumes were up in many areas, with reports of almost 1% growth in January, up 5.6% on last year. However, some areas were sustained by retailers having to slash prices. For example, the cost of computers and televisions were cut by almost 15% compared with the same period last year.

The Retail Prices Index rose at an annual rate of 4.07% in January, while the Consumer Prices Index, which excludes mortgage costs, was up 2.23%.

Northern Rock
The Chancellor’s decision to nationalise Northern Rock may be seen by some as inevitable and by others as too late; but it is a fact with which the banking community and investors have to live.

Shares carry risk, but should the amount be determined by government?

From banks’ perspective, they are now faced with a competitor which, according to new Chairman Ron Sandler, will be “vigorous” in its activities. Since NR is backed by the government, this could be seen as unfair and the European Commission may have something to say on the subject.

More importantly for the rest of us, the government’s own fiscal rules have been blown wide open by the move (which is either of limited importance or a good way of ‘burying’ other breaches, depending on your perspective). Investors are unlikely to see much in the way of a return – although this is one of the risks of investing in shares that should never be forgotten.

The level of compensation will be of more than academic interest to tens of thousands of investors, but it also raises a major question about the basis on which compensation should be paid; is it net asset value, or market valuation. The two are seldom the same. In theory, the market valuation is the price on the day trading was suspended (90p per share) which creates a market value of £380 million. However, looking at assets less liabilities could produce a completely different result. It seems likely that this will end up in court, so at least the lawyers will do well out of it.

Confidence

Red tape costs are soaring

According to GfK NOP, consumer confidence is at a 13-year low, at ‘-17’ on its index. In some respects, this is probably attributable as much as anything to the housing market slowdown; when prices are rising, people feel better off, even if they are not. With Nationwide reporting a 0.5% fall in prices during February, people could be expected to feel less confident.

But there is a broader issue that may not have entered the public psyche yet and that is the concerns of businesses that the cost of regulation by government has risen from £10 billion in 2001 to £66 billion in 2007. This is making the UK less attractive to overseas investors at the same time as important “non-domiciled” investors are being scared off by the threat of punitive tax charges … and in the face of concerted efforts by representatives of overseas territories such as Eire, Holland and Switzerland.

Lord Digby Jones (former head of the CBI and now a trade and investment minister) has joined the list of people pointing out the potential economic damage of scaring off investors. It is not the £30,000 ‘non-domiciled’ tax that matters so much as the threatened treatment of offshore trusts. The country stands to loose far more in actual revenue (including VAT) than it could hope to recover in putative taxes.

Government spending

Chancellor facing a bigger than usual challenge?

With the budget taking place during March, it is worth considering that a slowdown in the economy could greatly constrain the Chancellor’s freedom of action. Apart from headline grabbing suggestions that the duty on alcohol could be raised to reduce binge drinking (although few youngsters probably binge on wine, whisky/whiskey or brandy) the government knows that falling sales mean less tax.

Capital Economics has estimated that if economic growth grinds to a halt, the budget deficit could treble to £150 billion. The problem is that throughout the period of strong growth experienced in the past decade, all other major economies took the opportunity to reduce government borrowing, whereas hear it rose steadily. This means that the Chancellor’s options are limited; ‘tax/borrow and spend’ is no longer an option.

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