News
Economic Review of August 2008
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The economy has always provided a roller coaster ride |
We have witnessed economic cycles many times before (since biblical times, if you consider “seven years of plenty … followed by seven years of famine”) but it is only since the 1930s that fluctuations have been seen as intrinsically threatening. This perhaps has its ultimate incarnation in Gordon Brown’s claim to have put an end to ‘boom and bust’. In fact, it is arguable that the business cycle is cathartic; cutting out ineffective businesses and strengthening efficient ones.
By extension, one could argue that it is the very end of ‘boom and bust’ that is the problem. It led the government to turn away from fiscal sanity and to bridge the ever widening gap between rampant state spending and relatively tight control over direct taxation with massive borrowing. Because of the over-confidence that the economy would continue to grow infinitely, the Treasury ignored the fact that even a modest downturn would reduce government income and make servicing the debt rather more than just ‘difficult’.
Fortunately, if the world economy picks up (see below) then there is every chance that we will enjoy the benefits. However, we must then take the opportunity to reduce state borrowing; and fast.
Rising machinery orders indicate greater business confidence
World economies
Following the US economy in too much detail can give you a headache, so we tend not to do it too closely. But news that orders for durable goods rose by 1.3% in July – the second consecutive rise – certainly gives rise to confidence that there are signs of recovery there that side of the pond.
Even more encouraging is news that business orders on capital goods were also 2.6% up in July following a 1.3% rise in June. Long may this trend continue, because it augers well for the UK; especially as sterling is so weak against the dollar at the moment, which means that goods we export to the US will be cheaper for them to buy.
The UK may have seen zero growth in the second quarter of this year, but the Eurozone is already in decline, having experienced a fall of 0.2% for the same period, with France and Italy leading the way downwards.
Interest rates and inflation
UK interest rates were held at 5% during August in another three-way split in the Bank of England’s Monetary Policy Committee. This may be a good thing because while relatively high interest rates might cause some pain, a cut in bank rate is unlikely to influence mortgage rates, which seem to be following Libor (the London Inter Bank Offer Rate) at the moment. Several lenders have recently reduced rates, including Woolwich, whose fixed rate offerings are now up to 0.28% cheaper. Conversely business could do with some relief and a cut would not necessarily cause a further fall in sterling, which appears to be more influenced by world conditions than interest rates at the moment.
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Inflation is the greater threat |
It could be argued that we are actually facing a greater real threat, which cutting interest rates could contribute towards; inflation.
With RPI inflation at 5% and the more conservative CPI at 4.4%, we need to keep control over two factors if rampant inflation is to be avoided. One is wage settlements; high wage rises have led to spiralling costs in the past which must be avoided. Fortunately, restraint appears to be holding with average weekly earnings only 3.4% higher in the year to June 2008, down from 3.8% in May (source: www.statistics.gov.uk).
However, it is also important that manufacturers do not take advantage of current conditions to increase their prices more than necessary, simply to increase profits. There are already suspicions that some businesses are doing so and consumers should ‘vote with their feet’ to punish offenders.
Is this a bounce or the start of a recovery? Knocking down perfectly good property is a wasteful result of poor legislation
Markets (Data compiled by the Insurance Marketing Department Ltd.)
August was a surprisingly strong month for most markets with the FTSE100 recovering 4.15% (more than it lost in July) to end only 10.58% down on a year ago. The FTSE250 gained much more than it had lost a month earlier, ending 5.93% up for August. In the UK, only the Aim market continues its decline (albeit at a slower rate) to finish 2.55% down, more than a quarter lower than a year ago.
In the US, both the Dow Jones and Nasdaq100 rose for the second month running (1.45% and 1.80% respectively), but the Eurostoxx50 and Nikkei225 were very marginally down over the month (0.07% & 0.17%, respectively).
Oil ended the month 7.93% cheaper at $114.15 a barrel for Brent crude 1-month futures. However, 8.25% decline in the value of sterling will have offset any potential savings, which is why the cost of fuel in the UK has not fallen. Conversely, this currency movement is good for exporters and could give a much needed boost to UK manufacturing; unfortunately at the expense of those wishing to holiday overseas.
Perhaps predictably, gold lost a further 8.75% during August as equities rose in value.
With house prices down more than 10% (source: www.nationwide.co.uk) over the past year, it is hardly surprising that people are using the “R” word. But there is some good news in that, while the number of completions is low, the number of properties being offered for sale has started to increase again (which will continue to hold prices down).
The level of mortgage lending increased by £4.3 billion during July, but is still below the 6-month average and approvals are less than half the level of a year ago.
Taxation
Some of the tax changes made during the past few years are starting to have really disastrous consequences. Because rate relief on empty buildings was scrapped in April, landlords with empty property – and there is plenty of that about in the current economic environment – have little option but to knock it down, if they are unwilling – or unable – to find the money (often tens of thousands of pounds) necessary to meet these new bills.
For many small property investors – including those with self invested pensions as well as direct investors – this will be a major problem. Knocking down perfectly serviceable property is expensive, as would be rebuilding it. To do so is also wasteful of resources, which can only be used once, and therefore represents an absolute loss to the economy. Surely this is not what the government intended when it set out to attack landlords who deliberately sit on empty properties waiting for higher rental income opportunities?
Meanwhile two major financial groups (fund manager Henderson and Brit Insurance) and one world-class office services provider (Regus) are understood to be considering moving domicile away from the UK in order to escape increasingly draconian taxation. This can do nothing to enhance London’s reputation as a leading business centre; or to help the government balance its books.
Russia
It is impossible to look at economic issues without considering the potential impact of events in South Ossetia, Georgia. Whether this will lead to wider problems is difficult to determine. Clearly, some people are concerned that Russia is responsible for producing much of our fuel, so a re-opening of the cold war could be deeply damaging to all of us.
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War is economic waste gone mad |
Since the ‘invasion’ of Georgia, Russian equity markets have fallen badly with the RTS index falling 15.22% over August (Source: markets.ft.com). Compared with the FTSE100 and Dow Jones, this is unimpressive and should make Dmitry Medvedev exercise some constraint over his actions.
