01 - 06 - 09

The story most that interested newspaper editors during May was undoubtedly the MPs’ expenses scandal.

Of course, this is not really an economic issue, at least not directly so. However, it has served to take most people’s eyes off the ball in respect of the economy; which might not be a bad thing in the view of those who believe that our current woes are attributable to a lack of confidence.

Who is picking your pocket?

In reality, whilst the MP’s expenses revelations are important for reasons of morality and trust of elected representatives, the issue has not contributed significantly towards the profligate government spending that so threatens the speed of recovery we can expect. Similarly, the question of how much was wasted moving the entire Cabinet to Edinburgh for a meeting in April is only a minor irritant in overall terms.

What these both (including the Cabinet Office’s refusal to give us details of the waste involved in the latter under the Freedom of Information Act 2000 because of an exemption) demonstrate is how much of our money is wasted – and how little our political masters appear to care about financial prudence. No wonder millions of pounds each year are spent on consultants’ fees and special advisers!

Government borrowing
Treasury forecasts suggest that the actual borrowing requirement for the next 4 years will be £796bn; more than 10% higher than suggested in April’s budget. In fact government debt, which was predicted by the Chancellor to reach about 80% of Gross Domestic Product (GDP), could actually be as high as 100% of GDP by 2013, according to ratings agency Standard & Poor’s.

External scrutiny imposes additional constraints

This might seem academic, because it is, after all, simply a forecast. However S&P’s view is actually very important because if it is right, we can expect to see the UK’s credit rating reduced from its current “Triple A” level. The way capital markets work is that lenders – those buying government bonds – tend to rely on what the ratings agencies say, when setting the interest rate they will charge for their money. So if our rating is reduced, the cost of repaying the government’s massive borrowings will rise, which will make matters worse.

To avoid this happening it is essential that government spending is cut. Unfortunately, in a time of recession, this is easier said than done, because if the government spends less, the economy tends to shrink; not something we wish to accelerate at the moment. This is an issue that needs to be addressed urgently.

Economy
There appears to be a generally held view that the economy has gone “past the bottom” with positive indicators both here and in the US.

Not so much an upswing as slowing the downswing

The UK Construction Purchasing Managers’ Index rose from 30.9 to 38.1 in April; its highest level for 7 months. However, anything below 50 still represents contraction within the sector. Services and Manufacturing are also showing signs of recovery, as is the US Institute for Supply Management’s Purchasing Managers’ Index. Jobs data in the US is also encouraging, because while unemployment is up by 0.4% to 8.9%, compared with March, the increase is smaller than predicted. Conversely, it will be interesting to see what happens when the phoenix arises out of the ashes of General Motors, both in the US and Europe.

Despite comments by Federal Reserve Chairman Ben Bernanke that the recession will be “over by Christmas” (which is what they said about the Great War in 1914), over-confidence could actually be counterproductive if it leads to poor decisions, such as failing to manage spending plans tightly enough.

The OECD predicts that world trade is set to fall by 13% and warns against protectionism which, it says, could slow the rate of economic recovery. The UN says that the world economy will shrink by 2.6% in 2009 with poorest countries hit hardest. However it predicts a mild recovery for 2010 (Source: World Economic Situation and Prospects 2009 – US Department of Economic and Social Affairs).

Closer to home, the Statistical Office of the European Communities says that industrial production in the 27 EU states fell by 20% over the past year, with Spain (-24.7%) and Italy (-23.8%) worst off. Greece, in contrast, fell by just -5.8%. It predicts that the UK will recover faster than most European economies.

Markets (Data compiled by the Insurance Marketing Department Ltd.)
With equity markets recovering during the early part of the month and then bumping along at more or less the higher levels, all the indices we follow were in positive ground with the FTSE100 gaining 4.11% (on top of  April’s 8%) and the Dow Jones 4.07% (building on April’s 7%). The FTSE250 only managed 0.57% growth during May, whilst AIM grew 9.39%; again less than in April, but respectable nevertheless.

Can a ‘dead cat bounce’ last for three months?

Back in the US, the Nasdaq100 rose by 3.32% and elsewhere the Eurostoxx50 managed 3.2% and the Nikkei, 7.8% (the only one of ‘our’ indices to beat last month).

Sterling staged a major recovery against the US dollar, rising by 9.88%, but it only managed 3.01% against the Euro. Oil prices rose by 29.03% during May to end the month at US$65.52 per barrel for Brent crude 1-month futures. This is bad news for motorists and could also affect other energy prices, although it is often difficult to see why any link exists (unless it relates to speculation).

The price of Gold also rose during May by 11.15%, which is unusual, because we more normally see it falling when equity prices are rising. If this indicates that some professional investors are still nervous of equity markets and seeking an alternative home for their money, this is worth being aware of. However, with gold at one of its highest points for 20 years, there is no certainty that it will increase further in value – or even sustain its current price. After all, gold generates no income, while the yield from the FTSE All Share index is currently about the 4.57% mark.

Inflation
It is generally held that inflation is good for borrowers/debtors but bad for savers/lenders. In other words, pensioners and others on a fixed income tend to come out worst in inflationary times. But the biggest winner can also be the government, because of what is called fiscal drag, whereby more tax is generated on higher earnings and spending while allowances lag behind. This increases tax revenue as a proportion of gross domestic product.

CPI set to go negative later this year

Inflation is currently falling, with the latest figures showing an annual fall of 1.17% (compared with a fall of 0.38% last month) for the Retail Prices Index and an annual rise of 2.32% (compared with 2.91% last month) for the Consumer Prices Index. (The ‘fan’ chart shown gives an indication of the possible range of outcomes predicted by the Bank of England.)

However, it is still possible that inflation could rapidly return because of the quantitative easing programme currently being undertaken by the Bank of England. This puts money into the economy and could therefore prove inflationary.
Economists such as the Sunday Times’ David Smith tell us not to worry because, if inflation threatens, the Bank of England can simply sell gilts back into the market to slow things down. The question is whether it would actually do so?

Business
According to the Bank of England’s Agents’ report, the pace of slowdown in consumer spending has eased, both in respect of retail sales values and consumer services turnover; it is still negative, but less so. Housing market activity has also grown, with reports of higher enquiry numbers.

Business is still suffering from credit problems

The pace of de-stocking amongst retailers is apparently slowing, as inventories reach planned levels. Used car stocks are low, but new car stocks plentiful; so the new scrappage scheme has apparently yet fully to kick in.

Trade credit is still a problem with some firms taking the counterparty risk onto their own balance sheets, rather than refusing orders, although bank lending is up a little in some areas. However, the margins over base rate demanded by banks – and their arrangement fees – are still sharply higher, even on renewals and extensions of existing facilities.

Clearly, the banks still wish to make businesses (and therefore consumers) pay for their mistakes.

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