News
05 - 01 - 10
Economic review of December 2009
December’s Pre Budget Report could perhaps be described as “too little, too late”.
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No easy challenge for the Chancellor |
What was missing, for most commentators, was any realistic plan to reduce public borrowing within the short term. Indeed, there will actually be an increase in spending next year. Of course, the Chancellor faces a difficult challenge. He has to help businesses to recover from the effects of recession as well as the credit crunch, while planning to balance the Government’s books. Since supporting business usually involves either spending money or at least reducing the burden of taxation on them, this leaves no scope for reducing his borrowings.
The problem facing the country is that we are now borrowing some 60% of Gross Domestic Product (GDP), up from less than 50% this time last year. In fact we had to borrow £20.3 billion in November alone. It has been estimated that the government will have to sell £18 billion worth of gilts each month throughout 2010 in order to service the debt.
Quantitative easing …
In view of the slow growth in money supply (which has recently seen its smallest expansion for five years) and exports, the Bank of England’s Monetary Policy Committee is reported to be considering increasing its quantitative easing programme by a further £25 billion next year.
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Exports are core to our future |
Unfortunately, many people consider that this strategy is potentially inflationary as more money chases a finite supply of goods. The Bank of England says that this is not a problem, because there is spare production capacity, which means that manufacturers could increase supplies in order to match demand, thus avoiding rising consumer prices. However there is little evidence that this would be the case and it could be described as wishful thinking.
… and inflation
Consumer price inflation is currently running at 1.9%, but this has risen sharply from 1.1% just two months ago. The broader retail prices index is now back in positive territory at 0.3% a year; but again this is sharply up on two months earlier, when it was -1.42%. With a 2.5% rise in VAT in January and the prospect of higher oil prices never very far away, this is a matter of concern.
The Bank of England’s governor may feel that it is safe to “look through the short-tern rise in inflation” towards a period of greater stability which will allow him to increase quantitative easing in the medium term, but recent inflation figures, should they continue to grow, could easily act to destabilise the economy.
Interest rates
Interest rates have remained constant within the main economies but the CBI apparently believes that we are likely to see a 2% increase during 2010 before things level off again. This could be of concern to mortgage borrowers because lenders are likely to take the opportunity to increase their rates by at least the same margin.
The potential impact on the housing market is incalculable, with some people suggesting that prices will continue to rise and others anticipating a further fall.
Such uncertainty is paralleled by a degree of ambiguity over what will happen within the broader economy; while most major economies are now back in growth, our own continued flat-lining could presage a weaker period worldwide. Global GDP is actually down 1.1%, according to the International Monetary Fund, so anything could happen.
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The FTSE100 is still well below its long term trend |
The FTSE100 ended the month 4.28% higher, 22% up on the start of 2009; likewise, the mid-cap FTSE250 gained 4.36% during December to finish a massive 46.32% up over the year. The Dow Jones only managed 0.8% growth over the month, but its performance over the year was a more respectable 18.82%, while the Nasdaq100 grew by 5.81% (43.89% on the year) and the Eurostoxx50, 6.04% (21% over the year). The Nikkei225 gained 10.18% in December but since it has performed poorly for a long time its annual growth was just 19.04%, so the late sprint was helpful.
Nobody can tell what the next twelve months will bring but, although some pundits say that shares are overpriced, it is worth noting that the FTSE100 is still some 14.77% below its long term trend. While it is impossible to predict what impact uncertain economic conditions will have on markets, there appears to be some scope for further growth.
Oil prices rose by 1.1% during the month during December, but are 71.16% higher than at the start of 2009. Gold actually fell by -7.16% in the month, but is still almost a quarter higher than a year ago.
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Are we saving more, now? |
As we have previously noted, a time of recession is usually accompanied by an increase in savings. 18 months ago, the savings ratio was zero – that is, families were saving nothing from their household income. Now it has risen to 8.6% (Source: Times online 29/12/09), its highest level since 1998.
Unfortunately, the figures are not necessarily an indication of more saving, rather that people are reducing their debt. This, in itself, could be a positive move although it suggests that there is less spending going on, and such an outcome could be bad for retailers. On the other hand, anecdotal evidence suggests that we ended 2009 with a massive spending spree – to gladden the retailers’ hearts and beat the 2.5% increase in VAT. So unless all the household savings went on Christmas, we could find that we can, for once, have our cake and eat it.
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Would the last banker to leave please turn out the lights? |
One of the bombshells in the Pre Budget Report was that bank bonuses in excess of £25,000 were to be subject to 50% tax – payable by the banks, rather than their employees. This has, of course, resulted in threats that the big banks will move out of London. Indeed JP Morgan, the institution that was largely responsible for containing the 1907 banking crisis, may be reconsidering its plans to spend £1.5 billion on building new corporate headquarters in London; on the other hand, this could be a gambit to secure better terms from the government.
One has to ask oneself whether a mass exodus of banks from the UK would be such a bad thing after all. They claim to bring massive benefits to the country in terms of invisible exports – but then, so does the insurance industry, which has so far failed to bring the country to its knees. When you really get down to it, however, it is difficult to see that anyone other than the banks themselves really benefit.
Of course they do make payments to the Treasury in terms of corporation tax (when it is unavoidable) but they also charge massive fees to large companies for advice on mergers and acquisitions. If they did not do so, those businesses would presumably make more profits and pay tax on them. It has been argued that the fees charged by merchant banks are exorbitant and that institutions such as insurance companies and investment funds that own shares in the companies paying these fees should challenge whether their money is being used effectively.
Perhaps it might be better for all of us if our best talent were to be employed in industry and business, rather than being attracted into banking by massive salaries and bonuses, while not benefiting the country at all?
Are we shrinking in world importance?
There is something of a parallel between the banks telling us how important they are to us and the suggestion that by 2015 we will have fallen from being the fourth largest economy in 2005 to no longer being in the top ten (Source: Centre for Economics and Business Research - December 09). Would it really matter? It might hurt our pride and make us feel less secure, but it would have little practical difference. If we lost our status as a world leading banking centre, would that actually hurt our economy? Or is it time to re-create ourselves, yet again, into something fit for the 21st century?
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Selling cars can help the wider economy |
One of the more successful initiatives in the early days of the recession was to create a scrappage scheme for older cars. For some time, it appeared that it was not working, but recent data from the Society of Motor Manufacturers and Traders quoted in the Times (5/12/09) show that new car sales in November were up 57% year-on-year and that a fifth of these were part of the scheme.
Unfortunately, all but one of the cars listed amongst the top-ten sellers were manufactured largely or entirely overseas, so it is arguable that the scheme has mainly benefited overseas firms. But this would be simplistic, because there have undoubtedly also been benefits for UK based parts manufacturers as well as the distribution networks within the domestic market. So on balance, the money was probably well spent.
