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Thursday, 10 April 2008

Interest rate cut to 5% - helpful but pain in 2008 cannot be avoided

The Bank of England cut interest rates today to 5%. It has been said by many of my colleagues that this won't make any difference to the economy. This is clearly not the case and I think they are thinking more about their own economies rather than the rest of the UK.

It is fair to say that most of my colleagues won't see an instant impact upon their mortgage rates. Tracker mortgages will see a benefit but given the rapid decline of mortgages repayment costs for those looking to remortgage will probably remain high for some time. Nevertheless, they would be higher had the Bank not cut today.

For the wider economy this move should help to take some of the strain off the financial markets. Don't get me wrong, the problems in the financial markets can not be overcome by the Bank making a few interest rate cuts and the problems in the markets are likely to continue for some time. Nevertheless, this cut provides some breathing room which will give the financial some more time to sort out the mess they are in. Fundamentally, the problems in the financial markets is one of a lack of confidence, if the markets can maintain some sort of stability for a few straight months then maybe we will see of confidence return.

We continue to be in for a very rough ride with the problems in the financial markets compounding the growing problems in the wider economy.

The outlook for the jobs market is not great. First to go will be jobs in the financial sector - we have seen Capital One and the Royal Bank of Scotland announce job cuts this week. Next will follow job cuts in industries that support the financial sector such as business services and retail surrounding financial hubs like the City of London and finally cuts should be expected in the wider economy.

Although unemployment fell in January and February, the statistics will show this reversing very soon.

Be prepared for painful 2008 and a pretty average 2009.

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Thursday, 6 March 2008

Decisions decisions – the outlook for interest rates

Today saw the Bank of England keep interest rates on hold at 5.25 per cent, following a cut in February. Many people had been expecting this decision given that all the signs are pointing towards a period of higher inflation with both input and output prices rising, and commodity prices hitting record highs.

The economy also seems to be weather the storm for now, reducing the imperative for the Bank to cut rates immediately. Recent January retail sales figures as well as improvements in both the manufacturing and services purchase managers’ index indicated that the economy was still expanded, and was not in a period of universal suffering. Most significantly, the labour market has continued to perform well. Although wage growth has been squeezed in both the public and private sector, the number of jobs in the economy continues to grow, whilst the numbers of those claiming unemployment benefits continue to fall.

Despite a selection of “good news” stories, the outlook remains grim, and underlying problems are starting to show themselves. As a result, the primary reason why the Bank of England didn’t cut interest rates was because the short term outlook for inflation has increased, stifling the Banks ability to pre-empt the slow down in the UK economy. Inflationary pressures have been growing as a result of rising energy and food prices. These are clearly outside of the control of the Bank, which can now only hope for a good harvest, increased output from OPEC and a more stable international commodity market.

Higher prices not only reduce the ability of the Bank of England to cut interest rates, they also squeeze the consumer. With consumers seeing food prices rise by around 6 per cent over the past 12 months they have been forced to reduce their spending on other items. The crisis in the banking sector has seen lenders increase their margins which has resulted in mortgage repayment rates remaining high, despite the cuts in the base rate, resulting in mortgage interest repayments rising by over 16 per cent in the past 12 months. Household budgets have become increasingly stretched, and with few savings the consumer is likely to cut spending on non-essential goods over the rest of the year.

The housing market also continues to slow. According to both the Halifax and Nationwide house price indices prices have fallen in each of the past four months. Although this will not directly impact upon those who are not moving house, those that do move may face negative equity. The housing market has also allowed many to re-mortgage and release equity in their houses over the past two years which has helped to fund increases in spending. With falling house prices and less capital to lend, the ability to release equity is becoming increasingly difficult.

Another worrying sign is the revival of the spread between Libor and base rates. Libor indicates the interest rate that banks are willing to lend to one another. When there is a lack of credit or banks are worried about the risk of lending in the financial market, they will withdraw their credit, making it increasingly expensive to borrow money – increasing the Libor rate. The Libor spread had fallen steadily since the start of the year, but with expectations of further losses in the banking sector, it is once again increasing. This suggests that the worst is not yet over in the banking market, and it is far from getting back to a normal lending environment. As a result banks will continue to charge higher interest rates to both businesses and consumers.

So why hasn’t the Bank cut rates as rapidly as the Federal Reserve? There are two reasons for this. On the one hand the economy in the UK is not as bad as the US. The US economy has seen much larger losses in both the housing market and the financial sector. The economy appears to be shrinking and jobs are being lost. The other reason is that the Bank is far more tied to the inflation target of 2 per cent than the Federal Reserve which has a broader remit to maintain economic and inflationary stability.

Nevertheless the Bank will cut interest rates this year and next. Inflationary pressures are likely to limit interest rates in the next eight months. I would expect there to be just two 25bp cuts between now and September. However, as the economy slows and prices fall, and the rapid rise in prices at the end of last year fall out of the annual growth rate equation, the Bank will have the scope to cut interest rates more rapidly. I would expect further interest cuts at the end of the year, with perhaps even a 50bp cut before the start of 2009.

I remain positive that the UK won’t enter a recession in 2008, however, it will be a very tough year for many people and things will get worse before they get better. I would not be surprised to see unemployment start to rise in the next few months and the claimant count could well rise past one million, up from about 850,000 at the moment. With higher unemployment, wage growth is likely to remain low, and bonuses are unlikely to look particularly healthy. Expect plenty of disappointment in 2008, with fewer jobs about, lower wages and more stress its not going to be the nicest place to have a job – but it’ll be far better than having no job at all.

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Tuesday, 15 January 2008

A necessary evil - Inflation in 2008

The December consumer price index data was released today showing that annual inflation remained at 2.1 per cent in the month. Annual inflation has remained at 2.1 per cent for three months now, but is likely to pick up as the year continues, particularly following Monday’s producer price index and continued high price of oil.

Nevertheless, there are signs that inflation should moderate in the second half of the year. The biggest drivers of inflation in the first half of 2008 will be food and fuel. Food prices are very hard to forecast given the variability of the weather, however, there are a few of factors that should help to increase agricultural yields.

The first is that the European Union has decided to suspend its annual subsidy to farmers that leave ten per cent of their farmland fallow.

The second factor is the fact that record highs in the price of wheat will encourage farmers across the globe to plant more and to reduce the percentage share of their crop being used for bio fuel – particularly as the price of oil is likely to fall back as the world economy slows.

Demand is unlikely to be significantly reduced by the slow down in the world economy, as food is a necessity. Therefore the supply side will be the key to reducing food prices.

Oil prices have risen significantly, almost doubling over the past twelve months. The price of oil has been supported by a number of supply issues throughout the summer and rising world consumption. Despite this, it is likely the price of oil has risen above the level suggested by simple supply and demand. The weakness of the dollar and the wider United States financial system has encouraged investors to move to safer products such as commodities such as gold and oil. Nevertheless as the US economy slows in 2008 so will their demand for oil. A significant slowdown will dampen prices. Many forecasters are now suggesting that oil prices will drop by about 25 per cent in the year. As a result by the final quarter of 2008, the year-on-year price of oil could be having a negative impact on inflation.

The rate of inflation is important because it is the key measure in determining the stance of the Bank of England’s Monetary Policy Committee (MPC). With the consumer price index currently above the target of 2.0 per cent the MPC will be keeping a close eye on this measure. Nevertheless, this is unlikely to stop the MPC from cutting interest rates at least twice (and probably more) in 2008. The MPC is willing to live with above target inflation in the short-term to maintain economic output and stave off a recession.

Tomorrow’s labour market statistics will be particularly interesting to see whether the credit crunch and the wider problems in the economy are starting to have an impact on employment. I would suggest that seasonal employment in December is likely to have hidden some of the early signs of weakness. We will see…

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Thursday, 6 December 2007

Interest rate cuts

With the Bank of England cutting interest rates today it seems like some of my predictions for 2008 seem to be coming true - not that they were that hard to see. Hopefully the Bank has acted quick enough to stem some of the worst outcomes for the year.

The housing market will slow but if rates continue to fall then those people who have been holding off buying may start to come back into the market and look for bargains. This could help to keep prices from falling too far.

The banking crisis will continue to be a problem for both the banking sector and the wider economy. However, this positive move by the bank could help to reduce the cost of commercial borrowing and start to reduce the risk premium banks have currently placed upon borrowing. As a result businesses will struggle to find capital to expand but by the middle of the year liquidity problems could start to lessen.

The consumer is set to be squeezed in 2008. The previous interest rate cuts will hit home owners, especially with many coming off their fixed rates in 2008. However, some of the major building societies have already taken the positive steps of reducing their mortgage costs as a result of today's cut.

There continue to be many downsides facing the economy in 2008, however I think we must avoid talking ourselves into a recession. There are upsides and downsides. A period of slower growth will probably be good for the economy in the long run as it will make us reconsider some of the poorer decisions made over the boom years. However a sharp slide into recession will leave scars that will take a long time to heal.

As I always mention, whatever happens, people will be losing their jobs in 2008 and as such competition at interview will become more intense. Take advantage of this site and many others to try and stay ahead of the game.

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Wednesday, 29 August 2007

Sub-prime woes to hurt more than just the City Boys

To those who haven’t been around for the past couple of weeks the stock markets have been going through absolute turmoil. The fall out from the sub-prime lending market in the United States has had ramifications not only in the United States but across the global financial system. How long this crisis will last is yet to be seen and the wider outcome is yet to be known. However don’t be fooled into thinking this is not going to have an impact upon those outside the financial markets, it will.

To those who don’t know the current market turmoil has been created by a problem in the United States sub-prime mortgage market. The sub-prime mortgage market is where banks lend to people with a poor credit rating at a higher interest rate – in the hope of higher returns. However, the market became too loose and too overstretched. As base interest rates rose in the United States and the economy slowed, borrowers saw mortgage payments rise at a point when jobs were being cut and wage growth slowing. As a result defaults on mortgages increased rapidly.

So why didn’t the problem stop with the mortgage lenders? The problem has had wider consequences because those banks that lent in the sub-prime market packaged up some of this debt as a financial product and sold it to willing buyers in the international financial market. This was done as an insurance measure against widespread defaults. However, the selling of sub-prime mortgages went too far and rather than acting as an insurance against the risk, international financial markets have been pulled into the crisis.

The result is that financial markets have seen billions of dollars wiped off them in August. Several hedge funds have been closed and many of the major banks have suffered huge losses. This crisis has also led to a steep drop in confidence. Banks are no-longer willing to take the risk and lend to one another. As a result this has created a credit crunch where investors have not been able to borrow credit and as a result of a falling credit supply the cost of borrowing has risen rapidly. The Fed, the European Central Bank and other major banks have reacted strongly by cutting interest rates and by pumping credit into the markets. This has helped to temporarily stabilise markets but volatility remains high and no-one is yet saying things are in the clear.

Looking forward to the rest of the year and into 2008 it seems likely that the impact of the sub-prime market will run on and on in a number of different forms. Businesses are likely to find it increasingly difficult to find credit, especially the cheap credit they’ve been used to in recent years. This will reduce the ability of businesses to expand and capitalise on opportunities as and when they arise. Consequently business activity will be reduced, which will hit GDP growth.

The reduction in business activity will also hit employees. The first people hit are likely to be the City Boys who are not going to see the same bonus payments they have become used to. It has already been estimated that city bonuses may be reduced by up to 20 per cent in 2007. Jobs in financial services are also likely to suffer, with slowing headcount additions and even with a net loss of jobs.

However, with slowing business activity and reduced consumer demand from those working in financial services, the impact will be felt by every sector of the economy. There are few that will not be affected by the current financial crisis; jobs will be lost in all sectors. Those businesses which are not able to grow will not be able to increase the amount they spend on suppliers.

Those thinking that the sub-prime mortgage crisis is something that only those working in finance need worry about should think twice. Get ready for higher unemployment, slower wage growth and ultimately a difficult couple of years.

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