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Saturday, 6 September 2008

Credit crunch continued but now with an end in sight

The credit crunch is now over a year old but to many it must feel like it is a lot longer. Those working in banking, housing or retail have felt the direct impact of failing financial markets, rising borrowing costs and higher food and energy bills. These problems are not going to sort themselves out soon.

Financial markets still have a long way before they will be back to normal. According to the Nationwide today, they do not expect an end to the current problems until 2010. It seems likely that the banking industry will have to go through a long period of painful adjustment.

Without a return to normal banking conditions we will not see an end to higher and retricted borrowing. Therefore it will remain difficult for consumers and businesses to get debt for a mortgage or to expand their business without it being exceedingly costly. As a result housing prices will continue to fall in the UK and businesses will find it very hard to expand.

As the problems continue more and more businesses will be forced to cut headcounts and unemployment will continue to rise. This will have a further negative impact upon the economy as those without work will be forced to stop spending and those still in work will reduce spending in preparation of potential unemployment.

But there are now a few signs of what should help to bring the current downturn to a halt and start the economic recovery. It seems that some parts of the economy are now beginning to work as expected. With the economy slowing demand for goods such as food and oil are declining, and therefore, following the simple rules of supply and demand, prices have fallen. Oil is now $40 below its peak and food prices across the board are down. Wheat is currently slightly cheaper than it was a year ago.

Falling prices will aid economic recovery in two ways. The most obvious is that consumers will have more money to spend on other things. Given that many of the commodities that have risen so sharply in price over the last year were imported, the rising cost has had a net negative impact on the economy, having a greater negative impact on consumers and businesses than the benefit given to domestic producers of these commodities.

The second and more significant impact of falling prices is the impact it has on inflation. Across the globe rising prices have pushed up inflation. This has limited many central banks, such as the ECB and the Bank of England, in their ability to cut interest rates. The fall in commodity prices will aid the ability of the ECB and the Bank of England to cut interest rates, helping to cut borrowing costs and aid economic growth.

One further upside of potentially lower interest rates is that it will cut the valuw of the pound and the euro. This should help to stimulate exports as they become relatively cheaper. Its not good for those of us about to travel abroad, but it should have a net positive impact upon the British and European economies. Given that some of the earlier oil prices were also stimulated by a weak dollar, a weakening euro may even help to push oil prices down further.

So there is a potential end in sight for the credit crunch and its associated economic problems. This end is over a year away, the US, UK and eurozone economies will probably see recessions but with an end in sight it is easier to prepare for the year ahead and put yourself in the best position to weather the storm and take advantage where possible.

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Wednesday, 12 March 2008

Budget 2008 – how to make a financial crisis seem dull

Today saw the announcement of Alistair Darling’s first budget. Not the most interesting budget because the Chancellor had little room to manoeuvre. On the one hand, the government is becoming increasingly unpopular which is stopping them from making any major steps towards raising taxes. On the other hand, the Treasury has overspent in previous years, which has reduced their ability to increase spending now the economy is entering a period of slower growth – and could really do with a little help from the Government.

One major announcement was that the 2008 GDP growth forecast for the UK was revised down by 0.25% to between 1.75% and 2.25% in today’s budget. This still looks like a very high estimate given that the survey of independent forecasts, as mentioned on page 169 of the Red Book, presents forecasts that range from between -0.1% to 2.1% and average of 1.7% in 2008. Independent forecasts are also in a period of being downwardly corrected by many banks and consultancies. As the year continues the Treasury forecasts are likely to look increasingly unrealistic.

Other measures that will impact upon work and working life:

• Income tax changes confirmed for April. Basic rate drops from 22 per cent to 20 per cent and the 10 per cent band is abolished.

• New charge on non-domiciled residents to be introduced from April and won’t change during this parliament, and next if Labour remain in power.

• Public sector employment has fallen in the past year; private sector employment risen.

• Around £60m to be spent over the next three years to encourage people to move into work and to move up the employment ladder.

• Spend of £10m over the next five years to create a new science fund for teachers in secondary schools.

• Increase in the amount of funding for adult training. Investment of £200m in poorly performing schools to try and improve GCSE grades by 2011.

• Long-term sick to attend “work capability assessments” from April 2010.

• New contract to help parents into work involving a commitment to find employment. Benefits for working families will be boosted.

• Child benefit will be up to £20 per week for the first child in 2009, a year earlier than planned. Child element of child tax credit to be raised by £50 above inflation a year.

• Tax-exempt limits on individual savings accounts increased to £7,200 a year for standard accounts and to £3,600 a year for cash accounts.

• Launch of a “savings gateway” in 2010 to encourage people to invest.

…and worst of all:

• Beer duty to increase by 4p per pint, wine up 14p a bottle, cider up 3p a bottle and spirits up 55p a bottle.

Increasing taxation on alcohol and large cars were the only areas the Chancellor could get away with any major increases in taxation. With all the fuss about “binge” drinking and anti-social behavior the Treasury has decided to take advantage of this situation, increasing the duty on alcohol by 6% above inflation. This has been welcomed by the British Medical Association, but has raised concerns from breweries that sales will fall and more pubs will continue to shut.

It is unlikely that the Chancellor was too worried about the health benefits of high taxes on alcohol, and was more interested in the raising revenue, but perhaps that’s just the cynical views of a man who likes a pint.

All in all this was an uneventful budget that will not be widely remembered. The key things to take from this are: the government are likely to have got their sums wrong; there have been some moves towards reducing child poverty; there has been some simplification of the tax system (a good thing but could go further); and if you smoke, drive a big car and like to drink then the government thinks you are a bad person and wants you to pay for it.

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Wednesday, 16 January 2008

Labour market statistics - hiding the start of slowdown 2008

As I mentioned yesterday the Labour market statistics were released today, and as I expected they have yet to highlight the slowdown in the wider economy. However, with economic statistics, looking at one months worth of data can be very misleading, especially when you fail to put it in the wider context.

Looking at the monthly data nearly all the data was good news for the UK economy. Unemployment was down, employment was up and the number of people claiming benefits was down. This looked like a continuation of a very successful period of labour market expansion.

Nevertheless, these figures hide the variations caused by end of year demand for employment in financial services and Christmas employment in the retail and leisure sectors.

I would expect to see in first quarter of 2008 being a much less impressive year for the labour market. With retailers likely to have suffered a very tough Christmas, employment in these sectors is set to fall. The banks and other financial institutions are also expected to cut employment. Citi has already announced planned cuts of around 20,000 jobs worldwide - many of these are likely to be in London.

What is of a greater concern is that these figures may delay decisive action by the Bank of England. Today's release indicated a pick up in the rate of wage inflation, which in turn will stimulate general levels of inflation. As such, with the prospect of increased inflationary pressures, the Monetary Policy Committee may decide to be more cautious about cutting rates.

Today's data is likely to be one of the last bits of positive labour market news in 2008. Tougher times have already arrived for many people, the data will catch up in February and March to prove this.

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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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