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.

Jobs and the economy in 2008 - an update

It may seem like the slowdown in the world economy is not having an impact upon the jobs market in the UK. This is probably true for now, but this doesn't mean it won't.

The first people who are likely to lose their jobs in the current slowdown are those working for the big banks. Another big bank, UBS, announced 5,500 worldwide job cuts this morning. These jobs cuts will be made over the next year through a process of redundancies, fewer job created and natural wastage. All in all it is estimated that banking jobs and those jobs supporting the banking sector will fall by between 20,000 and 40,000 in central London alone.

Wider job losses are likely to follow soon after. The next groups to suffer will be those working in the housing market. With fewer housing transactions there will be less work for estate agents and house builders.

Next as the housing market slows and as the price of day to day living increases, people are likely to be spending less at the shops. Retailers have already started to see sales falling in March and probably in April. Some retailers will go bust and jobs will be lost.

Jobs will gradually be lost from the wider economy. As activity slows there will be less business to do and less need for additional staff. Tighter margins will mean that cost saving measures will be necessary for many businesses, including cutting headcounts.

One upside is that manufacturing may fair slightly better than it has done in the recent past. The weak pound should help to make British manufacturing more competitive, helping to support manufactured exports. However, with the world economy slowing and Britains export partners suffering this is not guarenteed.

Although the labour market has remained resilient in the first few months of 2008, expect to see unemployment start to rise in the next few months. We are not going to see unemployment levels at a level comparative to the early 90s, but it is going to be quite unpleasant for many.

Worst day for FTSE since 9/11

Today was the worst day for the FTSE 100 since the attacks on the Twin Towers. Fears that recession in the US is now more a probability rather than a possibility has fueled fears that this will have an impact on company profits in the United Kingdom, particularly the large, internationally focused firms.

The worst hit companies were commodity based firms. The slowdown in the US and the likelihood that China will put the breaks on is set to reduce the demand for commodities such as copper. As a result the price of copper and other commodities are likely to fall in 2008 and as such so will the profits of the major mining companies. Other factors such as stalled aquisition plans also had a negative impact upon firms in this sector.

With the US markets closed today the full impact of today's fall will start to become clearer tomorrow. The market has been particularly volatile during the past six months and as such it would not be a great surprise if investors believe the markets went too far today and start to buy some shares which now look cheap.

However this level of nervousness and instability is not a good sign for the markets and the wider economy. Markets now seem to be coming to a conclusion that the United States is entering - or may have already entered - a recession. This will have a negative knock on effect upon the whole of the international economy. Although it may take some time to directly impact the UK, it will put downwards pressure on exports from the UK - not just to the US but internationally as the whole world slows. Weaker financial markets will also hinder activity in the financial services sector in London which provides many jobs and is a principle driver of the whole economy.

Coupled with the credit crunch the financial system is not looking in good health. This coupled with the slowdown in the US, over stretched consumers, a weakening housing market, high government debt and continued inflationary pressures will not make 2008 a very tough year. A recession in the UK is still not a likely outcome, however it won't take to much for it to become more so.

Get ready for rising unemployment and a tougher labour market - if you're looking for a job expect less opportunities and greater competition. If you are moving jobs choose the sector and company carefully because not all companies will survive 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…

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.