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Northern Rock, the mismanaged bank, collapsed in 2007. Early in 2008 the global banking sector started to creak on its foundations before reaching near implosion in September 2008. Enough time has passed, you would think, for the UK regulatory bodies to have replaced the risk management by “box-ticking” process with something more robust. Wrong.
100 weeks have passed since it was blindingly obvious that a total over-haul of financial regulation was required and the latest government sponsored report, from the Treasury Select Committee, has described the current supervisory framework as a “muddle”. The committee also suggested that the measures to date were “merely re-branding” and that there remains a void of ownership in “strategic decisions and executive action”. They are not referring to the old system. They are describing the current structure.
Britain wasn’t always a 2nd class nation in terms of financial and economic leadership. 80 years ago we were lucky enough to have possibly the most gifted economist that ever lived, John Maynard Keynes, to advise the government on economic and financial matters.
Some weeks ago, the NIESR (National Institute of Economic and Social Research), released a relatively upbeat review of Q2 economic activity. Their thoughts, that Q2 Gross Domestic Product could be flat or marginally positive, were broadly in line with the growing number of cautiously optimistic predictions. March was to be the trough, the bottom, of the British economic cycle and April through June was to see expanding output and the start of the recovery after a year of contraction. The prediction was not a shoot from the hip exercise. Data across the economy had been improving for some months encompassing retail sales, the housing market, risk appetite, merger and acquisition activity, corporate profits and the back bone of every recovery, confidence.
Friday’s first official estimate of UK GDP is therefore a kick in the teeth for optimists. The Office for National Statistics reported a -0.8% decline in Q2 GDP quarter on quarter, against consensus forecasts of a -0.3% contraction. It’s highly unlikely ongoing revisions to the data will retrospectively propel the economy from contraction to growth, the gap is too big. The UK economy has therefore contracted for 5 consecutive quarters and has fallen over the period by -5.7%, resulting in the worst 12-month decline in economic output since 1955.
Predictably, analysts rushed to speculate. The Bank of England would have to re-think its stimulus policy. The £125bn quantitative easing program, recently put on hold, would have to be expanded. Interest rates would have to stay low, for longer.
In currency and bond markets guess-work was not required. Sterling fell against the dollar and government bonds rose as investors exposed to the UK economy de-risked their portfolio. Trading rooms across London were consistent in their analysis of the GDP data with “awful” being the singular opinion.
Slowly but surely the UK economy is moving further from the trough of the recession. Latest data from the retail and housing sectors suggests the recovery remains intact despite a “double-dip” in investor confidence in the US which has recently infected the appetite for risky assets globally.
UK retails sales, a tidy measure of consumer confidence, rose 1.4% in June relative to the same month a year earlier and new enquiries for home purchases rose for the 8th consecutive month, another firm sign of improving household sentiment. Also the RICS house price survey (Royal Institution of Chartered Surveyors) rose to its highest level since September 2007 and more surveyors now predict house prices increases, rather than declines, over the next quarter.
Also reassuring are the latest comments from the Bank of England. The deputy governor, Charles Bean, referring to the BoE’s decision last week to pause quantitative easing (at the £125bn initial budget) suggested more funds would not be needed if sufficient liquidity and circulation could be secured from existing stimulus.
The comments reinforce the view that the Bank of England Monetary Policy Committee are already pencilling in an exit strategy, in fear of inflationary pressures, from the unprecedented monetary easing campaign. Subject to the recovery persisting the BoE will likely look at raising rates late in 2009 or certainly in H1 2010.
The UK produced more than its fair share of economic headlines this week. Interest rates were kept on hold at the historical low of 0.5%, as expected. Not one commentator predicted a rise prior to the announcement and there was a similar paucity of predictions suggesting the Bank of England Monetary Policy Committee would cut rates further. The BoE did take the opportunity though to ambush markets with a surprise statement regarding its quantitative easing program. The £125bn originally agreed is almost fully utilised, with only £15bn of the budget remaining. The BoE have decided to pause the program when the £125bn initial budget is fully utilised.
Markets were broadly expecting an expansion of the policy. UK Gilt prices fell sharply in response, with yields spiking, as investors reduced exposure to the asset class on realisation a major buyer of bonds would imminently retire from the Gilt market, at least temporarily. The BoE advised it was keen to digest the economic and inflationary impact of the easing to date before possibly injecting further cash into the economic system. Following the announcement a number of analysts speculated the BoE had seen enough improvement in economic data to persuade them further action might provoke inflation and that the BoE, despite their cautious sound-bites, were confident the economy is already returning to growth.
Preliminary Q2 GDP data is due shortly, followed by a Q2 inflation report in August. Following those announcements, the BoE is likely to hold sufficient data to cement a decision, one way or the other, regarding the need for further stimulus.
Statements from the British Chamber of Commerce (BCC) are so predictably pessimistic. This week’s reasons to slash our economic wrists include “talk of a recovery is premature” and “serious downward pressures” persist. The words may change but the objective is forever set in stone, as is the target audience.
So why does the BCC always articulate views more suited to the anti-christ of economic confidence, even now, when the trough of the UK recession is clearly in the rear-view mirror? (Improving reports from the housing, retail, services and manufacturing sectors prove as much whilst excess liquidity, made available by the Bank of England, combined with generous fiscal support from the government have also helped cement the path to recovery).
It’s about interest rates and maintaining constant pressure on the BoE Monetary Policy Committee. The BCC want rates to be as low as possible for as long as possible, and that, they clearly think, is not a message that they can go off-mission from. Plus, a monetary policy change from easing to tightening mode is not a black and white decision-making process. The BCC deliberately invest in extra cautious sound-bites at least six months ahead of any BoE consideration of tighter monetary policy, which most commentators consider may arrive as early as Q1, 2010.
In fact, you could look back at BCC statements over the years, through asset bubbles, equity bull and bear markets, expansions and recessions and you would struggle to find any suggestion, ever, that interest rates should increase. Even at the peak of the cycle, the BCC focus on keeping UK PLC “competitive” and keeping the pound weak, to help exports. Both objectives are easier to secure with low interest rates.
The trouble with always crying wolf, particularly in the face of obviously improving data, is that you lose credibility. Sometimes, just occasionally, the BCC should think ouside the corporate cost of borrowing box, and god forbid, invest in confidence. A bullish statement highlighting the wide-spread improvement in economic data, one accompanied with measured hope would still leave the BCC with plenty of time later in 2009 to pile renewed pressure on the BoE to keep rates low.
I just wish for once they would change their broken record.
Since the near collapse of the UK banking sector an increasingly bitter political game is emerging. On one side is Labour, a tired and unpopular ruling party that has governed (in the loosest sense of the term) through the worst global recession since the Great Depression. Labour in reactive splendour is trying to fix the painfully flawed banking sector regulatory framework. It has decided the Financial Services Authority should be the tool fit for purpose.
Opposing Labour, is the Conservative party, out of power since 1997. The Tories smell blood, Labour’s blood, and are maneuvering ever closer to 10 Downing Street. Only an enormous and near-unprecedented change of public mood will prevent them from regaining power. The Conservatives have nominated the Bank of England as their representatives to secure deeper banking sector regulatory control.
With an election due in 2010, there is a race on. Can Labour force through the requisite legislation to strengthen the hand of the FSA before the election? Or can the opposing box-tickers at Conservative headquarters devise a sufficiently cunning plan to stall Labour’s efforts so they can appoint the BoE after their inevitable election victory.
Missing from this political game of regulatory chess is a cross-party consensus that puts aside political differences, and focuses on a single solution, that is best for the banking sector, the country and the economy.
Prior to the release of the BoE financial stability report (summarised below), Mervyn King the Bank of England Governor, suggested he had not yet received a copy of an unrelated and imminent government sponsored White Paper discussing changes to the current banking sector supervisory framework. An extraordinary statement considering the BoE is responsible for stability with the banking industry. An unnamed government bureaucrat privy to the White Paper publication defended the government’s corner and responded stating the Chancellor, Alistair Darling, had discussed the proposals with King less than a week ago. Children, please.
The Bank of England has published its bi-annual report on the stability of the UK financial sector. The predominately backward looking review enthusiastically summarises what the average investor already knows – about the recent fragility of the UK banking sector – but performs the function admirably with a wealth of pleasing to the eye graphs and charts.
One fact of genuine interest was the similarity between global equity price declines in this recession relative to the depression that followed the 1929 stock market crash. Mirroring the exact decline seen almost 80 years ago, global equities are now 40% lower exactly 20 months after the previous bull market peak. Interestingly the recent market rally enabled today’s market to catch-up relative to the 1929 crash. Without those precious gains enjoyed in March to May, the recent bear market would have been significantly more destructive in terms of equity wealth, in those 20 months, than the same period during at the start of the depression. We have lived through historic times indeed.
World Equity Prices During Crises 26th June 2009
The review also confirmed the reduction in market value of UK banking sector assets. In just 2 years £400bn has been lost. The survey included Banco Santander (Abbey), Barclays, HSBC, Lloyds Banking Group, Nationwide, Northern Rock and RBS.
Loss of UK Bank Assets by Market Value 26th June 2009
The other most eye-catching data reflected the crash in corporate lending growth. 12 months ago the year-on-year growth rate peaked at an insane and now evidently unsustainable 23%. Since then the growth rate has slumped to near-zero with a total disintegration in cross-border lending.
UK Corporate Lending Growth 26th June 2009
The report progressed and stressed the ongoing need for banks to strengthen their balance sheets and the introduction of tighter capital adequacy and risk controls. I don’t think the expression “better late than never” is appropriate in this instance. Late is as unforgivable as never when you are at least partly responsible for the financial stability of the country.
Gordon Brown continues to compete for title of the unluckiest prime minister in modern British history. Political views aside, he waited fairly patiently in the shadow of Blair for much the past twelve prosperous, albeit debt fuelled years, biding his time hoping that one day fate would be kind and hand him the key to 10 Downing Street. Even if Brown is at least partly responsible for the mess the UK economy is in, it’s hard not to feel sympathy for the man. Not everything wrong within UK Plc is his fault, surely?
So after getting beaten up by journalists for 14 days in relation to inappropriate expense claims by members of parliament he must have thought it really couldn’t get any worse? Wrong. It can always get worse. His only remaining trump card, the suggestion he was the inspirational leader and international co-ordinator in the fight-back against the global recession fell flat on its face this week when Standard & Poors placed the British economy on “outlook negative” citing rising government debt as the primary cause. Expensive bank bail-outs, rising unemployment, weakening tax receipts and a long-term budget deficit, S&P claimed, gave them no choice but to place the UK economy under closer scrutiny with the possibility of a humiliating downgrade now looming for some years hence. S&P also threw oil on the political fire suggesting it would look closely at the policies of the leading political parties in the run up to the next general election to clarify if plans were in place to fix public finances. Such is the power of S&P, the leading rating agency, their statement immediately prompted sharp volatility in currency and debt markets with Sterling falling sharply across the board before recovering, primarily against the Dollar, for reasons discussed in the previous ‘Global’ section.
It may also be appropriate to analyse the timing of the S&P announcement. The Northern Rock debacle was over a year ago. The near collapse of the global banking sector was 6 months ago. It was known UK government borrowing would break post-war records late in 2008. Even the farcical 2009 budget was weeks ago. Every man and women who lives outside of a remote Alaskan log cabin knows in great detail the economic and monetary problems the UK and the rest of the world is facing. In fact the S&P announcement is so late it’s almost sarcastic. And in this instance late is not better than never. But S&P likes to dwell thoughtfully on the obvious. A quick review of their banking sector analysis confirms as such, with downgrades to US banks coming thick and fast…. after the Lehman Brothers collapse.
Looking forward, if the UK is formally downgraded, the cost of government borrowing will increase as it will have to offer a higher rate of return to purchasers of its debt. Also, many investment managers that specialise in the purchase of government debt may have to sell their holdings of UK gilts, further pushing lower the price (and therefore the yield higher) if their fund investment objectives state they can only invest in top tier “AAA” rated debt.
There was further bad news. The UK economy contracted at its fastest pace since 1979, during Q1 2009, whilst consumers cut personal spending at the sharpest rate since 1980. The data was in line with expectations with the GDP data unchanged from the previous estimate. Market sentiment still suggests Q1 represents the trough of the UK economic cycle despite continued pessimism amongst consumers, due to the rising jobless number, weak house prices and the inability of many to secure credit. Admittedly, it’s only members of parliament that seem to need 3 house moves each year, moats and bi-annual home refurbishments but normal people, allegedly, still have important household expenditure too, like feeding the family and paying mortgages so not to be made homeless by unsympathetic banks, many of which would themselves be ‘bankrupt’, were it not for tax-payer bail-outs.
Of course the current interest rate of 0.5%, a record low, is helping homeowners lucky enough to be on a variable mortgage deal. However, concerns remain that prices will rebound before employment recovers. Such a scenario will place the Bank of England Monetary Policy Committee in the unenviable position of having to focus on its narrow, fighting inflation, remit instead of supporting the economic recovery with another 18 months of unchanged rates, which is probably required to fix the structural problems on corporate and consumer balance sheets. Then, perhaps, we can all pay for our moats to be cleaned, without having to claim the expense back from our employers.
Ted Hurlbut 3:57 am on July 19, 2009 Permalink |
It’s refreshing to read a blog calling for the end of all the doom and gloom. Things are tough, but the world’s not ending, merely changing. A little more talk about the things that both consumers and businesses need to be doing to thrive in this changed world would not change the facts but would perhaps change the context in which they’re received.