WISE MONEY

Sterling weakened against both the euro and the dollar yesterday ahead of Chancellor George Osborne announcing details of the coalition government’s spending cuts to tackle Britain’s record budget deficit.The Pound fell against 13 of its 16 most-traded peers as some investors speculated the Chancellor’s cuts will not reduce the deficit at the required pace.

With Bank of England policy makers split on whether to raise, maintain or withdraw stimulus, former MPC member Blanchflower expressed concerns of a renewed recession during an interview yesterday.

He stated that the UK is “desperately in danger of a double dip and the last thing you need to do in a recession is make things worse”.

He went on to suggest that stimulus expansion appears to be George Osborne’s only backup plan to avert the risks associated with the biggest budget cuts in UK history, but “quantitative easing just doesn’t act fast enough” to avert the risks of a contracting economy.

Watch for more GB Pound pressure ahead of the Spending Review tomorrow.

Despite posting disappointing industrial production numbers, the US Dollar continued to gain since Friday’s close, adding further weight to the argument that the market has priced in too much QE2 and the long dollar selling spree has created a market short of USD.

Overnight comments from Treasury Secretary Geithner helped the Greenback recover further ground.

Geithner said “No country can devalue its way to prosperity and that the US will not engage in such practice”.

He added that “He does not see a time in our lifetime when the dollar will cease to be the world’s key reserve currency”. There seems to be more room for the dollar to pull back particularly against the euro as expectations for monetary tightening by the European Central Bank appear excessive.

The interest rate market is pricing in a rate hike by the ECB in Q3 2011 suggesting that investors haven’t fully digested the slowdown in Europe.

The Irish Central Bank has said it will need to increase the amount of support to the country’s banking sector.It said supporting Anglo Irish Bank would cost from 29.3bn euros to a “stress scenario” bail-out of up to 34bn euros -£29.2bn. Only last month the cost of the bail-out of Anglo Irish was estimated at between 22-25bn euros.

The cost would push the Irish Republic’s fiscal deficit from 12% to a massive 32% of gross domestic product (GDP).

By comparison- including the cost of its bank support, the UK’s deficit is around 10% of GDP for this year.

The Irish Republic says its latest announcement represents the final costs of repairing the country’s banking system. It hopes this will reassure worried investors.

The Irish Finance Minister, Brian Lenihan, has announced what he hopes will be a comprehensive and final rescue scheme for Ireland’s banks, whose reckless lending has mortgaged the entire Irish economy. ”

The central bank also said it would also increase support to Allied Irish Bank, which would need 3bn euros before the end of the year.

The Irish Republic is viewed as one of the weakest economies in the eurozone, despite it taking tough action to regain control of its economy.

The extra support for the banking system has led Mr Lenihan to say he will cut another 3bn euros from spending in the budget later this year, a move designed to help shrink the deficit to 3% of GDP by 2014 to keep within eurozone rules.

This week, mounting concern over the Irish economy sent its cost of borrowing on the open markets to a record level.

The latest GDP figures showed the Irish economy contracted by 1.2% for the second quarter. Greece’s GDP dropped by 1.5% in the same period.

Mr Lenihan said the country would cancel its bond auctions in October and November and would not return to the bond markets until early in 2011.

The Irish government has previously rejected speculation that it could have difficulty raising funds and might have to seek help from a huge EU rescue fund set up after the Greek debt crisis earlier this year.

The interest rate on Irish government debt due on 10 year bonds reached a record 6.791% on Wednesday.

Global banking stocks are on the rise again today as regulators announced details of the Basel III accord.Proposals include raising the minimum core Tier 1 capital level from 2 to 4.5 per cent with a subsequent 2.5 per cent require as a buffer against future shocks, which is to act in a counter cyclical manner in the sense that Banks will set aside the money when the going is good.

Large British banks already meet the capital benchmarks comfortably, RBS, Lloyds Barclays and HSBC all have core Tier one ratios of around 9-10%, but the announcement will spark a fresh round of capital raising in the worldwide banking sector.

Deutsche Bank has announced it will tap shareholders for cash to pay for it’s acquisition of retail bank Deutsche Postbank and to bolster its own capital position, expect this to be the first of many over the next few months.

The announcement has signalled risk-on (at least for today) and Sterling is gaining against the safe haven currencies of the Dollar and Yen.

The gain in the Pound today look likely to be short lived, with the Chancellors controversial budget cuts sparking union discontent and threats of co-ordinated strike action across the country.

George Osborne detailed further reductions in the welfare budget, amounting to £4 Billion, but he gave no details on where the axe may fall (this is on top of the £11 Billion of cuts announced in the emergency budget in June).

The strikes would see disruption to the economy on a scale not seen for many decades and will be heavily Sterling negative – this will be on top of the effect on the Pound of a reduction in growth levels when spending cuts begin to take effect.

Central bank governors and senior regulators yesterday agreed new rules designed to prevent a repeat of the recent global financial crisis.
At a meeting in the Swiss city of Basle, they agreed a deal requiring banks to hold more capital in reserve.

European Central Bank chief Jean-Claude Trichet said the new regulations – called Basel III – were “a fundamental strengthening of global capital standards”.

“The transition arrangements will enable banks to meet the new standards while supporting the economic recovery,” he added.

In a joint statement, the US Federal Reserve and other major US banking regulators said the deal “provides for a more stable banking system that is less prone to excessive risk-taking”.

Low levels of capital relative to assets were a major factor in the recent global financial crisis.

The agreement, due to come into effect from 2013 and be phased in over several years, still needs to be ratified by the heads of government of the G20 group of nations at their summit in November.

The amount of common equity – the tier one capital for absorbing losses – that banks have to hold will rise from 2% of their loans and investments to 7%.

The 7% includes a 2.5% “conservation buffer” to protect banks against periods of difficulty or stress.

If banks’ capital ratios fall below 7%, regulators may place restrictions on their ability to pay dividends and bonuses.

The biggest banks – whose failure could bring down the entire financial system – will have to hold even more capital.

But regulators say that if these new restrictions are phased in over several years they will not undermine economic recovery.

The new requirement should prove little problem for UK banks, as it is in fact lower than the 8-9% ratio currently held by them. It is also well below the 10% level that was being pushed for by the UK, the US and Switzerland.

The updated rules will mean some banks will need to raise a lot more money from shareholders.

The rules may have the effect of limiting lending, at least in the short term, as most banks – particularly those in Europe – have too little capital for the loans they have already made.

We can all agree that the economic data releases at the moment are confusing and clouded in fog. In the UK, the Nationwide survey last week showed UK house prices declining month on month by 0.9%, today the Halifax Survey reports house price increases of 0.2% from July.

Positive consumer confidence figures were followed by disappointing PMI index figures, with the net result that traders have been left bewildered and slightly uncertain and the markets necessarily choppy.

This morning’s releases are no different, industrial production came in lower than forecast and manufacturing production exactly as predicted, but we saw an almost one cent move upwards in Sterling in the run up to the figures, and are in the midst of a retracement back to where we started.

Conflicting data has also been a theme in the US, with the raft of negative data suddenly reversed with positive ISM & employment figures at the end of last week.

What was becoming a clear picture of a slowing US economy and potential re-entry into recession was suddenly muddled slightly with the apparently positive figures. However, investors remain fearful of the stalling US recovery (and impending QE2) with traditional safe haven currencies like the Swiss Franc and Japanese Yen continuing to perform strongly.

The Yen hit the highest level against the Dollar since 1995 yesterday, as the supposedly psychological key level of 84 was brushed aside easily. This afternoon sees Narayana Kocherlakota of the Federal Reserve speak, along with the release of their beige book & consumer credit statistics.

Euro worries have remerged with the  market’s realising the total uselessness of the eurp bank stress tests, and a unexpected drop in the growth of German Exports.

Back in July, 91 of Europe’s largest banks were required to disclose how much government liability from European countries they held on their balance sheets. Euro regulators said the data showed banks’ total holdings of that debt as of March 31st. At the time, worries about the Banks’ government-debt holdings were fanning fears about the health of Europe’s banking system as a whole.

Release of the bank data was considered the main benefit of the stress tests, which were widely criticized as being lenient overall, but taken as showing that the exposures were not as widespread and extreme as had been feared.

According to an article in today’s Wall Street Journal, “An examination of the banks’ disclosures indicates that some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed.

Some banks excluded certain bonds, and many reduced the sums to account for “short” positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July”.

Asian markets, starved of news or data input following the US/Canadian Bank Holiday, seized upon this article and dumped the Euro – especially versus the Yen – on fears that eurozone governments and institutions would accordingly find it difficult to raise new and renew maturing funding with doubts returning over the health of the region’s finance.

The Yen was the favoured recipient on the lack of mention of the strength of the currency in the statement from the Bank of Japan which followed their decision to leave Japanese rates and QE levels on hold.

The Central Bank now seems more confident of strong domestic growth, and the expectation is that lower unemployment and increasing inflationary pressures will prompt the Bank to resume a hike in official rates later this year.

Also this morning, Australia’s Labour Prime Minister, Julia Gillard, finally secured the support of two key Independent MPs which enable her to form a working Government with a majority of 2 over the opposition party.

George Osborne has said that banks must increase lending to businesses rather than boosting bonuses and dividends now that they have weathered the worst of the credit crisis. Britain’s Treasury chief said that banks “have an economic obligation to assist” small and medium-sized businesses.

The statement comes in line with half-year figures released this week that are expected to confirm that the major institutions have returned to profit after two years of turmoil.

Lloyds Banking Group, which is 41% owned by the taxpayer, and the 84% state-owned Royal Bank of Scotland are both expected to post a profit. But Osborne questions the ability of British businesses to raise credit from the banks.

“The danger is that, particularly next year, when there is a huge amount of refinancing required, that the small and medium-sized businesses suffer from a lack of access to working capital,” he said.

Osborne continued that British banks “are in no doubt that the government wants to see reasonable access to credit on reasonable terms in the small to medium-sized business sector.”

The expected bank profits have boosted the recent Cable rally and we are now trading in the 1.58s and well on track to the key 1.60 psychological level.

One in fifth of the 7.66 trillion yuan (1.1 trillion dollars) that Chinese banks lent to local governments is “at serious risk of default”, is the latest potential default risk problem to halt the global recovery. Chinese banks lent vast sums of capital to local Chinese governments for construction projects after Beijing called for nationwide efforts to stimulate the economy.

However, only one quarter of projects financed by the loans have the ability to meet repayments, according to the Century Weekly.

The banking regulators, along with the banks that have the biggest exposure, will carry out detailed discussions with local governments starting in September about how to recoup the loans, the report said.

China has powered out of the global crisis on the back of a stimulus package worth four trillion yuan and the state-backed bank lending, which saw new loans nearly double from the previous year to 9.6 trillion yuan in 2009.

This latest potential default raised concerns in Beijing over a possible new crop of bad loans that could threaten the world’s third-largest economy.

The results of the Eurozone bank stress tests were eventually released on Friday evening showing only 7 of the 91 banks tested were deemed to have failed, and the capital shortfall was estimated at €3.5 bn. Both are very much at the lower end of consensus forecasts, raising questions over the credibility of the tests. Interestingly, a sovereign default or restructuring scenario was not included, as media leaks earlier in the week had suggested.

At the press conference, ECB Governing Council Member Constancio justified this decision by noting that “instruments have been put in place precisely to avoid that scenario”. Nevertheless, as the leaks had suggested, many participating banks voluntarily disclosed their sovereign debt holdings, and this has brought some improved transparency on sovereign debt exposure.

This seems to have averted any euro selling pressures as the single currency continues to trades close to Friday’s 1.29 range against the dollar.

From a data perspective, the euro had already managed to move higher on Friday morning after stronger than expected German business sentiment data. The German IFO business confidence index recorded its strongest rise for 20 years in July.

The closely watched index rose to 106.2 points from 101.8 in June. Germany’s economy shrank by almost 5% last year, but has been recovering due to strong exports. The result was much better than expected, with most economists having expected a slight fall.

Sterling has just received a welcome boost after the release of positive retail sales figures.Data showed a 0.7% increase month-on-month & 1.3% yoy, the highest monthly figure since April 2008.

The ONS suggested the World Cup boosted consumption of electrical goods, which after England’s performance should see a double whammy when people look to replace the TV’s thrown out of the window after the Germany game.

Bank of England minutes released showed a 7-1 vote in favour on keeping interest rates on hold, with Andrew Sentence, the only dissenter, voting for a rate rise. More interestingly, the minutes showed discussion of an extension to the asset purchase scheme if, as expected, the economic outlook continued to deteriorate.

Sterling continues its recent volatility in light of the comments & also rumour circulating yesterday that the bank has reopened dollar swap lines and low liquidity in the market exaggerates moves.

The Euro continues to tread water ahead of the Stress test results. There is increasing uncertainty around the release of the results, the planned announcement is today at 4.30pm.

Strange that an exercise in reducing uncertainty and restoring credibility is actually having the opposite effect, and that is feeding though to the Euro which now trades lower against both Sterling and the Dollar.

The perceived safe haven of the Swiss Franc has also hit the headlines as the SNB announced a huge FX loss following large bouts of currency intervention earlier in the year. The continuing strength of the Swissy will be a real headache for the central bank as it fights to remain out of a potential deflationary spiral brewing in the Eurozone.