WISE MONEY

The pound strengthened to 1.22 against the Euro yesterday for the first time since November 2008.

Sterling continues to benefit from the UK budget announced earlier this week and the news that one MPC member voted for a rate hike this month. A strong response from the credit agencies took away fears that the UK’s AAA rating could be downgraded.

Concerns over the European debt crisis were on the rise again yesterday with Greek credit default swaps hitting a record high.

ECB president Trichet said he is “pleased” with Germany’s decision to concentrate on fiscal discipline, he also commented that the idea that austerity measures could trigger economic stagnation is “incorrect” and he does not think the risks around deflation will materialise.

Another cause for concern in the Eurozone is the requirement for European banks to repay the $540bn of ‘special’ 1-year loans that they borrowed from the ECB.

The added problem here is that a number of the banks used the loans to buy up bonds in Greece, Spain and Portugal – fixing in a healthy interest margin in the process. Now they have to repay their ECB loans, the banks may decide to offload some of these bonds, which could reignite tensions in European financial markets.

Chancellor George Osborne’s produced the toughest Budget in a generation yesterday with Britain facing drastic cuts of 25% to government departments.
The exception will be those departments with “protected budgets,” such as the National Health Service and foreign aid.

Other key take outs include an increase in the VAT from 17.5% to 20% from January next year and a new £2 billion levy on the banks.

The budget reveals a more rapid fiscal response than that planned by the previous Labour government. The Chancellor said, “This emergency budget deals decisively with our country’s record debt.”

The budget also found support from Fitch, the rating agency, who stated the budget “…sets out an ambitious deficit reduction path that, if delivered upon, will materially strengthen confidence in UK public finances and its ‘AAA’ status.” The Office for Budget Responsibility cut it’s economic growth forecast to 1.2% this year and GDP growth next year has been cut to 2.3%.

The news provided further support for Sterling yesterday as it rallied against the Euro and the Dollar. Pre-budget we were trading GBP/EUR 1.1960 and GBP/USD 1.4730, the markets view this as a credible plan and we currently sit at 1.2139 and 1.4924 respectively.

Over in the US and existing house sales numbers were below par despite the continuing tax incentives for the housing market. Although we saw little reaction in the currency markets, (EUR/USD currently sits at 1.2279 from a high of 1.2320 yesterday) equities did sell off at the close leaving a weaker outlook for stocks across Europe and Asia.

The Spanish government’s cost of borrowing has hit a new record hign amid renewed concerns over the state of its economy and public finances.
The interest rate Spain is being asked to pay by investors is now 2.23 percentage points higher than that being demanded of Germany.

This widening gap in the bond market marks a drop in confidence in Spain’s ability to repay its debts.

The Spanish cabinet has also approved unpopular changes to labour rules. The changes, which include a cut in the level of severence pay, have prompted a call for a general strike in September.

Spain, which is emerging from a two-year long recession is now pursuing austerity measures. These include a 5% cut to public sector pay in an effort to bring down its borrowing and help restore its credibility among international lenders.
IMF speculation

Its budget deficit is currently running at over 11% of GDP – way above the 3% limit imposed by the EU.

This week the Spanish government has also been forced to deny newspaper reports that it is in talks with the IMF over a Greek-style bail-out package to help it manage its debts.

The Spanish Prime Minister Jose Luis Rodriguez Zapatero is scheduled to meet IMF chief Dominique Strauss-Kahn on Friday, but Spanish officials say the talks are unconnected to the press speculation.

Investors remain concerned about the underlying strength of Spain’s economy.

There are also worries that spending will hamper its recovery from recession, with its unemployment rate of 20% – the highest in the eurozone – a significant concern.

The government has approved long-awaited labour market reforms, which it says will encourage firms to hire more people, easing the jobs crisis.

But the plans have met with demonstrations from unions, who fear the changes will hurt workers’ rights.

Sterling held steady yesterday as the reintroduction of a star chamber to quiz ministers on spending decisions marked the start of the Government’s formidable challenge of reducing its £156 billion budget deficit.The last time a star chamber was in use was under Margaret Thatcher, but even she did not face cuts of the scale that now face George Osborne.

To maintain a triple A rating, Britain must cut £92 Billion (or roughly the annual NHS budget) over the next five years according to the credit rating agency Fitch, and Mr Osborne made it clear to MP’s yesterday that the role of the State is about to change significantly.

Social security payments, tax credits and public sector pensions are likely to bear the brunt of any cuts, which may end up being as high as 20 per cent. Mr Osborne cited the example of Canada, which faced similar difficulties to the UK in the 1990’s, but successfully turned a large budget deficit into surplus by strongly challenging ministerial spending decisions.

What he failed to point out was the Canadian restructuring was achieved in a period of strong world growth with foreign demand able to replace government spending. We are certainly not in this situation now, and we are far from a consensus over whether current fiscal tightening will put Britain back on the long term path to growth or tip the economy back into recession.

This uncertainty is reflected in the markets; Sterling is treading water in the run up to the Bank of England meeting tomorrow and the Emergency budget on the 22 of June.

The Euro broke the physiologically important 1.20 level against the Dollar on Monday and continues to trade weakly against all the major currencies.

This morning there are reports that Spanish banks are having difficulty accessing funding in the European interbank markets, an ominous sign if true.

The contagion from Eurozone members to periphery nations continues to spread with Hungarian Ministers stating their economy was left in a perilous state by the previous government, sparking significant price action in the Florint-Swiss pair.

The latest European administration to worry the markets is the new Fidesz Hungarian government, who suggested their predecessors had mis-led the population and markets about the financial state of the country.In order to try and prepare the population for the strict austerity measures that they will need to introduce, a newly appointed senior member of the government stated that Hungary has only “a slim chance” to avoid a “Greek situation”.

So with markets still concerned how the untried Fidesz Party are intending to marry up their populist policies with the austerity demanded by the IMF in return for its ongoing aid programme, the government’s first action was an apparent threat of default.

Given the Eurozone countries’ exposure to Hungary, it is no wonder that the Euro dropped in value. Concerted fire-fighting has limited further erosion this morning but EUR/USD has hit a new low of 1.1873 over night.

Over to the US and it was a disappointing Jobs report on Friday afternoon after figures suggested that 431,000 jobs were added to the economy in the month of May after it was widely considered to be in excess of 500k.

In addition to the top line weak data, the fact that temporary census workers accounted for 411,000 of the jobs could suggest that Uncle Sam’s recovery could be slowing.

Finally, David Cameron has spoken this morning and given a stark warning about the action needed to tackle Britain’s budget deficit and public debt. His key take outs were:

• Overall scale of deficit problem is even worse than we thought

• Potential consequences of deficit more critical than we feared

• Last government’s estimates show debt interest payments at 70 bln in 5 years

• Economic growth will not fix borrowing as much of deficit is structural

Sterling regained some ground this morning after Nationwide house price data showed a better than expected monthly rise of 0.5% and yearly 9.8% gain.Yesterday’s announcement that Prudential had formally abandoned its takeover of AIA led to a strong rally in Sterling as banks behind the deal rushed to convert the Dollars that had been purchased to completed the deal back into Sterling.

This pushed Cable to a 3 week high although it has now softened a little. Today’s Services PMI number, which measures the activity levels of purchasing manager in the services sector came in at 55.4, slightly less than expected but still a bullish figure.

The Dollar opened slightly firmer today on rumours that the Iran Central Bank has begun the process to reduce euro reserves from 55% to 20-25% and convert them to Dollars and gold. The first stage of sales has started which involves selling of 15b euros and is expected to be completed by September 22.

The dollar also found some support from upbeat U.S data, including numbers released yesterday showed pending sales of previously owned homes topping expectations.

Standard and Poors, Moodys and Fitch are all being scrutinised by European leaders who are blaming the credit rating agencies for aggravating Greece’s problems through sovereign downgrades.

Plans unveiled in Brussels yesterday showed that there may be a new European supervisory body with the power to hand out fines to countries that fall short of expectations. However questions are already being asked about how credible this new body can be when it is reviewing sovereign debt of nations whilst at the same time being financed by the same sovereign nations.

The euro has continued sliding against the US Dollar, reaching it’s lowest level in four years.

Concerns remain about the massive bailout package announced by the EU and IMF last week and how effective (or not) it might be in addressing the core issue affecting troubled EU member states, namely huge fiscal deficits.

The ECB have been intervening directly in secondary bond markets, bringing some well needed stability and halting the huge volatility in yields over past couple of months.

The side effect of the ECBs intervention has been to move all traders with negative view of the Eurozone from the bond market to currencies, and with EU officials publicly announcing the need for a weaker currency, it looks like a one way bet at the moment.

Most of the financial press over the weekend were calling for parity in EuroDollar, but if the market is oversold we may see a short squeeze over the next few days before the Euro moves lower again.

The new UK Government is indicating that is making deficit reduction a priority, Chancellor George Osborne has just announced £6bln of savings the details of which will be announced next Monday.

The emergency budget promised by the Tories in their manifesto will be on the 22nd of June and the Office of Budget Responsibility (newly created by the Conservatives) will publish economic forecasts before the EM because Osborne think the market has completely lost confidence in the current Treasury forecasts (3.5% growth next year does seems on the high side).

Sterling has rallied on the back of this but market sentiment seems still to be for further falls in Sterling against the Dollar- which has reached 1.45- from 1.50 only a week ago.

The Eurozone took yet another pounding yesterday as rigorous fiscal tightening threatens to dampen an already weak recovery.

The euro has crashed to 14 month lows of $1.25 after boosting to nearly $1.31 on Monday after the $1 trillion emergency rescue package was announced.

News that one of the “PIGS”, Portugal is attempting to cut €2 bn from its budget gap has done little to reduce the weakness in the Euro and with more tax hikes and salary cuts due, we could see ugly scenes like those witnessed from Greece.

ECB President Jean-Claude Trichet has stated the ECB is not “embarking on quantitative easing” and he reiterated that “the Governing Council will not tolerate inflation” leading to speculation a rise in interest rates could be on the horizon.

Sterling has also taken a hit this morning with news that the new coalition has already come to loggerheads. With two political parties with separate agendas leading the country, a schedule for cutting the deficit will take longer to agree, and with the credit agencies hovering, a negative outlook over the UK will remain.

A cut in the UK’s prized AAA credit rating would have disastrous consequences to the recovery. Data released yesterday showing the UK’s trade deficit widened more than expected damaged hopes for an export led resurgence.

The US Dollar has been the main winner from the negative news from Europe as investors run for their “safe haven”. The greenback has also been supported by encouraging figures from the US and expectations that the FED will be the first among the major central banks to raise interest rates.

The Conservatives and Liberal Democrats have formed the first coalition Government since the Second World War.

After negotations last night that went to midnight, here’s an initial take on what’s been agreed:

ECONOMY
- A significantly accelerated reduction in the structural budget deficit over the course of a parliament, the main burden to be borne by reduced spending rather than increased taxes
- Six billion pounds in cuts to non-frontline services this financial year subject to advice from the Treasury and Bank of England
- Partially reverse Labour’s planned increase in payroll tax
- Create independent Office for Budget Responsibility

Nick Clegg becomes deputy prime minister. Some junior ministerial posts will also go to Lib Dems.

TAX
- The Conservatives agreed to scrap their commitment to raise the death tax threshold to £1 million over the next parliament.
- Instead the two parties have agreed to adopt the Lib Dem policy of raising the personal tax allowance to £10,000 as a long-term goal, with a promise to take “real terms steps each year towards this objective”.
- The parties did not agree to a Lib Dem call for a “mansion tax” on high-value properties or to stop tax relief for higher rate pensioners.
-The parties agreed to a substantial increase in the personal income tax allowance from April 2011, with the benefits focused on the lower and middle classes.
- This will be funded by dropping plans to increase the employee threshold for the national insurance payroll tax and by raising capital gains tax for non-business assets so it is closer to the level of income tax.

Sky News is reporting that Vince Cable will be put in charge of policy for banks and businesses. This is the same man who in the Chancellor’s debate said that the Tories were just waiting to “get their noses in the trough and reward their rich backers.”

The political change should remove a substantial part of the uncertainty that has been weighing on Sterling of late.

Evidence of further recovery in the UK labour market today as well as market speculation about changes in the monetary policy outlook following the release of the Bank of England’s Quarterly Inflation Report should be supportive for the Pound.

Billions wiped off global markets with Greek bailout fears spreading to Portugal, Italy and Spain.

Wall Street suffered one of its worst falls in a single trading session yesterday, with mounting concerns that the sovereign debt crisis in the eurozone will not be confined to Greece.

In one of the most frenetic trading sessions in memory, the Dow Jones industrial average fell by 500 points in a matter of seconds at one point, prompting an investigation by the New York Stock Exchange.

At its worst point, the Dow fell by just under 1,000 points or more than 9 per cent— which would have represented the biggest one day fall in 17 months.

The market immediately rebounded, raising speculation that the falls had been caused by a “fat-fingered” trader who had entered an erroneous transaction, although the New York Stock Exchange was quick to point out that the fall was largely due to programme trading.

About $16 billion worth of stock changed hands during the burst — suggesting that genuine trading activity was behind the fall and rally.

Other markets also saw some spectacular lurches, with US crude oil futures for June delivery collapsing by just under 4 per cent to $76.70, its lowest level since February. Amid signs of safe-haven buying, gold prices also hit a record high.

Earlier the euro fell by more than two cents against the US dollar. Having traded at $1.2856 earlier in the session, the currency fell to as low as $1.2653 in the late afternoon, after the European Central Bank (ECB) killed hopes of early action to limit the crisis.