WISE MONEY

The newest member of the Bank of England’s interest rate setting Monetary Policy Committee hit the headlines this morning.Britain faces “significant” risk of a fresh slump into recession according to Dr Martin Weale, who said it would be “foolish” to rule out the possibility of a double-dip downturn. He also thought the Banks central outlook on growth could be too optimistic in light of the fiscal cuts currently being implemented.

The BoE forecast is for growth of about 2.8% in 2011 and 3.2% in 2012. Sterling has dropped over a cent against the dollar following the news and has traded as low as 1.5371.

M&A activity in the US, helped lift sentiment yesterday, unfortunately this did not last for long and both main stock indexes closed marginally down on the day.

There is little economic news again today so focus is likely to remain on the existing home sales in the US which is out this afternoon at 15:00. Figures are expected to show that sales of existing US homes fell to an annual rate of 4.67million in July from 5.37 million in June.

The Bank of England has kept its economic stimulus programme and record low interest rate of 0.5pc in place yesterday amid lingering doubts among rate setters over a sustained recovery for the fragile UK economy.The nine strong Monetary Policy Committee (MPC) was not swayed by the UK economy’s rapid 1.1pc advance between April and June, with growth expected to fade in the second half of 2010 as the biggest Budget cuts since the Second World War take hold.

Mervyn King, the Governor of the Bank of England, has repeatedly emphasised that there is no guarantee that the recovery which began in the fourth quarter of 2009 is sustainable.

The MPC held rates at the historic low of 0.5pc – where they have been since March 2009 –and maintained its target for bond holdings at £200bn, when it announced its monthly decision at noon.

The MPC maintained the ultra loose policy stance it established when the crisis took hold, despite a return to economic growth and a persistent failure to meet its 2pc inflation target.

The consumer prices index – the official measure of inflation – has been above 3pc since the beginning of the year. The Bank is expected to raise its inflation forecasts when it publishes the August Inflation Report next week, to reflect above-target inflation for most of 2011.

Mr King has stated that a failure of banks to lend, as well as weakness in Britain’s key export markets, could hamper growth in the UK.

Fears that Britain’s recovery will slow were reinforced by a snapshot of the UK services sector in July on Wednesday.

Economists had expected a slight improvement to 54.5, and the disappointing news for the economy helped to drive sterling pound down almost a cent lower against the dollar, to close at $1.5877.

The UK’s Consumer Price Inflation rose by 3.2% year on year in June 2010 compared to 3.4% in May, more than the 3.1% average forecast by analysts.

The widely used Retail Price Inflation decelerated to 5.0% in June compared to 5.1% in May. RPI-X also slowed from 5.1% in May to 5.0% in June. However, core inflation accelerated from 2.9% in May to 3.1% in June, which matched the highest reading since 1997.

According to the Office for National Statistics, the biggest downward pressure to CPI inflation between May and June came from falling energy (petrol and diesel) prices. Another significant downward contribution came from clothing and footwear, where prices fell due to the June sales season.

The latest inflation data will boost the case by Andrew Sentance who is the sole member of the MPC who is looking for a gradual interest rate rise and said the path to economic recovery could be uneven but that did not equate to a risk of a double-dip recession. “I favour a gradual rise in Bank Rate which would be aimed to avoid destabilising confidence through a sudden lurch in policy.”

Sterling reacted well against the US Dollar and moved up to above the 1.52 levels at the close of play from opening at 1.4996.

In European news yesterday, the rating agency Moody’s downgraded Portugal’s debt rating by two notches to A1 from its previous AA2 rating, with a stable outlook. Moody’s explained the downgrade with the ongoing deterioration in the debt ratio as well as the dim medium-term growth outlook.

Markets showed little reaction to the news, probably because Moody’s initially placed Portugal on credit watch in May 2010.

The euro held steady against the dollar after a smooth Greek Treasury bill auction eased some concerns about Europe’s debt crisis, this helped take the sting out of Portugal’s expected credit rating downgrade and disappointing German Zew index.

Sterling weakened yesterday after the S&P said it was maintaining its negative outlook on UK’s AAA credit rating. Data released from the UK included a survey by GfK, which showed 58% of U.K. households expect economic conditions to deteriorate further, with nearly two fifths of the respondents looking to cut back on consumption.

In addition, the final Q1 GDP reading showed economic activity expanded 0.3% from the last three-months of 2009, which was largely in-line with the initial forecast.

However, the growth rate slipped 0.2% from the previous year to mark the slowest pace of contraction since the third quarter of 2008.

Comments from the BoE’s Posen that a continued UK recovery can not be guaranteed also weighed on the currency.

The euro consolidated well below two month peaks against the US Dollar as investors were cautious about the single currency ahead of Greece’s return to capital markets for the first time since late April.

This along with Moody’s cut in Portugal’s rating to A1 with a stable outlook is going to continue to weigh on the euro in the short term and doesn’t bode well ahead of the bank stress test results due next week.

The Greek debt situation continues to deteriorate with the terrible news that three bank employees were burnt during riots in Athens.

The EuroDollar lost almost two cents yesterday as continued worries over a Greek default and contagion fears in other Eurozone countries played on the minds of investors. At one point euro/ US Dollar broke through 1.28, the lowest level since March 2009.

Today, the ECB meet for it’s monthly interest rate decision, with the actual decision widely expected to be an non-event. That said, the press conference afterwards will be closely watched for any mentioned of the possibility of the ECB buying bonds (QE or printing money to you and me) and any further developments in the bailout package.

Leading economists continue to be sceptical on the success of the proposed bailout – history is littered with examples of countries receiving money from the IMF and then promptly defaulting. Whether Greece defaults will increasingly be decided not by their ability to pay, but rather by their willingness to.

From pictures reported yesterday of the strikes, and with more planned next week, it looks likely that some sort of debt restructuring will eventually have to be implemented.

The number of Britons claiming unemployment benefits fell unexpectedly by 32,300 in February against the expectation for a rise of 8,000.

January’s reported rise of 23,500 was also slashed to 5,300. This fall is the biggest monthly fall since November 1997 and the claimant count rate eased to 4.9%- the lowest since August 2009.

This is timely feedback on the job sector for the Labour government as we draw nearer to election day. Although the data is certainly encouraging we should not carried away as there is still a significant risk of a stuttering recovery.

The labour market is still adjusting to fragile market conditions and this will lead to schisms in employment data. Looking forward we still have the threat of sharp public sector cuts which will lead to a rise in unemployment going forward.

The Pound has welcomed the news by rallying sharply against the US Dollar and the Euro- gaining over 1% against the USD and 0.8% against the euro. This is a welcome relief rally for the pound which has been on the ropes especially since the beginning of March.

The pound was also lifted by the MPC minutes which showed a vote of 9-0 to hold interest rates and QE. The unanimous decision has helped ease fears of further QE and division within the MPC.

The euro has held its neck above 1.37 today after testing over 1.38.

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Wise Money has sat through various BoE / MPC meeting/announcements when the Central Bank have surprised the market far more frequently on the hawkish side as it turns out but never has the market been so caught out by a UK decision.

The minutes in 2-weeks time have become more important than ever with the chance that the vote for a 150bp cut was unanimous inconceivable.

The process by which the committee came to the decision, will therefore be avidly anticipated. Last night’s evaluation of the cut and its likely effect centred solely on just how much of the cut will filter through to the economy as a whole and how much would be absorbed by Banks to enhance their capital position and their bottom line.

Government pressure must be brought to bear especially as they are a major stakeholder in most of the major institutions after nationalising them.

There was very little market reaction immediately following the news as dealers, investors and the like seemed to be at a loss as to what they should do next.

The ECB weighed in with their expected 50 basis point cut bringing its rate down to 3.25% – a 75 point cut was discussed but ultimately rejected. According to ECB President Trichet euro zone inflation was expected to continue to fall back hinting strongly that another rate cut could follow as early as next month.

Reacting to the interest cuts and an IMF report released yesterday predicting that the world’s developed economies were heading for their first full year contraction since the Second World War stock markets took fright and share values plummeted.

In New York the Dow Jones ended down 443 points or 4.85% following a decline of 5.7% in the FTSE 100. There were similar declines in Asian markets with the NIKKEI dropping 3.55%.

Turning our attention to today’s key data all eyes will be on the US non farm payroll numbers for October due for release at 1:30pm GMT. Expectations are for a decline in jobs by some 230,000 taking the unemployment rate to 6.3% from 6.1% in September.

The effects of Hurricane Ike came too late to be fully reflected in September’s figures so we could see the delayed impact of hurricane related disruption in this months figure. Not surprisingly private service sector job losses have accelerated adding to continuing reductions in manufacturing and construction jobs.