WISE MONEY

Today sees the start of a new age of austerity as the Government announces £6.2 billion of immediate spending reductions, paving the way for much deeper cuts in the future.

The Liberal-Conservative coalition is hoping that these initial cuts will prepare the population for severe fiscal measures next year with reports of up to 300,000 public sector redundancies.

Despite these unpopular decisions, markets have been indicating that they want these measures in place if Sterling is to recover against the majors in the long term.

Over to the European mainland and the Euro recovered somewhat on Friday, reaching a one week high against the Greenback as buyers returned to the Euro and halted the currency’s decline. This welcome support came on the news that EU officials pledged to tighten sanctions on high-deficit member countries and said that no European country will be allowed to renege on its debts.

In the early session this morning, the Euro has given back some of these gains with traders reported to be selling into the bounce on ongoing concerns about the outlook for the Eurozone.

To add the Euro’s problems, concerns that the EU credit crisis is spreading with the announcement that the Bank of Spain is to take over the running of one of the country’s saving’s banks.

This pushed the Euro lower against the Dollar and Sterling from highs of $1.2510 and $0.8635 respectively. However the Euro remains well off last week’s four year low of $1.2146, as markets awaits further developments in terms of the sovereign risk issue.

Stock markets around the world suffered further falls yesterday as investors continued to unwind risky positions and move into calmer waters.

The problems in the Eurozone have been the driving force behind the huge market movements we have seen across the currencies over the past few days.

China has been powering the world’s economy over many years, but with Europe its largest customer, investors fear a European induced Chinese slowdown would derail any economic recovery.

Hedge funds are reported to be reversing positions to preserve capital, most notably in the Aussie dollar pairs, which have seen large swings in value over the past few days.

Disappointing economic data yesterday from the USA showing a surprise increase of 25,000 in jobless claims and poor Eurozone consumer confidence figures exacerbated the negative sentiment in the market yesterday.

Sterling fell to its lowest level in 13 months against the Dollar driven by the rush into the safe haven rather than anything Sterling based.

Retails sales showed a third straight month of increases, a positive bit of data for the UK that was shrugged off very quickly by the market. Sterling sentiment remains weak, so expect the Pound to come under further pressure as risk is taken further off the table.

Last night, the US Senate approved the financial reform bill after lengthy negotiations. The legislation, penned as a response to the Credit Crunch will, amongst other things, stop deposit taking banks from trading on their own accounts (proprietary trading) and allow the government to seize control of a failing firm that is judged to be systematically important.

We will have to wait on the fine print, but this will almost certainly have large implications for the markets because the biggest players (the banks) will be forced into restructuring. The added uncertainty of how this will work is adding to fears over the Eurozone.

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 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 euro fell further against the US Dollar today after Germany demanded stringent new austerity measures from Athens before committing to the rescue.

The cost of insuring Greece’s mounting government debts against default rose to a record high over fears that the ailing economy could still be denied financial aid. The loans rates demanded of Greek bonds now exceed those of Argentina.

Five year credit default swaps on Greek government debt rose to 718 basis points at the close of the New York markets.

Investors are forecast to push risky European sovereign bond yields up further after a sell off in Greek and Portuguese bonds overnight.

European stock markets slipped in early trading in response to the Greek fiscal crisis and President Obama’s failure to press ahead with reforms of the US banking sector. The euro fell by 0.2 per cent against the dollar to $1.3368.

Asian stockmarkets also fell, with Chinese stocks leading the decline to 3 per cent.

Greece could become the first eurozone country to be bailed out by its fellow members and has asked the International Monetary Fund and the European Union for £40 billion of rescue money.

The bailout package was initially greeted with optimism, but some investors now fear that it might not be enough to prevent Greece from defaulting on its debts.

Investors also fear that a Greek default could spark a domino effect among other weaker economies.

The German Chancellor was forced yesterday to issue an emergency statement promising aid to Greece — but her words failed to ease bond market speculation that Berlin might not support the eurozone’s €30 billion package.

Bond market investors pushed up the interest rate on two-year Greek debt to almost 14 per cent yesterday as rumours surfaced that Greece might seek an emergency restructuring of its short-term borrowings.

The market reaction effectively closed the door on further short term commercial borrowing. The ten-year Greek bond rose above 10 per cent yesterday as George Papaconstantinou, the Finance Minister, described the rates as prohibitive. The German Government responded with a calming statement but fell short of unequivocal support.

The German Chancellor is under pressure to take a tough line since public opinion in Germany is solidly opposed to supporting Greece. The German Government needs to pass legislation to obtain authority to issue its €8.4 billion share of the eurozone package, but it faces a potential political challenge from a regional election in North Rhine-Westphalia on May 9. Guido Westerwelle, the Foreign Minister, warned of the danger of taking pressure off Greece “by making promises of concrete aid too soon”.

The euro continued to slide towards a one year low as the downgrade in Greece’s credit rating weighed heavily on financial markets.

The single currency fell to $1.3201 in Tokyo trade, its lowest since April 30, 2009, and reached 86.26p against Sterling. It slid against 14 out its 16 major currencies.

The falls will put added pressure on the G20 meeting in Washington today to find a solution to Greece’s financial woes.

Yesterday Moody’s cut Greece’s credit rating from “A2” to “A3” and said that further downgrades would follow unless Athens could restore market confidence.

Moody’s cut its rating after it was confirmed that the Greek Government ran up a budget deficit of €32.34 billion in 2009, representing 13.6 per cent of gross domestic product — far worse than the expected 12.7%.

Finance ministers are attending the G20 summit from today to discuss the global economic recovery but investors’ caution about the summit’s outcome pushed Asian stocks down today.

Fears that the G20 may not come up with an effective plan to tackle Greece’s debt are fuelling concern that the euro could drop below $1.3000 next week.

The yield on ten-year bonds surged from 8.246 per cent on Wednesday to as much as 9.163 per cent, while that on five-year bonds, which was 8.256 per cent on Wednesday, surged to 9.818 per cent.

Economists said the moves strongly suggested that the market expected Greece to default on its debts, an outcome that Germany’s Foreign Minister has said would be critical for the euro.

Greece, which has a national debt of some £270 billion and must refinance  £7.75 billion of bonds maturing on May 19, began talks yesterday with the European Central Bank, the European Commission and the IMF about the conditions that would be attached to an aid package worth up to £40 billion.

Germany, which would be the single biggest contributor of support within the eurozone, has insisted on an interest rate of 5 per cent.

Meanwhile, public services in Greece came to a standstill for the third time in two months yesterday as government workers, actors and archaeologists took to the streets to protest deep public-sector salary cuts (John Carr writes).

There were isolated scuffles between protesters and police in two rallies in central Athens.

The demonstrations came on the second day of an inspection of the nation’s finances by a team of IMF and European Central Bank officials, who plan to announce their findings next month.

Schools and government offices were closed and hospitals accepted only emergency cases as doctors joined the strike.

The financial cost to the economy of the airline chaos has intensified with Iceland’s volcanic ash cloud disruption far from over.

On top of the huge loss in revenues for airlines, other companies are suffering disruption to deliveries and supplies.

Food goods face delivery problems, with delays spreading to the drugs and hi-tech sectors if the crisis continues.

Meanwhile, more airlines have launched test flights to assess ash damage to jet engines, amid signs that some feel the threat is being overstated.

While airlines are the biggest losers, with revenues down an estimated £130m a day, other companies are starting to feel the effects of the flying ban.

They are beginning to question whether the Met Office’s computer model of the ash cloud is exaggerating its size

Although air freight represents just 0.5% of the UK’s international movement of goods, it accounts for 25% by value, and includes item like pharmaceuticals and luxury goods.

Goods air-freighted for just-in-time deliverys are especially vulnerable.

A spokesman for the British Retail Consortium said that only more exotic food produce was likely to be affected for the moment.

With the impact on businesses and travellers worsening, some people are starting to question if the air traffic authorities were too quick to shut down European air space.

The Independent newspaper’s Travel editor Simon Calder told BBC News that some airlines he has talked to are unconvinced about the extent of the safety threat.

European airlines are continuing to run test flights to assess possible damage to jet engines caused by the volcanic ash cloud. KLM, whose Saturday test went without incident, is running another eight, and Air France is also taking to the skies. Lufthansa has also run test without any problems.

British Airways ran a test flight early between Heathrow and Cardiff yesterday evening.

Meanwhile the ash cloud is spreading to the north east coast of the USA and is expected to pass over land this evening.

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