Investment Overview August 2012

‘Double Dip’ or ‘Triple Dip’ recession in the UK?

Following a number of months focusing on the Problems in Europe I thought it would be a change to examine another area so for this overview my focus will be on the UK and how our economy is coping with the pressures of Austerity and the Global Slowdown.

Like all economies around the world the UK has found the recession and banking crises of 2008 very difficult to ‘get out of the system’. A number of major economists are saying that this is not just a ‘double dip’ recession that we are experiencing but a ‘triple dip’ recession - something that has not been seen in our economy since the early 1950’s. Over the last three years we have seen record low interest rates, record low gilt yields, and record low bank lending in the form of mortgages and loans to households and business. With high inflation still in the system this has meant that spending within our economy, both internally and externally, has slumped. As you are aware the Government’s main focus at present is to look to cut the ‘budget deficit’ and, as in Europe, ‘Austerity’ has been the way forward to reduce spending to get the UK back on track. The principles were and still are very sound however with any ‘economic programme’ there will always be other factors that will influence the end result.

When Governments undertake the level of Austerity that we have seen from this Government the difficulty will always be how to stimulate growth at the same time. Add to this the ‘High Inflation’ that we have experienced over the past few years and it has been very difficult to implement the usual policies that Governments (or in our case Central Banks) could use to control spending and give business and households the opportunity to continue to spend. Therefore it is very difficult to assess whether, at this stage of this particular economic cycle, the plans of the Government and Central Bank are having a real effect or whether at some point in the near future the so called ‘Plan B’ will need to be implemented.

One important area that needs to be mentioned is how this current crisis is being handled by the Monetary Policy Committee (MPC). Despite having a real struggle this time last year recent events have shown that they are starting to gain a real understanding of the complexities of this current crisis and how to get meaningful policies into the economy to support managing the crisis. This time last year they did not have a clue about the role that Inflation was having on economic conditions. They believed (wrongly) that high inflation would start to fuel additional wage inflation and they were very slow in bringing in Conventional Quantitative Easing (QE). However, recently they have shown, with a number of excellent policy decisions, that they are capable of dealing with this crisis and if they continue in the ‘same vain’ for the next few months we should start to see some growth back into the UK Economy. One area of particular interest, which was widely acclaimed by a number of Senior Economists, was the policy to lend to banks at extremely low levels of interest if they increased their lending to Business and Households. We are just starting to see signs that the main banks have taken to this and we should see a sharp increase in lending levels being announced over the coming months compared to the ‘dire’ results we saw in May and June. With a continuation of this policy into Quarter Four and the effect of the recently announced increase in conventional QE beginning to show in the economy I would not be surprised to see a positive growth position in the UK by the end of the year. This will allow the UK to be one of the drivers out of the global slowdown along with China and the US.

Even though things in the UK seem very difficult economically there are a number of areas that place the UK in a far better position than several other counties in the Eurozone. Despite the fact our borrowing remains high as a percentage of our Gross Domestic Product (GDP), the cost of the borrowing has fallen dramatically over the last three years. We have seen month by month gilt yields continue to fall both for short and long dated gilts with a position at one stage last week when our 10 year yields were as low as 1.44%. Even though this has meant that individuals who have taken out annuities or annuity-based products have seen a real decline in the income provided, it has meant that the rate of interest payable by the UK Government on it’s issued yields is at a level that will give them additional time to bring borrowing back to a controllable level going forward. It will be important for the UK to keep their current ‘AAA’ rating with the rating agencies even though there was no real impact on the US Gilt yields last year when they lost their ‘AAA’ rating. Pressure would certainly come to bear on the UK if they lost their ‘AAA’ rating which would automatically increase the Government’s borrowing costs overnight.

Another area that has been very favourable for the UK is that of the our currency, Sterling. Despite the fact that we are seen as a safe haven for Governments Gilts our currency never really gets too strong, in fact over the years we have been quite fortunate to have a weak currency as we are seeing at present when times are difficult. Compare this to Japan’s experience over the past 15 years and to Switzerland more recently were extremely strong currencies have really weakened their respective economies. In the UK we have the ability to keep Sterling at a competitive level allowing our exporters the chance to be competitive on price and for our imports not to have too big an impact on Inflation.

So all in all, despite the concerns for the ‘Global Slowdown’ from which we in the UK are clearly suffering along with everyone else, we can be very positive in the UK about the real signs that we are moving out of recession and staying out of recession. Normally I do not like to make predictions however I am fairly confident that by the end of this year the UK, alongside the US, will be two of the areas pulling the Global Economy out of the current negative position.

It would be very wrong of me not to mention Europe in my overview as it has dominated the financial news for well over 12 months (and my overviews as well). We seem to be in a ‘State of Limbo’ again as the policy makers and politicians try to convince the markets that they are doing everything that they can in order to save the Euro. I think the only thing that is different now to other times in this crisis is that Mario Draghi, the President of the European Bank, seems to understand what actions need to be undertaken in order to get Europe back on track. However, as before, the stumbling block to any firm and positive action that will need to be taken will be agreement by the Germans. In my June overview I pointed out the actions that I felt needed to be taken within the Eurozone to bring this crisis to an end. Since that date we have seen each one of them being put forward as a potential policy by some EU Politician or Policymaker only to rebuffed immediately by either the German Bundesbank or a senior German politician, if not Angel Merkel herself. So for me now I see the situation in Europe as a couple more months of talking, which should provide a small respite for the markets, followed by some Major Event which will bring the matter totally to rest. This Major Event could be Positive or Negative but, whatever it is, it will have to be big so there will be no further back tracking or rebuffing of policies and things will take a natural course. Clients whom I have spoken to recently regarding this have asked whether I felt it would be a positive or negative event when it happens. It is difficult to say for certain however, I would say this, I am no longer discounting a total breakup of the Eurozone at some stage in the next 12 months.

Ian Jackson

Investment Manager