Time to panic?

After weeks of vigorous speculation, it seems, for a brief moment at least, that there are signs of an underlying confidence looming over the future of the global economy.

Self-belief was apparent in the UK and the US today. The FTSE rose 8.75% at 5552 whilst the S&P 500 rose managed an 8% increase.

On the employment front, the US has experienced a 2 year low in unemployment, dropping to 8.6%.

Action! Reaction!

A large quantity of this burst in confidence can be attributed to coordinated government intervention across the globe. In the US the Federal Reserve dropped the penalty rate on dollar liquidity from 100 basis points to 50. This in turn allowed the European Central Bank (ECB) to relax their lending requirements to financial institutions looking to raise capital. It is expected that the ECB will offer 3 year long euro loans, instead of the current 13 month ones on offer. In addition less collateral will be demanded for dollar loans, from 20% to 12%. 

Whilst on the topic of Europe, Italian bond yields are still at 7% - indicating the level of risk that is still present in the troubled country with debt at 110% of GDP. Angela Merkel has made an impressive fiscal union speech today in Deutschland. Accompanying this is the stronger commitment by the ECB to provide greater assistance in the eurozone.

Analysts at leading financial institutions have voiced their concerns that the current short term benefits of government intervention may be in vein if the underlying causes of the sovereign debt crisis are not mitigated in a timely manner.

On the Asian continent, China announced a round of monetary easing restrictions. This included a reduction of the reserve ratio by 0.5%. As a result, banks have been able to increase their leverage in the country, encouraging economic growth.

Regardless of the benefits that investors reaped this week, the real test will follow the outcome of the Brussels meeting, and whether investors are confident that eurozone leaders will be able to finalise a solid plan to control the flailing damage from the volatile currency. If this is not successful then the past week might as well be forgotten. Banks are looking uneasy on Europe and investors are becomming increasingly impatient. Time for the euro is running out.

A Warm-ish Welcome

We start the beginning of an academic year with glum news.  The world economy shows signs of slowing down, harboring myths of more recessions with greater proportions. It is important to distinguish fact from reality.

It is true that growth has slowed in Europe and in the UK. Jobless figures out today set a record that has not been beaten for decades. 8.1% of people are now without a job, and hence a stable income. Although we are growing and we are in considerably better shape than Europe, the actual 'success' story of Britain is very limited. The effects of quantitative easing did not rescue any industries as it soon became apparent that commercial banks were simply hoarding their profits to beef up their quarterly balance sheets. The chancellor announced last week a new plan that would somehow involve the treasury lending out money to businesses seeking loans, thereby skipping out commercial banks. There are two problems with this. Firstly, the amount of money demanded through business loan applications exceeds the amount George Osbourne has promised to lend out. Secondly, this plan will only raise the deficit Britain is already in, sacrificing potential growth in the future with some average growth now.

Another continuing issue is the EU and the state of Greece. The IMF has still delayed the second installment of the bailout. The economically deceased nation warned they did not have enough cash to pay for next month's wages - a great way to convert any remaining uncertainty into confidence for investors. Germany has voted for the new EFSF - European Financial Stability Facility, which has greatly improved the chance of a successful motion across Europe. There are many who still believe the best scenario is to ring fence Portugal and Italy form the euro and let Greece default. There is only so much time before people start to get bored. The only reason Europe is still under the watchful eye of investors is because it is very cheap at the moment. Should the euro come out of this mess, many people will make serious returns on their investment. On the other hand the current more likely scenario is for the currency to collapse and void all investments.

Moodys screw the French over

The credit ratings agency has changed targets to mainland European banks this time. Both Crédit Agricole and Société Générale were downgraded today as a result of uncertainty over the exposure the French have to Greek debt. Investors are worrying and this is being reflected directly in the marketplace. SocGen shares closed today at 6% down – a clear response to the downgrade.

 

However this does not mean the French are in trouble, yet. This downgrade has brought the two banks into line with the general trend of French bank credit ratings. The governor of the central bank of France, Christian Noyer, insisted French banks had enough capital to protect them from Greek default. BNP Paribas, France’s largest bank, is still having their Aa2 rating discussed.

It is estimated that the private sector will invest 80% in €135bn debt swap that will form part of Greece’s second bailout package. Policy makers have narrowed down 4 complex options that involves taking a 21% loss on bonds maturing by 2020

MORE INFLATION

Inflation figures came out to day and it still doesn't look good, but when has it ever looked good recently? 

The CPI reached 4.5% today, up 0.1% from July. Unsurprisingly this is still miles away from the Bank of England target rate of 2%. The BOE claims one of the main causes of the rise is due to the VAT increase and the recent rise in energy prices. 

Everyone seems confident that the inflation rate will fall next year. And so would any sane man if he realised what was going on. The Office of National Statistics plan to cut out the effect of the VAT increase by next year. This will definitely drop the level of inflation. But will prices really follow suit? This seems very doubtful.

Mervin King expects inflation to reach 5% by the end of the year as energy providers further increase prices in the Winter months. This will tighten the already suffocating squeeze on households. After this it is hoped that commodity prices will fall in 2012, assuming investors regain confidence in equities (it would be very speculative to confidently say at this stage), bringing inflation down with it.

If all else fails the BOE will have no choice but to raise interest rates back up to pre-2008 levels. Depending on the state of the economy this could push the UK back into recession. Nothing new there.

Its just a shame house prices aren't rising too...

Changes to UK Banking

The Vicker's report has recently been released with recommendations very similar to those that were expected. I have had a speed read through it (which is one of the reasons why there was no recent news on Kenny Edition). Here are the main details:

A wide ring-fence has been suggested in order to separate retail and investment banking divisions. But this is not clear cut and leaves a considerable amount of decision making to cross platform banks such as Barclays, HSBC and RBS. So called 'corporate deposits' will be decided at the banks' discretion whether to put them in the retail or investment side.

UK retail banks should have equity capital of at least 10% of their risk-weighted assets. This is quite a change for many banks considering their leveraged ratios used to be a massive 40:1 on assets. However this is still a high percentage considering Basel III recommended 7%. 

Retail banking groups should be able to absorb losses of up to 20% capacity, should another crisis occur.