The Sterling Election

The Sterling Election
By Joseph Trevisani, Published: 04/05/2010

Have the improved prospects for a Conservative victory in the upcoming British election and the reduced chance of a hung parliament revived the sterling, or has the recovering British economy provided the boost? A little more than a week ago, the pound came within twenty points of its post crash low of 1.4781. By Thursday it had regained 3.4% versus the dollar and 2.1% against the euro. Yet the reason probably has more to with Greek debt than resurgent manufacturing in the Midlands.

The British economy has recently been performing better. Fourth quarter GDP was unexpectedly revised 0.1% higher to 0.4% after six straight quarters of negative growth. Yearly manufacturing production turned positive in January for the first time in 21 months. The March Purchasing Mangers Index (PMI) in manufacturing at 57.2 was the highest since October 1994. Unemployment has been at stable within 0.1% of 7.8% since last June.

Britain’s main continental currency trading partner, the EMU, has seen similar improvements in national figures. Euro zone GDP was positive in the fourth quarter rising 0.1% q/q; it had expanded 0.4% in the third. These are the first positive quarters since the beginning three months of 2008. EMU manufacturing PMI in March also pointed to higher growth ahead, at 56.6 it was the strongest since November 2006. Euro zone unemployment was 10.0% in February, which is substantially higher than in England but it has been unchanged by more than 0.1% for four months. The comparative advantage between the island economy and the continental has not altered in almost a year.

Economic figures in Britain and on the continent have seen the same order of gradual improvement over the past six months. If the British economy is slowly leaving the recession behind so are the Germans, the French and their EMU partners. In fact, the English GDP and unemployment numbers are better. Nevertheless, for the past six weeks the sterling has been weaker against the euro then at any period since the beginning of the year.

The same is true of the Sterling-US Dollar comparison. The American economy has been improving faster at least in GDP terms but its unemployment rate is worse and there is limited indication that its wholesale government revitalization plans will produce more substantial results than in the UK. As with the euro, the sterling has been punished against the dollar despite its rough equivalence in economic status.

According to a British Government website, “Public sector net debt, expressed as a percentage of gross domestic products (GDP), was 60.3 per cent at the end of February 2010 compared with 50.5 per cent at end of February 2009. In 2009 the UK recorded a general government deficit of £159.2 billion, which was equivalent to 11.4 per cent of gross domestic product (GDP)”.

At 11.4%, the British government deficit is similar in magnitude to Greece and Spain. The source of recent sterling weakness is not the size of the deficit or the performance of its economy but the uncertainty surrounding the victor in the June election. Until the most recent polls, the possibility of a hung parliament rose with the decline of the Conservative lead over Labor. The Greek deficit and debt problems have a unique reflection in Britain.

In Europe, the problem of Greek debt is not ability but intention. No one doubts that the EMU members can create and fund a plan for the bail out of Greece when they decide to do so. In Britain, however, a hung parliament would throw up difficult political obstacles to a credible deficit control plan. Without a clear majority for either party in Commons, intention will matter less than the functional limits on government power. Even with the best intention, it may be difficult for any British Government presiding over a stalled parliament to enact an austerity budget.

In order for the UK to regain control of its finances, it must have, in the market view, a unitary government. A hung parliament would be the functional equivalent of the squabbling nations of the EMU, unable to agree on a policy though all agree something must be done to save the euro.

The currency markets clearly take the UK election more seriously than the bond markets. That is why the sterling rose on reports that the Tories had climbed several points in the most recent polls. A Tory Government has a chance to control the deficit, a split parliament has none Perhaps the bond markets will begin to pay attention to the British election, until now they been busy enjoying the Greece debacle.

Interest Rates Back To Haunt Sterling

http://www.fxclub.com/dj-forex-focus/review1621/

Sterling bulls should be quaking.

If interest rate expectations are now driving currencies as much as it appears, the pound's slide will only accelerate.

The Bank of England will likely add to the U.K. currency's woes if minutes of its last meeting earlier this month, to be released at 0930 GMT, show that further monetary easing is still on the agenda.

The improved prospects for the dollar aren't helping either. As U.S. economic data improves and speculation over U.S. monetary tightening increases, support for the dollar is only likely to rise at the expense of the pound.

For several weeks now, the pound has been on the decline--being pushed steadily lower after rising over $1.68 in the middle of last month.

As it gets down closer to $1.60, the slide is showing signs of getting faster, driven by a steady flow of disappointing economic data.

The latest of this came Tuesday with the contraction of third-quarter gross domestic product revised to 0.2% from a decline of 0.3% previously.

Some optimists had been hoping that the revision might have taken GDP into positive territory. Instead, the figures merely confirmed that the country lags behind the recoveries in every other major economy.

And signs are that the U.K. economy isn't going to get much stronger. Sure, there could well be real growth showing through by the end of this year.

But, noted Jonathan Loynes, chief European economist with Capital Economics in London, "with household debt still very high, credit constrained and a fiscal squeeze looming, the economy still has a lot to contend with."

"We continue to expect GDP to expand by a modest 1% or so in 2010," Loynes said.

As Loynes remarks suggest, there is little to get excited about.

Take the U.K. housing market. The latest forecast from The Royal Institute of Chartered Surveyors suggest prices will rise between 1% and 2% next year. But, the institute warns that most of this small increase will take place at the start of the year with prices falling back again in the second half.

However, it is the looming fiscal crisis that some analysts feel will not only keep U.K. growth subdued for years to come but that will ensure that the pound remains weak.

With a national debt set to reach GBP1.5 trillion by 2013/2014, the U.K. faces servicing costs that will act as a major drag on the economy, preventing it from catching up with the growth that will be taking place in other major economies.

"In the circumstances, we struggle to come up with a convincing long-term argument to support the pound," said Simon Derrick, a senior currency strategist with Bank of New York Mellon in London.

Add to this the increased speculation of dollar strength that is likely as 2010 gets underway and there appears to be little chance that the pound will be revisiting resistance up at $1.62 again just now.

Instead, UBS's forecast for sterling down at $1.56 in three months looks that much more likely.

Overnight there was very little movement in the major currency pairs with volumes low in Asia Wednesday due to Japan markets being closed for the Emperor's birthday.

Around 0730 GMT the pound is little changed from levels seen in late U.S. trade Tuesday fetching $1.5961 from $1.5965. The euro is worth $1.4259 up marginally from $1.4255 while the greenback fetches Y91.67, down from Y91.82.

UK Bank Landscape Set For Revamp As Big Bks Sell Assets

http://online.wsj.com/article/BT-CO-20091102-708534.html

LONDON (Dow Jones)--The still-fragile U.K. banking sector is set for a major overhaul that will see two of its biggest banks getting smaller and potential new players arriving in the market--including an entity with its roots in music and a supermarket.

The Royal Bank of Scotland Group PLC (RBS) and Lloyds Banking Group PLC (LYG) are expected to disclose Tuesday what assets they will have to sell in order to satisfy European Union competition concerns, after they were bailed out by the government last year amid of the worst financial crisis on record. They will also announce their intentions toward a government plan to insure toxic assets.

The EU's competition regulator has told both banks that they must divest of businesses to make it fair to banks that stayed independent.

Lloyds, which is 43%-government owned, has said sales won't be material to the bank, while RBS, 70%-government owned, said it expects divestments "not initially contemplated."

Lloyds could be selling some retail branches and part of its small-to-midsize enterprise portfolio. It became U.K.'s biggest retail bank in terms of market share after it bought HBOS PLC in January in a government-brokered takeover. Its SME business' market share is 24%.

RBS is expected to sell dozens of retail branches in England and Scotland, as well as insurance operations and other divisions.

The number of potential buyers will largely depend on market-share limits imposed by U.K. and EU authorities, something they are also likely to announce this week.

On Sunday, Alistair Darling, U.K.'s top treasury official, told BBC that the hope is "that you would have perhaps three new entrants over the next few year."

Darling didn't give specifics but said new entrants into the sector could be some that are already in banking "and others may decide it's something they want to get into."

The British Bankers' Association said Monday that it "has always welcomed competition for high street banking services and choice for customers."

One potential competitor is already making its plans public. Virgin Group founder Richard Branson said Monday that it is interested in the assets of RBS, Lloyds and Northern Rock PLC.

"We will be setting up the new bank in the new year," Branson said in a news conference in Milan. "We may also buy some assets of the nationalized banks." Branson's Virgin empire has its roots with Virgin Records, which was later sold to help support Virgin Atlantic Airways.

Virgin was the preferred bidder for Northern Rock, the U.K. bank that collapsed in 2007, but was left out in the cold when the government said none of the rescue plans put forward provided taxpayers with enough guarantees. The bank was then nationalized.

Last week, the EU cleared a plan under which the lender will be split into a "good" bank - which will hold the bank's deposits and some existing mortgages - and a "bad" bank holding mortgages that will be gradually wound down. The plan is to sell the "good" part.

Another contender for buying assets could be retailer Tesco PLC (TSCO.LN), which has said it wants to make its personal finance business, Tesco Bank, a full service retail bank, from the smaller handful of products it currently offers.

A Tesco spokesman couldn't be immediately reached for comment.

Analysts have also said foreign banks could be among buyers, including Banco Santander SA (STD), which added ailing banks Alliance & Leicester and the good parts of Bradford & Bingley to its U.K. operations at fire-sale prices in 2008. It entered into the U.K. market in 2004 with the acquisition of Abbey National PLC.

The bank's chief executive, Alfredo Saenz, however, said last week that Santander had no plans for acquisitions "in any of our main geographical area."

New small banks formed by a consortium of investors are also in the list. Panmure Gordon banking analyst Sandy Chen is reportedly trying to set up a lender for small businesses. Chen couldn't be reached for comment.

Analysts, however, said names like Tesco and Virgin could emerge as the biggest winners because they are popular brand names that are already well received by the public.

"One thing the government can't afford to do is to be in a situation where Lloyds and RBS are forced to sell assets and then people leave the new owners in droves because they don't know who they are," said Simon Willis, an analyst at NCB Stockbrokers.

To be sure, it may take years until the new banking landscape in the U.K. becomes clear.

Although the future of Lloyds and RBS is expected to be decided shortly, implementation of any plan is likely to take years.

"Five years seems to be the benchmark for banks under the EU to reorganize themselves, so the new banking landscape won't come up overnight," Willis said.

-By Patricia Kowsmann, Dow Jones Newswires. Tel +44(0)207-842-9295, patricia.kowsmann@dowjones.com

(Sabrina Cohen in Milan contributed to this article.)

Sterling Uncertainty Shows 'Benign Neglect'

Ex-FSA chief Sir Howard Davies sees 'dramatic’ risks for Britain

http://www.telegraph.co.uk/finance/economics/6339642/Ex-FSA-chief-Sir-Howard-Davies-sees-dramatic-risks-for-Britain.html

The British people are living in a fool's paradise and have yet to understand the gravity of the economic crisis, according a former head of the Financial Services Authority.

Sir Howard Davies, now Director of the London School of Economics, said Britain faces a dangerous rise in the levels of public debt – even taking into account tax increases planned for coming years.

"The next six months are going to be extremely delicate in the UK", he told a gathering of HSBC clients in London. "It is very clear that something dramatic has to happen to control spending: but is the economy robust enough to survive fiscal tightening?"

The Government is already running out of weapons to fight the crisis. While the fall in the pound has helped boost exports and proved benign so far, Sir Howard said that past experience handling sterling crises had taught him that the matters can turn ugly fast once confidence is lost. "The pound never stops where you want it to," he said.

What is disturbing is that the British people seem unwilling to face minimal belt-tightening. Even professors in higher education are balloting to strike, demanding a continuation of boom-time pay raises. "You have the best minds in the country planning to go on strike for 8pc. People are miles away from understanding what is needed."

Polling data shows that 48pc of the public are against any spending cuts and only 20pc see the need for retrenchment. Britons appear to assume that the "fantastic growth in public spending" over the last decade has become an entitlement.

Sir Howard said the reality is that the Government has so far come clean on just half of the fiscal consolidation necessary over the next five years merely in order to stabilize debt. By 2014 we will be among the Big Four of global profligates. "It is not a great club to be in," he said.

Britain's secret weapon against a fiscal crisis

http://blogs.telegraph.co.uk/finance/edmundconway/100001403/britains-secret-weapon-against-a-fiscal-crisis/

If you dig a little bit into the way the UK debt market is structured, there are actually some pretty reassuring quirks which imply that Britain may be that little more resistant to the armageddon-style outcome of a debt crisis about which some are so worried.

As we all know so well, governments around the world have rather a lot of money to raise in the next few years to pay those bills to mop up the mess of the economic crisis. Britain, for instance, will increase its deficit by £175bn this year alone, partly because of the cost of the recession (extra unemployment benefit etc), partly due to the sudden disappearance, perhaps permanently, of tax revenues the Treasury thought were permanent features – ie from the City and those associated with the property bubble. But the UK is not alone; with everyone around the world raising so much money, and, after the Bank of England and central banks slowing their quantitative easing programmes with little option of printing money and selling the stuff to yourself (one presumes), there may be limited demand for this debt. The big question over the next few years is whether investors will feel ready to stump up the necessary cash to keep these governments functioning.

If they get worried because, for instance, they suspect a government is not good for its money, and will either default or inflate away its debt, they will ask for a higher price for that debt; the government will have to offer them a steeper rate of interest. Eventually, if the cost of financing these interest payments become too big, the government can get trapped in a debt spiral out of which it may struggle to escape alone. It is precisely the same as any household borrowing too much on a credit card, and in time seeing that they cannot afford to make the minimum payments each month, let alone pay off the bill in full.

According to Moody’s that danger level of interest payments is about 12.5pc of a country’s tax revenues (in other words when 12.5p of every pound you pay in tax goes straight towards paying off interest on your pile of debt). Although circumstances differ from country to country, it views it as broadly unacceptable for a triple-A rated economy to have a debt interest burden much higher than this. The worrying thing is that in the UK, the debt interest level is likely, according to Standard & Poors, to head up to the 12pc level within a few years.

But here’s where the structure of the market comes in. In order to finance its deficit, a government issues lots of bonds to investors at varying different lengths of maturity, from the short ones of three to five years to ones which last for half a century and will still be paid off well into the next generation. At any one time, the Government is paying interest to investors on bonds from a whole variety of periods – whether it is short term stuff it issued a year or so ago in the wake of the financial crisis or long term stuff from back in the 1980s.

Every week old bonds expire and in their place the Government has to issue new bonds to take their place (unless, of course, it is in budget surplus and is trying to erode away its debt – but that’s hardly something we have to worry about right now). So although the Government’s deficit this year will be £175bn (public sector net borrowing), the actual amount of cash it must raise in the markets is £221bn, with much of the difference accounted for by those extra bonds it has to issue to replace those that are expiring. This last figure is referred to by Treasury wonks as the net cash requirement.

If you’re a government, should an investor get worried about your creditworthiness and demand higher interest rates for lending to you, those higher rates only apply to the new bonds you’re issuing - not the existing bonds accumulated over the previous years. Once those bonds (or gilts, as they’re known in the UK) are issued by the Government, the, say, 4.5pc rate is set in stone (for the Government) for the bond’s lifetime. It is rather like a fixed-rate mortgage: some of them may be fixed for two years, some for five years, but when that moment arrives you may have to re-fix (or, if you’re a government, reissue the bond) at a far higher level.

The upshot of this is that a government’s vulnerability to a sudden increase in interest costs is largely affected by the amount of extra debt it has to issue to replace these expiring bonds each year – above and beyond the simple increase in its overall level of indebtedness. Which is why I wrote a couple of weeks ago that it was alarming that the IMF had said countries had, in the face of the crisis, taken to borrowing in shorter maturities during the crisis.

What I hadn’t realised was that the UK’s debt market is peculiar. In the US, average length of the existing Treasury bonds was, at recent count, 4.7 years and falling. Because this is such a short maturity, it means the debt has to be rolled over far more often, and at every point the government runs the risk of setting in stone any changes in interest rates. In France, the average maturity is 7.1 years, in Italy 6.9 years, in Germany 6.35 and in Japan 5.7 years.
In Britain, the weighted average maturity of government bonds is a whopping 14.2 years. Admittedly, as the IMF points out this is slightly lower in the wake of the crisis, but it is still significantly longer than any other major economy.

This peculiarity – largely a result of the way Britain’s pensions and savings market is constructed – happens to be one of the few things in the UK’s fiscal favour these days: it means the UK is that little bit more insulated from the chance of a sudden jump in overall debt servicing costs in a way that other major nations simply are not.

Unfortunately, this hardly offsets the simple fact that because the deficit is climbing so rapidly in the next few years, we have to issue a disturbing chunk of new debt for the foreseeable future, so it does little to rule out a crisis. But it is worth bearing in mind given that so many other countries around the world are seeing large increases in their deficits but also having to issue a hell of a lot of new bonds simply to replace the ones that are expiring.

There is a downside, of course, which is that if investors start demanding higher interest rates on government bonds, and if we issue a lot of long-dated stuff, those high rates will still have to be paid off many years into the future.

Still, this is an important and underappreciated issue with extremely important consequences. This coming week, the Debt Management Office is set to issue the longest-dated normal gilt in history, with an expiry date in 2060, by which time, one presumes, most in the DMO will be long dead. Whether this is enough to protect the UK from a funding crisis remains to be seen.

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