A taxing time in the UK

April 25, 2009 — Mitul Kotecha

It has been a truly gloomy week for the UK economy.    Firstly there was the shock budget announced by UK Chancellor Darling in which the scale of UK borrowing requirements became worryingly clear.  To summarise briefly the government expects tax revenue to come in at around £175 billion or a whopping 12.4% below public spending in this fiscal year.   What’s more the bulk of this is structural or persistent so will not be erased without adding another layer of taxes. 

It will take several years to reduce the budget gap according to the budget estimates, with the government predicting that the deficit as a percent of national income will drop to 1.2% by 2017-18 but this relies on highly ambitious forecasts.  The scale of government borrowing required and the reliance on government bonds to bridge the gap is worrying enough and has caught the attention of ratings agencies.   It also effectively rules out further stimulus should the economy turn even more sour than expected or if anticipated recovery does not take effect.    

The bigger problem is that the deficit reduction plans bank on highly optimistic and probably downright unrealistic growth growth forecasts.    This was demonstrated by data released shortly after the budget announcement revealing that the economy shrank by a much bigger than expected 1.9% in the first quarter of this year,  the worst growth outurn since the third quarter of 1979.    So much for hopes that the worst was over at the end of last year.   Although the government has said that this does not alter their budget forecasts, as they are based on growth for future months, it does reveal that they vastly underestimated the depth of the recession in the UK.  

Even the forecasts for economic growth in the next few years look highly ambitious with the pace of contraction forecast to ease over coming quarters and stabilise by year end.   Further out, if growth does not pick up as forecast there is a real risk that not only will tax rates not be reduced for several years but that the UK taxpayer is destined for even higher taxes for years to come.     

There has much press on the increase in the high rate of income tax from 40% to 50% but the reality is that this will only bring in a small amount of revenue and will do little to close the gap between spending and tax revenues.   It will require a substantial easing in spending for the government’s plans to have any validity.  It appears that the aftermath of the bursting of the debt fueled consumer spending bubble is still being felt and will continue to do so for years to come, much to the expense of the taxpayer.

Posted in Bond markets, Economics, Financial crisis, UK. Tags: , , . 1 Comment »

Q1 earnings in focus

April 10, 2009 — Mitul Kotecha

Equity markets have continued their ascent albeit with continuing volatility around the Q1 earnings season. Other indicators of market stress have also improved whilst bond yields haved edged higher. Next week will test the markets optimism with a plethora of banks set to release their results for the past quarter. Wells Fargo provided a boost to financials today with its earnings report. Banks will benefit from the changes to mark to market accounting regulations allowing banks more flexibility in valuing their dodgy assets. Although I am somewhat concerned about the political push for the change in these accounting rules it will no doubt ease some of the pressure on banks and their estimates of writedowns.

Meanwhile the economic news continues to be less negative as the bigger than expected narrowing in the US trade deficit reveals. This adds to the run of better than expected numbers over recent weeks that is perhaps showing that the pace of economic deterioration globally is easing. The economic news has also contributed to the better tone to equities and improvement in risk appetite.

Action to prevent the economic and financial crisis from deepening is also creating a floor under markets. The Bank of England left interest rates unchanged but maintained its commitment to conduct asset purchases having done around 1/3 of the planned GBP 75 billion so far, with the remainder to be undertaken over the next couple of months. Elsewhere Japan will provide further fiscal stimulus to boost its flagging economy although the unstable political situation could yet derail such plans. Nonetheless, the picture is clear as policy makers continue their battle to boost sentiment and thaw credit markets.

If markets can get through Q1 earnings without a major set back there maybe hope that the rally really has got legs. I still think there is a whiff of a bear market rally going on but I would happy to be proved wrong.

Posted in Bond markets, central banks, Currencies, Economics, equity markets, Financial crisis, UK, US. Tags: , , , , , , . 1 Comment »

Fed throwing everything but the kitchen sink at the crisis

March 20, 2009 — Mitul Kotecha

The aftermath of the Fed’s surprise decision to buy US Treasuries was dramatic across markets, with Treasury yields dropping, equities rallying and the dollar sliding. The Fed has now moved from what was initially credit easing to full blown quantitative easing. Effectively the Fed is throwing everything but the kitchen sink at the problem and is arguably the most aggressive central bank at present.

What are the implications:

1) Equities like the news and it helped extend a rally that had been in effect for a couple of weeks. But the momentum is likely to run out quickly as the bad news starts to filter back into the market once again.

2) Commodity prices rallied, especially gold. Why? Inflation concerns intensified following the Fed move due to the risk that the Fed will not be able to end it’s programme of “printing money” quickly once the economy starts to turn around. Commodities are set to rally further.

3) The dollar dropped like a stone, and although it is difficult to see it regaining much ground in the wake of a central bank that flushing the market with dollars, its falls looks overdone. For now, the dollar looks like it has entered new weaker currencies and may even benefit if the market appetite for risk declines again.

4) Other central banks in particular the European central bank will be under huge pressure to follow the Fed. The Bank of England, Bank of Japan and Swiss National Bank have already moved but not as aggressively as the Fed. So far the ECB has been reluctant to act and technical issues mean that it can’t act in the same way as the Fed. Nonetheless, the rise in the euro means that something may need to be done and quickly.

5) The move by the Fed shows that policy makers are doing all they can to turn things around, but this is merely a reflection of the severity of the crisis. Economic recovery is still some months away

Posted in Bond markets, central banks, Commodities, Currencies, Economics, equity markets. Tags: , , . Leave a Comment »
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