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Economics Weekly - Economic downturn hits UK public finances; Weekly economic data preview - US Fed FOMC meeting & Q1 GDP

Economics Weekly - 27 April 2009

 

For a full analysis of Budget 2009, please visit our

website: www.lloydstsb.com/corporatemarkets

 

Economic downturn hits UK public finances

 

Overview

UK Budget 2009 announcements were as grim as expected. Official borrowing will reach over 12% of the economy in the current financial year, or £175bn. It will fall only slightly in 2010/11 to £173bn, and to 11.9% of the economy if the official forecast of 1.25% growth for 2010 proves correct. If the official growth forecast is not met, however, the actual borrowing outcome in 2010/2011 may be as much or higher than this year. These figures must be seen against the backdrop of a continuing global financial crisis and a world economy in synchronised recession, making it the worst downturn since the 1940s. In spite of the efforts to mitigate the effect of the current crisis, it is still not even clear that the worst is yet over. This is the context for the big increases in public sector government borrowing that were announced in the 2009 Budget. When will recession end and borrowing start falling? From the Budget details, the next two years are assumed to be the worst and so borrowing only starts to fall steeply from 2011/12 as economic growth is assumed to rise by 3.5% in 2011. There will likely be vigorous debate about whether the medium term projection is one that sets out a path to sustainable deficits. However, the official assumption is that by 2013/14, government borrowing is down to 5.5% of gdp from a peak of over 12% this year and balance is achieved by 2017/18. This is based on tough spending control and assumptions about strong economic growth, efficiency savings and fiscal drag.

 

Fiscal outlook

The economic downturn is squeezing tax revenues whilst at the same time boosting spending, as unemployment rises. The increase in the Budget deficit to 12% of the economy is a consequence of this, as efforts to rein in the deficit while the recession is ongoing, say through tax rises or spending cuts, would simply make the downturn in the economy worse and ultimately raise the deficit even more. This is partly why it is assumed that public spending growth will slow sharply after trend growth returns, to 0.7% from 2011/12, after a rise of 1.2% this fiscal year and next. But the outlook for the public finances is grim, with net borrowing of 12.4% of the economy this year and 11.9% in 2010/11. By 2013/14, the deficit is projected to decline to 5.5% of the economy, partly a result of an economic assumption that sees growth of 3.5% in 2011 and 2¾% growth a year thereafter. Net debt as a share of the economy is projected to fall back from a 79% peak, from 2013/14 onwards. The stance of the public sector in the medium term is geared towards a net tightening position, as tax revenues rise as a share of the economy though not enough by itself to achieve stability without other assumptions.

 

Economic outlook

The UK’s economic outlook is not the worst amongst the top seven developed economies, but the official view from the Treasury is that there will be a contraction of 3.5% this year followed by a recovery next year to 1.25% growth. The forecast is pretty much in line with the consensus for 2009 but above for 2010. Much of the reduction in the ratios of borrowing and debt in the medium term projections is dependant on the Treasury forecast for economic growth being proved correct. Inflation is set to stay low for this year and next; exports to rise as the pound stays weak and consumer spending to weaken as unemployment rises.

 

Company and financial market impact

The business specific measures announced in Budget 2009 were aimed at protecting hi tech or ‘green’ sectors, autos and housing and related activities but were understandably fairly small in relation to the size of the increase in borrowing set to take place. The financial market impact has been relatively muted so far but the announcement of big increases in government debt and borrowing may cause further unease in gilts and foreign exchange markets unless they are convinced that the deficits will come down.

 

Although it is still too early to properly assess the financial market reaction to the Budget, we have plotted the performance of some sectors of the market. Chart e shows that the biggest shift since the Budget has been in fixed income markets, where there has been a rise in 10-year bond yields, perhaps due to the size of the borrowing requirement for the year ahead. Since the Budget on Wednesday, the ftse 100 is slightly higher. The trade-weighted index of the pound has been modestly volatile since the Budget but has ended the week slightly lower than it started. Chart e also shows that 3m libor has fallen back somewhat, on the basis perhaps that the official forecast for gdp is in line with the more pessimistic view of independent forecasters, at least for 2009. This means that the likelihood is that short term interest rates will stay lower for longer. However, the final judgement on the Budget is still clearly some way off, as intensive analysis of the Budget is still underway.

Trevor Williams, Chief Economist, Corporate Markets

 

Weekly economic data preview -27 April 2009

 

US Fed FOMC meeting & Q1 GDP

 

Financial market attention will focus on the Fed’s FOMC meeting and US Q1 GDP data on Wednesday, while still awaiting the outcome of the US bank stress testing exercise. In terms of the Fed’s meeting, there seems little more that can be done to loosen monetary policy for now, as official interest rates are 0-0.25% and a scheme to buy up to $300bn of long-term treasuries and expand purchases of agency debt and mortgage backed securities is already underway. Instead, it is likely that the Fed will maintain a wait and see approach, closely monitoring the ongoing economic impact of monetary and fiscal policy measures introduced so far. However, there may be comment on the wider economy, including members’ assessment of the slightly better Fed Beige Book report of economic conditions in the Federal Reserve Districts. We will be looking out for any evidence of a change relative to last month in the Fed’s tone in relation to the pace of the downturn and the risk of deflation. Elsewhere, the BoE publishes its quarterly Asset Purchase Facility report on Monday, while the UK Budget 2009 implications for gilt markets and relative differences in US, UK and Europe Q1 GDP outcomes will continue to be debated intensely in financial markets. On Thursday, the Bank of Japan is likely to hold interest rates at 0.10% as the Japanese economy faces the deepest recession of the major economies this year.

 

􀂄 The UK’s Q1 GDP outcome of a 1.9% contraction, significantly worse than the market consensus forecast of 1.5%, means that market participants will remain keenly focused on lead indicators that may add insight to the Q2 result - whether it will be better or worse - and the timing of eventual recovery. A key question is, will Chancellor Darling be correct in predicting that the UK economy will be growing again by the end of this year or will incoming data be more suggestive of a situation of stabilisation - there may be no clear direction for now? This week, latest housing market-related data are published. Whereas the recent RICS survey showed new buyer enquires increasing for the fifth consecutive month in March and at the fastest pace since September 2003, its balance of actual completed sales has barely improved. What this could imply is that whereas there are cash buyers picking up discounted properties, mortgage-backed purchases remain weak, holding back the wider market. BoE mortgage approvals for March, published Friday, will provide evidence for this - they are likely to rise a little, but stay close to February’s figure of 38,000. Also, the Nationwide publishes its house price index for April - the market consensus forecast is for a monthly fall of 1.2% to partially offset the rise of 0.9% in March. So on balance, with recession deepening in Q1 and growing worries about job security, it is fair to say that the outlook for the housing market remains far from rosy. Also this week, the BoE publishes March M4 growth (final), consumer credit and net mortgage lending figures. GfK consumer confidence and the CBI distributive trades’ surveys are also due.

 

􀂄 We expect US Q1 GDP to have contracted at an annual rate of 5%, slightly better than the 6.3% decline in Q4. Although the detailed composition of GDP is not published in this release, the monthly series is likely to show continued falls in personal income and spending in March. Consumer confidence remains very weak, as highlighted by the University of Michigan confidence survey. The US also publishes the core PCE deflator, the Fed’s preferred inflation measure, which may have stayed at an annual rate of 1.8% in March. The ISM manufacturing survey for April may stabilise at 36, which is still indicative of falling production levels.

 

􀂄 The eurozone economy has been at the forefront of concerns about the depth of recession - GDP could fall by as much as 4% in 2009. The business survey outcomes have been mixed, however, with the ZEW current economic conditions index falling to a low of 91.6 in April, but the economic sentiment index strengthening. In addition, the April PMI manufacturing and services index increased, but both remained well below 50, indicating contracting output. The eurozone unemployment rate for March is published this week and is expected to have risen for the twelfth consecutive month to 8.6% from 8.5% in February, which may further damp consumer confidence.

Nichola James, Senior Economist

 

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

 

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