Market Bulletin - A positive negative
The Bank of England confirms deflation expectations, as eurozone brinkmanship pushes Greece to the edge.
Deflation but no downward spiral was the message from governor Mark Carney, as last week’s quarterly Inflation Report confirmed the Bank of England’s forecast that Britain is heading for a period of falling prices for the first time since current records began in 1989. Hailing the sharp fall in oil prices as “unambiguously good” for economic growth, and the main reason for the recent spell of low inflation, the Bank expects inflation to remain close to zero for the rest of 2015 and to turn negative in the first half of the year.
However, Carney stressed that a period of “good deflation”, which would help sustain the recovery and keep wages growing faster than prices, did not signal that Britain was entering a protracted period of deflation. The Bank expects the effect of low oil prices to wear off after a year and Consumer Price Index (CPI) inflation to return to its 2% target within two years. It anticipates that the increase in household income will boost consumer spending growth to 3.75% this year, and maintained its forecast that the economy would expand by 2.9% in 2015, its strongest growth in nine years. In a speech last week, Prime Minister David Cameron again urged business leaders to pass on the benefits of growth in the economy by boosting workers’ wage packets to help maintain the recovery.
Although considered unlikely, Mr Carney stressed that the Bank had many options available should inflation remain stubbornly below target, which could include an extension of its asset-purchase programme or even a further cut in interest rates. As it stands, markets are anticipating that the first move in interest rates will be a rise in summer 2016, but that rates will not rise to 1.5% until 2020.
In a further demonstration of the determination of central banks to prevent deflation strengthening its grip over European economies, Sweden’s Riksbank on Thursday became the first to set a negative main ‘repo’ interest rate – the rate at which a central bank lends to commercial banks in the event of any shortfall in funds – and also launched its own form of quantitative easing. Headline inflation in Sweden has been negative for much of the past two years, and the move follows four rate cuts in 18 days by the Danish central bank. The moves highlight the difficulty for small, independent central banks in controlling their monetary policies in the face of the ‘tidal waves’ created by the actions of the likes of the European Central Bank, US Federal Reserve and Bank of England.
First to blink
Elsewhere in Europe, the brinkmanship that typifies eurozone politics was in full swing last week as talks between the Greek finance minister and his eurozone counterparts over the terms of the country’s bailout deal broke down on Wednesday without agreement. On Thursday the ECB extended another €5 billion in emergency loans to banks in Greece, following fears that a spate of withdrawals could leave the country’s lenders short of funding.
Arriving at a conference with other EU leaders, German Chancellor Angela Merkel stressed that “Europe’s credibility depends on us sticking to the rules”, but that “compromises are made when the advantages outweigh the disadvantages and Germany is prepared to compromise”. At the same EU summit, David Cameron warned Alexis Tsipras, the Greek prime minister, that he must make peace with Germany and the eurozone before market turbulence and political uncertainty damaged Europe’s growth prospects. Brussels is the capital of late-night compromises, but this time it was different.
Failure to agree a solution will leave Greece with no financial support in just over two weeks but, as it stands, the new Greek government will not agree to extend the existing bailout – an agreement against which it campaigned so strongly. Athens said it would make every effort to reach a deal at Monday’s scheduled EU finance ministers meetings, and the hope is that officials should be able to achieve a compromise that keeps Greece in the eurozone while also providing debt relief and an easing of austerity.
Neil Woodford of Woodford Investment Management sympathises with Greece’s new government. He believes that Germany’s steadfast refusal to write off any more debt could cause “problems” and that Greece’s lenders were just as irresponsible as the country itself. “It’s ludicrous to think that Greece can function as a democracy and repay debt that’s 180% of GDP,” commented Woodford. “It’s almost sadistic to require it to do so and I think it’s undemocratic and wrong.” Others are less sympathetic to the country’s cause, citing the current challenges as the inevitable hangover from using the debt to support a bloated and overpaid civil service, an untenably early retirement age, and a laissez-faire attitude to paying and collecting taxes.
Despite the impasse in negotiations over the Greek debt and wariness about the fragile ceasefire agreement for Ukraine, global equity markets ended the week in a positive mood, boosted by better-than-expected fourth-quarter growth figures of 0.3% for the eurozone economy that gave hope of an ongoing recovery in 2015. For 2014 as a whole, the region achieved 0.9% growth – the fastest rate since 2011. Only three of the 18 member states – Greece, Finland and Cyprus – recorded a contraction in the final quarter. Germany and Spain surprised on the upside as both reported 0.7% growth over the period. Economists suggested that cheaper oil, a weaker euro exchange rate and the government bond-buying by the ECB should all help Germany – the largest economy in the eurozone – more than offset the short-term risks such as the Greek and Russian situations.
Germany’s Xetra DAX index briefly moved above 11,000 for the first time, whilst the FTSEurofirst 300 finished with its best close since January 2008, up 0.8% on the week. The FTSE 100 index ended the week at a five-month high and less than 2% below its record peak, as mining and energy stocks got a lift from rising commodity prices. In New York, the benchmark S&P 500 index was up 1.8% over the week to end on a record high, with traders also cheered by a generally positive earnings season.
Last week’s launch of Pension Wise, the government’s retirement guidance website, marked another step on the journey towards April’s brave new world of pension freedom, and prompted more speculation as to the nation’s readiness for the choices and challenges it faces. Any help for consumers should be welcomed; however some experts were quick to suggest that some of the information was misleading and could give consumers the wrong impression of the cost and tax implications of the new freedoms. A leading pension provider underlined fears that retirees will overlook the need for guidance and expert advice when it reported that only 2% of its customers made contact with the free pensions guidance service – The Pensions Advisory Service – after being prompted to do so in packs sent out in the last quarter of 2014.
Meanwhile, the Liberal Democrat pensions minister, Steve Webb, provided an insight into the possible future direction of policy on pensions tax relief when he announced proposals for a flat rate of 33%. “For every £2 you put in a pension, the government will put in £1,” he explained. Webb said the current system of giving savers relief at their highest rate of Income Tax only incentivised “the wealthy who will save anyway”. Labour plans to restrict tax relief for 45% taxpayers to just 20%. As we have said before, faced with many uncertainties in the future, savers and investors can only plan and act on the basis of what they know, and should take advantage of the tax reliefs available now.
Woodford Investment Management is a fund manager for St. James’s Place.
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