Tag Archives: Bank of England

Britain, Economic, Financial Markets, Government, Politics

UK economy: Growth is returning and the signs are promising…

SPENDING REVIEW

The Chancellor, George Osborne, is determined to stick to his guns, with yet another £11.5 billion of budget cuts to be delivered in an election year. Some may say this is a massive gamble for a Conservative Chancellor who will wish to see his party elected at the next general election.

But the Chancellor has to retain the confidence of the financial markets by showing he is willing to tackle the legacy of deficit and vast levels of debt left by Labour.

If the markets no longer have confidence in the economy, Britain’s low interest rates, which are so vital a component to recovery and growth, will come to a shuddering-halt. If that was to happen, many would face financial disaster.

The first fruits of Mr Osborne’s determined approach is seen in the latest publication from the Office of National Statistics which has presented its revisions of gross domestic product (GDP), the key measure of the total output of the economy.

After a dreadful couple of years, the economy appears to be genuinely on the mend. In the first three months of this year it recovered healthily, despite some poor weather which usually slows down performance, but this trend is confirmed by all the major economic indicators and surveys.

The influential National Institute of Economic and Social Research, an often stringent critic of the government, says that output expanded by 0.6 per cent in the last three full calendar months.

This means that the ‘modest recovery’, often referred to by the retiring Bank of England Governor Mervyn King, is well and truly underway.

Earlier estimates of GDP underplayed the actual health of the economy. Early estimates of construction activity, for example, fell short of the true picture. Building programmes ranging from shopping centres in Leeds, to new office towers in the City of London, as well as new homes being built across the land is evidence of that.

The building industry certainly looks to be doing much better than was previously thought. It is this improvement – together with a formidable robust service sector, sharply better production from the North Sea, and higher export levels (especially to America) – that is turning the economy round.

According to fund managers Henderson of the City of London there has been a strong pick-up in the amount of money circulating in the economy. They suggest that, on current trends, the UK could be among the fastest-growing leading Western nations this year, expanding by a remarkable 2 per cent.

In his House of Commons address, Mr Osborne hinted at the underlying strength of the economy. He pointed out that for every one public sector job that has been lost as a result of austerity and cost cutting, another five have been created in the private sector.

Essential to the delivery of continuing growth, however, will be the discovery of new markets for Britain’s goods and services – not least because of the appalling health of the economies of our major trading partners in the European Union.

The Chancellor said that one of the keys to this will be a ‘strengthening of trade and investment links with China’. As a spending priority, the Government is planning to work with Britain’s exporters to set up a series of centres to promote British goods and services in China’s fastest-growing cities. Switching the focus from Europe to the new wealth-creating economies of Asia is going to be critical for our continuing recovery.

In the meantime, however, it is Britain’s close trading and financial relationship with the United States and its recovering economy that is proving most important to export-led growth. Exports of both goods and services to the U.S. have been climbing strongly in recent months.

Amid the intense interest with what is going on in Brussels and the eurozone, it is often forgotten that America is by far our most important single marketplace. The UK exports to the U.S. everything from Rolls-Royce engines to defence equipment as well as music made by British iconic figures in our pop industry.

No one, though, should underestimate the task of what the government is faced with in building up the economy to the peak it reached before the 2008 financial crisis.

The UK’s debt is continuing to climb despite the cuts and will not reach its height until 2016, when it will be the equivalent of an alarming 93.2 per cent of the nation’s output according to the latest IMF forecast.

If items such as public sector pension liabilities, which are hidden from the country’s balance sheet, are included, our debts will actually exceed national output in 2016. The Chancellor’s latest reductions in spending, in fact, represent less than 0.1 per cent of the national debt as projected in the year 2015-16.

The Chancellor’s trimming of the national budget, despite the hysteria of hard-hitting cuts, is no more than a holding operation designed to stabilise market confidence between now and the election.

The arrival nest week of the new Bank of England Governor, Mark Carney, poached from the Bank of Canada, has the task of not just keeping inflation close to the Government’s 2 per cent target but also to support growth.

Now that the housing market finally appears to be recovering from the shock of the financial crisis, and more small and medium-sized businesses are taking out bank loans to expand, any increase in interest rates by Mr Carney would be the last thing the Treasury needs. Mr Carney will chair his first meeting of the interest-rate-setting Monetary Policy Committee next week and will set in place the new mandate for the Bank of England as outlined in the budget.

Mervyn King has warned of the dangers this would pose in terms of homeowners struggling to pay mortgages and the loss of confidence in business circles.

The financial markets, it should be remembered, are still extremely jittery. The mere suggestion last week that the United States might curb its huge amounts of quantitative easing (Q.E.) – or printing money – sent share prices crashing across the globe. Mr Carney will want to prevent that happening at all costs, as will the Chancellor.

State spending reductions, while necessary and essential to calm the markets, can only make a small dent in Britain’s deficit and debt. It is higher-than-expected growth that could radically alter the picture.

The greater the output of the economy, the more taxes are paid – and the less money is paid out in welfare benefits because so many more people are employed.

If Mr Osborne can deliver sustained growth by the election, he would then be in a strong position to be even more radical, by taking a long-overdue axe to Britain’s mammoth social security bill – by removing, for example, many generous benefits to wealthy pensioners – and put the economy on a path to true prosperity.

 

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Banking, Britain, Economic, Finance, Government

Meddling and mismanagement at the Co-operative Bank…

The Co-operative Bank has unveiled a rescue plan to plug a £1.5 billion black hole that will see the mutually-owned lender trade shares on the stock exchange for the first time in its 169-year history.

The group needs to repair a balance sheet ravaged by bad loans taken on when it merged with Britannia Building Society in 2009.

The bank said £1 billion of the cash will come from the bank’s junior bondholders, who will see much of their debt turned into equity in the ailing bank, which serves some 4.7 million customers.

The deal, to be completed in October, is expected to see around 25 per cent of the bank traded on the London Stock Exchange.

Euan Sutherland, the Co-op Group’s Chief Executive, said that this rescue plan is a comprehensive solution which seeks to be fair to all parties. Mr Sutherland says this will not mean the core values the Co-op have held as a mutual will change when the bank is traded.

Around 7,000 small investors in the £1.3 billion junior Co-op bond will be affected by the debt-for-equity swap. The bank will pay for their financial advice as they plan on what to do next.

The plan is known as a ‘bail-in’ process, which draws funds from bondholders as opposed to the bank bail-outs of 2007-08, which saw billions of taxpayers cash pumped into lenders such as the Royal Bank of Scotland and Northern Rock. The Co-op will find the other £500 million it needs to fill its funding gap by selling a range of financial services firms to rivals.

Earlier this month the Royal London mutual agreed to buy the Co-op’s life assurance and asset management unit for £219 million.

It is believed the bank will shrink its balance sheet by focussing on activities it perceived as being good before the Britannia acquisition. This will include the firm concentrating on lending to individual customers and small businesses. The bank will also boost IT spending in an effort to build its online banking unit, Smile.

The bank believes the deal will give the firm a core tier 1 capital ratio – a key measure of balance sheet strength and liquidity – of 9 per cent by the end of the year. Banking regulator the Prudential Regulatory Authority, which backs the deal, says that all UK banks must have a minimum tier 1 capital ratio of 7 per cent by the end of 2013. The troubles at the Co-op stem from its 2009 purchase of Britannia, which has amassed £14.5 billion of bad mortgage and corporate loans.

In March the bank revealed large losses with an announcement a few weeks later of scrapping a plan to buy 632 Lloyds branches. Since then the bank has made sweeping management changes.

COMMENT & ANALYSIS

The implosion at the Co-operative Bank which will wipe out the savings of thousands of smaller investors and trusts is the result of hubris and mismanagement on a mammoth scale.

Instead of the ultimate owners of the bank – the wealthy Co-operative movement – digging into its own treasure chest, it is the bondholders who are being asked to carry the can.

The debacle at the Co-operative Bank is the closest Britain has come to a Cyprus-style rescue in which ordinary investors are made to pay for errors of management and government.

The crisis at the so-called ‘ethical bank’ is the result of political interference in decision-making and inadequate banking disciplines.

This interference and poor decision-making has left a £1.5 billion black hole in the bank’s balance sheet, placed the whole Co-operative movement at risk and created huge uncertainty for the bank’s 4.7 million customers.

Undoubtedly, successive governments have contributed to the crisis. It was Gordon Brown’s administration that sought to back a new ‘super-mutual’ bank as a challenger on the high street.

The Labour Party’s favourite bank, the Co-operative, was chosen as its preferred vehicle and the Government backed a 2009 merger with the much larger Britannia Building Society. Dozens of Labour MPs, including Shadow Chancellor Ed Balls, are sponsored by the Co-op movement.

The Britannia deal turned out to be a disaster. Large numbers of mortgages on the Britannia’s books were rotten and the building society had become embroiled in commercial property deals that went wrong during the recession. Much of this was hidden from public view until George Osborne gave the nod to the Co-operative Bank bid for 632 Lloyd’s branches.

The former Financial Services Authority should have stepped in and made it clear that the Co-op lacked the management and balance sheet resources to enter the big league.

Not surprisingly the deal fell apart when the Co-op revealed heavy property losses and acknowledged it lacked systems to manage the operations of the bank.

It was then that credit ratings agency Moody’s downgraded the bank’s debt to ‘junk’ status. That meant traditional customers, such as local authorities and non-governmental organisations, could no longer safely hold deposits with the bank.

Under the complex rescue package just unveiled by the Co-op after extensive talks with the Bank of England’s Prudential Regulatory Authority watchdog, it is bondholders rather than the Co-op movement who will bear most of the pain.

That has left investors holding bonds angry, disappointed and disillusioned with both the Co-op and the government that allowed this series of catastrophic errors to happen.

As part of its grand plan, the Co-op will no longer pay income to its bondholders, most of whom are retired. Some were being paid as much as 13 per cent in annual interest – or £1,300 for a £10,000 investment.

Instead, in exchange for their bonds, investors will be offered either a cash payoff, shares in the new bank, or new bonds. But they face losing 35p for each £1 of Co-op bonds they hold.

These bonds are a type of investment, and not to be confused with the fixed-rate savings-account bonds offered in branches. Known more specifically as ‘retail bonds’, they are simply an IOU written to investors to raise funds for business growth. But the price of many bonds has halved over the past couple of months, leaving thousands out of pocket. Some £60 million worth of bonds are held by individual investors that have paid an annual rate of interest of 5.5 to 13 per cent.

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