MORE QE ON THE CARDS TO BOLSTER UK
JANE FOLEY
RESEARCH DIRECTOR, FOREX.COM
the release of stronger-than-expected US GDP data last week and favourable confidence numbers from the eurozone highlight the position of the UK as being one of the weakest economies in the G10. There is a strong chance that this week’s Bank of England Monetary Policy Committee (MPC) meeting will bring yet another dose of quantitative easing to try to to remedy this situation; a policy which has weighed on the pound since its introduction last March.
Although sterling is considered to be undervalued against the euro, the UK economy has remained in recession while the Eurozone recovery appears to have stayed on track, which suggests that euro-sterling could remain elevated for some months to come.
The substantial cost of bank bailouts following the financial crisis has clearly put the UK economy at a disadvantage to the Eurozone. But it wasn’t just the balance sheets of British banks that were exposed: those of UK consumers are in equally poor shape heading into the financial crisis and the repairing process could hinder consumption and growth for years.
Last week Eurostat reported that the household savings rate (savings as a percentage of disposable income) in the Euro Area stood at 16.5 per cent in the second quarter of 2009 – the highest rate since the series began in the first quarter of 1999.
An increase in the savings rate is natural at this point of the economic cycle and it shows that consumers are looking to protect themselves from the increased threat of unemployment and are saving more to make up for wealth lost during the financial crisis.
In the second quarter of 2009, the UK savings rate rose to its highest level for several years after hitting a low in the first quarter of 2008. That said, there are striking differences between the savings rates of the UK and the Eurozone. The second quarter high in the UK rate is a relatively moderate 5.6 per cent.
DEPRESSED CONSUMPTION
The British consumer has been hit hard by the loss of wealth tied up in housing and if the UK’s saving rate was to rise to even half of that in the Eurozone, this will severely depress consumption levels.
The lessons of the crisis have led to a tightening in UK credit in favour of a more prudent system and this has forced down the level of net new consumer credit.
The negative numbers posted for consumer credit in the three months to September suggest that UK consumers are paying back debt rather than taking out new credit arrangements.
Credit can be a significant supplement to household income, so the decline in net credit tells the same story as the rise in the savings rate – namely that consumers are entering a phase of reduced consumption. Fiscal incentives will continue to lend support for the rest of the year, but government policies will turn towards reducing the deficit in 2010, which will undermine the recovery further.
REPAIRING PROCESS
The repairing process in consumers’ balance sheets will help address the current account deficit. However, the implications for domestic demand are dismal and this will put the focus back on the exchange rate. The weaker pound implies the potential for more support for economic growth from the external sector.
There have been accusations that Bank of England governor Mervyn King has manipulated the currency lower to benefit from an export cushion. More support for the British economy may come further down the road from the UK’s flexible labour market, which suggests that once unemployment starts to drop, it is likely to do so at a faster pace in the UK than in Germany or in France.
While UK fundamentals remain very poor, there appears to be a lot of hope in the market that the dismal third quarter GDP number will be revised higher on 25 November, as indicated by the better news from recent UK services PMI survey – the next services PMI is out on Wednesday.
This expectation has already helped euro-sterling push below the level held prior to the GDP release, suggesting the market has already priced in an upward revision. However, on 13 November Germany and France will release their third quarter GDP reports and if these figures confirm that the Eurozone recovery remains on track, then euro-sterling could push back above 0.90p.
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