Wednesday April 22, 2009

British Chancellor, Alistair Darling addresses the House of Commons in London today announcing the need for a further £292 billion ($423.4 billion) over the five fiscal years ending in 2014. Plans to spend more coupled with an increasingly dry well hole of tax revenues brought on by recession mean that the November prediction of a cumulative 2014 deficit of £434 billion is now projected to reach £703 billion. Gilt yields rose while the pound shed more than two pennies against the dollar to stand at $1.4460 before he sat down.

Britain’s 2009 fiscal deficit is now scheduled to come in at £175 billion or 12.4% of GDP. The deficit is the outright largest in the G20, while as a percentage of GDP it exceeds that of the U.S., which is expected to read 12% this year. The news from Chancellor Darling brought Britain’s growth trajectory onto the same page as other forecasters. In November at the tie of the last official forecast he predicted that the British economy would shrink by 1.25% in 2009, but now expects contraction of 3.5%, although signs of growth should be evident by year-end. As far as 2010 is concerned Mr. Darling expects to see a 1.25% growth rate.

The budget summed to a fiscal 2009 (that’s ending in April 2010) giveaway of £5.16 billion but just £100 million by the end of fiscal 2011. By April 2012 the budget should yield a net inflow to HM Treasury of £5.23 billion based on an economic revival and growth in tax receipts. The Chancellor brought forward by one year his plan to tax income above £150,000 ($217,500) at a 50% rate, while taxpayers earning over £100,000 ($145,000) can also expect higher tax rates sooner than they thought. Tax on fuel, alcohol and cigarettes was increased at an above inflation rate, while the Chancellor also sought to stimulate both housing and auto spending with incentives to sell homes valued at less than £175,000 without paying tax, while paying £2,000 to owners of cars older than 10 years to scrap them in exchange for newer vehicles.

It’s hard to criticize the government’s measures at such a dire time for the global economy and with such an open economy as that of Britain whose reliance on the financial services sector is so great, the wrath delivered on the economy also explains the dire state of the budget deficit. But the recent recovery in the fortunes of the pound has now hit a brick wall. The structural nature of the fiscal deficit will be difficult to shake off leaving the path of the pound linked to an unwinding of the fiscal mess, which by anyone’s admission is no longer on the horizon. Last week’s $1.50 against the dollar sure looks like a significant hurdle going forward. Against the euro, the pound is weaker at 89.78 pence.

Ahead of the budget government data revealed a first quarter increase in unemployment of 177,000 jobs bringing the total number of jobless to 2.1 million and the highest since the Labour government rose to power in 1997. The ILO unemployment rate rose as expected today to 6.7%.

The yen rallied sharply this morning following a slowdown in the rate of decline in exports. Pardon our cynicism here, but the fact that the value of annual exports only declined by 45.6% while imports dropped 36.7% hardly seems cause for celebration. Still, in some quarters there is argument that resulting inventory declines will continue to give the appearance of further improvement in the terms of trade. Bottom line, the yen rallied sharply against the dollar to ¥97.90 and against the euro to ¥127.34. Two other factors have assisted the yen lately. The increase in the expected toll of global loan-losses as predicted by the IMF recently from $1 trillion to $4.1 trillion is a further hurdle to the global financial sector, while investors are worried over the results of the stress tests of the 19 U.S. banks under scrutiny.

The equity market appears to be flip-flopping ahead of the results. On the one hand investors took heart from treasury secretary Geithner’s comments to Congress yesterday when he said that the “vast majority” of major U.S. banks won’t require more capital. But investors remain concerned. Rumors have started that the government will also release its stress testing methodology to add a layer of confidence to show there is no fudge. However, if the testing fails to properly assess the value of banks’ impaired assets the market will be swift to place its own value. And if the tests are stringent, investors will be left chasing their tails in the dust.

European government debt rose as a percentage of GDP at the end of 2008 amongst Eurozone members from 66% to 69.3%. More worrisome is the fact that five members broke the Maastricht Agreement as they breached the spending ceiling. France, Spain, Greece, Malta and Ireland all produced budget deficit’s as a proportion of GDP in excess of 3%.