Austerity packing a punch in the UK

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At we reach the back end of this year, UK property prices are having a proper reality check as austerity and Europe’s debt crisis combine to curtail spending down on all but the bare essentials. According to the property website Rightmove, asking prices dropped by 2.7% this month, after a 3.1% decline in November.

Over the second half of this year, average property prices fell by 6%. It would have looked a great deal worse if not for the resilience of London prices, down less than 1% since the middle of the year although in the last two months they have fallen by 3.4%. Separately, retailers generally confirm that the climate has been ‘challenging’ which, translated, means utterly miserable. The City will have been be startled by the report in the Sunday Telegraph claiming that RBS could cut its investment banking division in half.

RBS has already announced job cuts of 30,000 since the global financial crisis struck in 2008. Heading into 2012, the UK looks just like nearly all other countries in Europe – on the edge of recession.

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Commentary

More strain in Spain. Spain’s new Prime Minister Rajoy reaffirmed the enormity of the task he faces in a wide-ranging speech yesterday which laid out his plans for government once he takes the reins on Wednesday. Claiming that the outlook for Spain “couldn’t be darker”, and that the country risked “being left behind”, Rajoy undertook to raise pensions, profoundly alter labour laws, revolutionise public administration and deliver a budget by March. With public debt to reach 79% of GDP by the end this year, Rajoy suggested that the budget deficit needed to be cut by at least EUR 16.5bln next year in order to reach the 4.4% target mandated for 2012. Apparently, urgent fiscal initiatives will be implemented by the end of this year. Also, Rajoy wants to see a constitutional amendment sanctioning balanced budgets approved by Parliament as soon as possible. The rating agencies are growing impatient. Fitch placed Spain on review for a possible downgrade on Friday. It is an unenviable situation for Rajoy. The unemployment rate is an incredible 23%, property prices are plunging, regional government finances are a mess and beyond his control, and bad debts continue to mount. Notwithstanding what was another decent day for Spanish bond yields yesterday, Europe’s fifth largest economy remains in intensive care.

Getting tougher in China. Policy-makers in China are being confronted with a myriad of challenges over the course of this festive season. In the first instance, they are trying to contain what has become a constant outflow of capital since the end of the third quarter. With foreign investors repatriating capital at the fastest pace for 11 years, the currency has been under sustained pressure, necessitating continual dollar sales by the PBOC from its monstrous stockpile of foreign exchange reserves in order to keep the yuan reasonably stable. If left to their own devices, policy officials might actually be prepared to allow the currency to depreciate slightly given the strength of the dollar, the narrowing trade gap and the reduced international appetite for yuan. However, the Chinese currency remains an international political hot-potato, especially now that the 2012 US Presidential campaign is underway. Secondly, it is clear that house prices are responding to the tighter credit conditions imposed over the course of this year. Overnight, the government produced some statistics that showed that 49 of China’s 70 largest cities registered a decline in house prices last month after a similar decline for half of these cities in October. Particularly effective in taking some of the froth out of the housing market has been the requirement to raise required deposits on mortgages, as well as restrictions on home purchases in 40 of the country’s largest cities. Developers in China have been hit hard, with sales down sharply in the second half of this year. Finally, and not surprisingly, China’s debt mountain is likely much larger than has been officially reported. According to some research done by Bloomberg, 231 local government financing companies that sold bonds had debt outstanding of four trillion yuan (around USD 630bln) up until very recently. However, the National Audit Office claimed back in June that total debt outstanding of these types of entities (of which there were 6,576) was five trillion yuan. In other words, 231 of the 6,576 entities (3.5%), accounted for 75% of the debt, which seems incongruous. It is the local authorities that undertake most of the infrastructure investment in China. Regulators and senior banking officials are now issuing louder warnings on the state of local government finances and the systemic risk that it poses. For now, policy-makers seem relatively relaxed about property prices declining – indeed, they appear to welcome it. And the currency question is manageable, given the massive reserves’ mountain. However, if foreign investors continue to exit from China at the pace they have been recently, then this will significantly tighten monetary policy at a time when financial conditions are already fairly restrictive. It will also accentuate the problem of mounting bad debts. China bears very close watching over the next few months.

The new EU monster. As things stand at the moment, the main winners from the EU summit earlier in the month appear to be lawyers, translators and the maker’s of large tables around which 26 or 27 people can meet.  This is not something that should be welcomed. Indeed, it comes at a time when rating’s agencies are becoming increasingly frustrated but also sensitive to the political process and how it can impact the longer-term budgetary outlook. As such, the way things are developing suggest things will get worse on this front. Right now, the path on which the EU is headed appears to be one based on setting up a number of parallel institutions, either working within or alongside current EU institutions, to police the new fiscal rules. France appears to be pushing hard for this new set-up, in other words a new inter-governmental agreement that does not require a totally new EU treaty. This development reminds me of a sign in a church vestry I saw years ago.  Above a picture of Jesus were the words “God so loved the world, he didn’t send a committee”.  Of course, the point is not a religious one; it’s merely that committees don’t offer a stream-lined process of decision making.  Furthermore, for the most part they don’t make radical or unpopular (but usually necessary) decisions, even more so when their members are answerable to domestic electorates. It’s been notable that regarding the US downgrade earlier this year and in the recent S&P warnings on Europe, the political process has been a key determinant in the change of view, or risk thereof.  But in Europe this remains a valid response and the way the current fiscal stability treaty is headed, with more layers of institutions and oversight.  Furthermore, it’s the EU’s already over-burdened and ill-equipped institutions that have contributed to the piece-meal approach to solving the current crisis.  As well as falling short of mapping out a path towards fiscal union, the EU summit has created a political and institutional monster which may please lawyers and translators, but won’t please markets.

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