Sterling / Euro
The Pound continued to trade downwards yesterday ahead of today’s Emergency Budget.
Chancellor George Osborne will have to perform the difficult balancing act of showing that the UK means business about reducing its debt while not threatening the fragile economic recovery.
In the election campaign the Conservative party made no secret of its desire to slash public spending, though it was careful to be vague about where the axe would fall, and it will also have to bite the bullet and raise taxes. The expectation is that the ratio of cost savings to increased tax revenues will be about four to one.
Osborne toed the party line in a week-end TV interview by repeating the mantra of his leader that “we are all in this together” so it is likely that the tax burden will affect all parts of society, though perhaps the middle classes have the most to fear.
The government has already flagged its intention to hike capital gains tax (CGT) from its present level of 18% to 40% but it is probable that there will be numerous exemptions and taper relief clauses following grumbling from the Tory back benches.
Value Added Tax (VAT) could be increased from 17.5% to 20%, or the number of items which are exempt from VAT could be reduced, or the chancellor could do both of these things. Retailers moaned when the previous chancellor temporarily cut VAT to 15% in an attempt to keep the economy ticking over, and they moaned again when VAT went back up to 17.5% so soon after the busy Christmas trading period and ahead of the January sales, so there is a good chance that any increase in VAT will be delayed to give the retail trade time to adjust their prices.
The departed Labour administration was surprisingly macho about cutting the basic rate of income tax and the political world really will have turned on its head if a Conservative dominated government put up income tax. It is possible, however, given that a two point rise in the basic rate would still leave income tax lower than it was under the last Conservative government, plus they could lump the blame for it on to their Liberal Democrat partners.
More probably the chancellor will bump up the tax-free allowance, with the consensus view being that it will be raised to £10,000 from £6,475, a move that will be of greater benefit to those on low wages. Official forecasts will show George Osborne’s emergency Budget hitting growth and costing jobs in the short term, government sources said last night, but the austerity measures will also create a brighter climate for the economy by the end of the parliament.
In a tough Budget that seeks to over-achieve on plans to eliminate the deficit, Treasury ministers accept that the new and independent Office for Budget Responsibility will mark down the growth and jobs forecasts as government spending falls and taxes rise.
But insiders who have seen the forecasts said that because the OBR will assume this is just a temporary shortfall of growth, the effect will be to increase spare capacity in the economy, creating room for a faster growth forecast just before the next election.
On a quiet day for data, property website Rightmove reported that House price inflation eased in June, with asking prices up by 0.3% on average, down from a gain of 0.7% in May as a wave of new houses came onto the market.
The online agent estimates there was a 22% increase in sellers coming to the market in June following suspension of home information packs with a large chunk of these still unsold.
The annual rate of inflation picked up from 4.3% to 5%, but Rightmove expects this to ease back as conditions get tougher later in the year.
Sellers and tenants face tougher times as deficit reduction measures, such as rumoured CGT increases, disrupt the fragile housing recovery, it said.
Rightmove’s commercial director Miles Shipside added that a continued dearth of mortgage availability and a recent surge in sellers will also knock confidence.
“These factors are likely to put an end to this year’s recovery in house prices,” Shipside said.
In Brussels, European Central Bank President Jean-Claude Trichet said governments in breach of European Union fiscal rules could face tougher punishment including the withdrawal of voting rights.
“A wider spectrum of financial sanctions needs to be considered, along with non-financial and procedural sanctions, such as more stringent reporting requirements or even a limitation or suspension of voting rights,” Trichet told lawmakers in Brussels today. The ECB’s chief also said that governments could consider changing the euro’s founding treaty.
EU officials are devising new fiscal rules to prevent a repeat of the European sovereign debt crisis, which was sparked when Greece’s budget spiraled out of control and forced it to seek an EU-led bailout. European leaders plan to outline the strengthened enforcement system by October after hammering out a $929 billion rescue program last month.
Trichet said governments should explore every route that “the legislation of Europe permits” to toughen EU rules. Beyond that “we could reflect on changing the Treaty.” The last revision to the EU’s treaties, signed in Lisbon, took eight years to negotiate and ratify.
The ECB last week published a document ruling out expulsion from the euro region as the ultimate penalty “because the very existence of this option would put the viability of the common currency into question and would thus not be seen as credible.”
Sterling / US Dollar
The pound initially made gains against the dollar as risk appetite was back on the agenda following the weekend action by the People’s Bank of China thus reducing the safe haven status of the dollar.
The Chinese authorities allowed the renminbi to appreciate modestly on Monday in the first day of trading since the end of the near-two-year currency peg with the US dollar was announced.
The central bank left the reference rate for trading of the currency unchanged in the morning, but the renminbi strengthened and was up 0.43 per cent at one point. The currency is allowed to trade 0.5 per cent above or below the reference mid-point every day.
Had Beijing not wished the currency to appreciate by that much, it could have asked the People’s Bank of China to intervene in the market.
Chinese central bank announced the shift in policy in a statement on Saturday.
However, in a follow-up statement on Sunday, it stressed that a substantial appreciation in the currency was “not in China’s interests” and that the exchange rate would remain “basically stable”.
Beijing’s statements appear to be a delicate political compromise aimed at defusing the mounting international criticism of its exchange rate, especially in the US, while reflecting the lack of domestic support for a significantly stronger currency given the ongoing problems in Europe.
Even with the modest appreciation on Monday, many asset markets round the world rallied, in part because they interpreted the decision as a sign of Chinese confidence in the global economy but also because it considerably reduces the chance that the tensions surrounding the level of the renminbi will spiral into a global trade war.
To put things into perspective, China now exports every 6 hours what it did in the whole of 1978!
The morning optimism from the Chinese move soon gave way to renewed fears about the health of the European banking system after a senior official stated that European financial institutions face mounting funding difficulties.
World stock markets, which had started the day brightly soon declined with the North American and Far East markets breaking a nine day winning streak.
This increased the appeal of the dollar as a safe haven and the dollar made late gains against the pound, Euro and Yen which continue to this morning.
GBP/High Yielding Currencies
The Chinese move improved sentiment and thus risk appetite with the high yielding currencies, principally the Australian dollar; New Zealand Dollar and South African Rand making gains against both GBP and the Euro as commodity prices jumped on renewed hope that the worldwide economic recovery would continue.
With today’s budget in the UK likely to dampen the appeal of the pound, further gains, at least until the Federal Reserve rate meeting in the US on Wednesday evening (UK time), are in the offing.
Data Released 22nd June
GER 09:00 – Ifo Index (June)
EU 9:00 – Current Account (April)
U.K 12:30 – Emergency Budget
US 15:00 – Existing Home Sales (May)
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