Let Battle Commence

So the lines are drawn. In one corner sits Confederation of British Industry director general John Cridland saying that the Government would be ‘barking mad’ to push forward with plans to ring fence UK banks given current grim economic conditions. And in the other corner sits the Chancellor George Osborne and Vince Cable taking Mr Cridland to task signalling their backing for the ring fencing plan.

It will be interesting to see what comes out of the final report to be presented by the Independent Commission on Banking (ICB) on September 12. Its provisional prescription for higher capital requirements, bail in provisions and a measure of separation between retail and investment banking has certainly shaken up the banking industry.

I can see both sides of the argument and whilst I agree that the timing isn’t ideal, my view is that short term pain is needed for long term gain and these suggestions are pragmatic and necessary.

Of course there will be huge amount of costs and disruption in setting up a new system with potentially higher funding costs which could ultimately get passed on to the consumer. It’s natural for banks to recoil against any change to the way they operate. So what will it mean for the mortgage industry in terms of supply of credit and cost of funds?

Difficult to answer and as usual there are two sides to this. By separating the investment bank activity from the ‘normal’ banking you take away the cross benefit to the retail bank from investment banking activities. How so? Investment banking allows banks to run a significantly leveraged model through trading and derivative activities which require significantly less capital than lending to you or me. The profits to be made are huge and across an integrated bank these allow the bank to maintain efficient balance sheet ratios and subsidise costs of lending activities.

So without these ‘subsidies’ the costs are likely to go up for the consumer at least in the short term. But you have to look to the future.  By taking away these other profitable albeit racier activities you remove a good degree of risk to banks.

The solution is to be realistic and pace its implementation. If we take the opportunity now to make these changes, over the longer term we will be left with a more robust financial system and ultimately it will be in the taxpayer’s interest.

Life's a Riot

So we have more gloomy economic data to contend with on top of the riots and turmoil in the markets? Manufacturing data fell by 0.4% in June and Britain’s deficit in goods trade with the rest of the world widened from £8.5bn to £8.9bn in June. Not looking good and I guess it’s hardly surprising that we are starting to hear more of the words ‘double dip’ from many analysts. Oh to be in England…! Then again the rest of Europe and the US don’t look so hot either at the moment either.

With this backdrop it is hardly surprising that Mervyn King and his friends at the Bank of England have revised UK growth forecast for the year from an always optimistic 1.8% to a not so healthy 1.4%. I predicted this would happen in June and  sadly I think he may have to revise this forecast down again in the next couple of months; things don’t look to be getting better anytime soon and not only do we have to look at economic data at home but what’s happening overseas also. Surely it’s only time before the Office of Budget and Responsibility will follow suit very soon forecast down from its buoyant forecast of 1.7% for the year. 

For me, I think 1.1% for the year is more likely a figure. And that’s me being optimistic!

The Black Hole

Santander UK recently announced a 21% drop in gross mortgage lending for the first six months of 2011 compared to the same period of 2010 and similarly today Barclays reported a drop of 10% for the same period. Santander said it reflected the weaker pipeline from the last quarter of 2010, representing reduced consumer demand.

I’m led to believe this scenario is not uncommon and other lenders are facing a similar drop in gross mortgage lending for the first six months of the year - and beyond.

Surely therefore this makes the CML’s revised market forecast for 2011 predicting an increase in gross lending to £140bn from £135bn implausible? This seems to go against other data which suggests general stagnation of the market due to severe rationing of funds by lenders and lack of demand from would be buyers prompted by fears of a downturn in the economy including higher unemployment and weaker consumer confidence.

I appreciate that it is sometimes good to talk the market up. However it is very difficult to see exactly where this extra lending is coming from. Methinks another revision is on the horizon.

A change of heart

I’m worried that my blogs are becoming a little predictable with their gloomy outlook on the economy and the world generally. All I seem to do is write bad news stories although arguably I just write about what I see. However even I was starting to get down so this week I wanted to find something positive in the economy to write about. I was determined to find some good news.

And on the face of it I found some.

So three cheers then. The Office of National Statistics claims unemployment is down. And inflation has fallen. I guess therefore we can celebrate and go on a shopping spree down the High Street then.

Sadly not the case. It is true that unemployment has fallen by 26,000 in the three months to May. This is particularly heartening for the 16 - 24 year olds where the latest figures show a drop of 42,000 in the three months to May to 917,000. However looking beyond the headline figures there are more worrying statistics. For example, the claimant count is up rising 24,000 in June to 1.5m, there are 5.4 unemployed people vying for the same job plus there is evidence that most young people are putting off looking for a job and are going back into full-time education which accounts for the drop in figures. (The real test will come in September with the yearly influx of school-leavers and graduates into the market.)

And what of inflation? Well it turns out that the reduction in the CPI was largely due to the early summer sales, with prices for games, toys and audio-visual equipment all falling. The cost of staples – such as bread, meat, fish etc- continue to soar and will add to concerns about household finances. So despite the surprise drop in inflation, economists still reckon CPI is likely to breach 5% in the autumn as higher utility bills kick in. So the analysts say this is a blip.

Ah well. I did try…

It's grim out there

More depressing news from the High Street. According to the British Retail Consortium, shop prices rose at their highest rate for two and a half years in June. This is hardly an inducement to lure would be shoppers back into the stores.

And this follows a run of bad news with Habitat, TJ Hughes, Jane Norman and kitchen and bathroom company Homeform, all having gone into administration. The gravity of the High Street downturn is outlined further in new research published which shows UK retail chains closing stores this year at a rate of about 20 a day. The latest figures from PricewaterhouseCoopers show 375 retailers went bust in the second quarter of 2011, a 9% increase on the same period last year.

So how can we persuade customers to return to the high street?

The simple answer is we can’t, certainly not in the short term. Recent research from the Joseph Rowntree Foundation found that British families need to earn 20% more than they did a year ago to remain out of poverty as the squeeze on household budgets worsens. Any spare funds seem to be earmarked for cutting mortgage debt, as outlined by recent figures from the Bank of England. There is little money left over in the kitty.

It’s fair to say that weak consumer spending has devastated the high street and I fear there is more pain to come. Conditions will remain difficult for some time.

The US Connection

The Federal Reserve has announced that it has cut its growth forecast for the US economy in the face of higher energy prices. It now estimates that the US economy will expand between 2.7%–2.9% this year, down from its April forecast of 3.1%–3.3%.

This follows on the back of recent figures published by the IMF, which has lowered its UK growth forecast expecting growth of only 1.5% this year, well below its 1.7% forecast in April and the 2% it predicted last autumn.

While the US and UK markets are very different, economic indicators across the Atlantic seems to have been plotting a parallel course to its UK counterpart. Of course, these days it is very much a global thing: a crisis in the euro zone can have a huge impact on the US markets via contagion. However I would argue that the UK rather than any of its other euro colleagues mirrors what’s happening in the US, albeit lagging a little way behind. So it’s worth keeping an eye on the US economy. Until their economy picks up we can see little hope of ours making a meaningful recovery.

It's a numbers game!

So where do we think we are on GDP? It’s mightily confusing We’re now being told that economic growth is likely to undershoot the Government’s official forecast for the second quarter in a row after worse than expected figures from Britain’s crucial services sector. Markit, the financial consultancy, reported that businesses experienced a slowdown in growth last month and taken together with poor manufacturing and construction figures the data points to an overall sorry 0.3% between April and June.

So not inspiring confidence is it? Then you have various organisations revising their predictions. The CBI and OBR now expect growth to be 1.7% for 2011 whilst the IMF predicts a lower 1.5%. I have to say that where we stand at the moment with some of the worst austerity measures still to kick in, and declining consumer confidence, these numbers look a tad optimistic. I predict that these forecasts will come down again.

Good news for borrowers though. Whilst economic growth falters it is unlikely that the Bank of England will do anything but hold rates as they are at 0.5%.