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Economic review of July 2007 
The early summer has been rather more than a damp squib; it has been the wettest on record. While this will have depressed many people, the impact on the economy could be more far-reaching. Food prices are likely to go up (some commentators think by as much as 5%) but this is unlikely to put more than 0.15% on inflation. Some parts of the agricultural sector will be reeling under the loss of crops – although thankfully the massive arable areas of East Anglia appear to have escaped unscathed, this time. In any event agriculture only accounts for some 1% of Gross Domestic Product (GDP).
The principal impact is likely to be on the insurance sector, where estimates of total claims range up to £2.5 billion. Of course, this is what insurance is there for – to collect premiums from the majority of people in order to cover the losses of the minority. Unfortunately, it is unlikely that insurance companies will have anticipated the extent of the floods and this will impact on their profits (and therefore their share prices) which will hit many small investors directly and via their pension funds. It will also inevitably mean that premiums will go up in the future, especially if the incidence of such claims can be expected to rise. This could be yet another inflationary pressure as it will affect business costs, as well as those of consumers. An interesting sideline is, however, that some commentators are suggesting that refusal by insurance companies to offer flood insurance to homes in “high risk” areas could well lead to a massive fall in the value of homes in those parts affected. One estimate is that this could be as much as 80%, although that could prove to be nothing more than a “headline grabbing” exercise. What is more important is the proposal that more homes should be built on flood plains. It is not simply a matter of creating homes that are likely to flood and therefore not be able to get insurance. Building on flood plains – in fact on any green field site – actively reduces the capacity of the ground to absorb excess rainfall. This, in turn, leads to a greater prospect of flooding when extreme weather occurs, which has extended implications for the economy.
Interest rates By the time you read this the Bank of England’s Monetary Policy Committee (MPC) will probably have met for August and may have taken the opportunity to hike rates again. After all, it has announced a move following each of the last three August meetings (2005 was quarter point fall while 2004 and 2006 were each quarter point rises). The “shadow” MPC has voted 5 to 4 for holding the rates in August (and it has a fairly good track record for predicting the actual MPC’s movements accurately). But it is interesting to note that of the four “hawks” two felt that 6% would be insufficient to halt the rise in inflation while one of the “doves” was actually sure that the current level was already beginning to bite and that the growth in GDP will fall from 3% to 2.5% at current interest rate levels. This view is based partly on muted wage demands and a slowdown in the rate of increase for house prices. One word of caution relates to oil prices. These are now at roughly the same level as this time last year, so any further increase will add to inflation. Some commentators are predicting us$100 or more per barrel by the end of the year and this could have a serious impact. The MPC should be well advised to take this into account if growth is not to be stifled. Government spending Public sector borrowing hit a massive £7.4 billion during June; the highest figure on record and well in excess of the expected £6 billion. This appears to be largely down to local authority borrowing, rather than that of central government, so it is hopefully a cash-flow issue, rather than being symptomatic of an even greater expansion in government spending.
As we have previously indicated, we fully recognise the need for governments to provide essential services, but are concerned that lack of control over spending is a real threat to the economy. If the “productive” sector of the economy fails to grow – and further increasing interest rates could well bring this about – fiscal targets will be missed and the need for higher taxation (or even more borrowing, which is simply a way of deferring tax increases until the next administration comes in) will be inevitable. The only real question will be to what extent Alistair Darling is as good as his master in introducing stealth taxes that voters do not notice? Markets (Data compiled by the Insurance Marketing Department Ltd.) But investments are all about the long term and, even after a poor July, the FTSE100 is still 7.28% up on this time last year, while the mid-cap FTSE250 is 21% up – with the Dow Jones not far behind. Rather more worrying is the price of oil, which has risen by a further 6.15% this month to US$75.74, making the price just higher than 12 months ago. Sterling is currently “benefiting” from the prospect of high interest rates, but this is principally due to “punting” on a further increase. Some economists expect exchange rates to soften to about $1.93 to the pound by the end of this year and perhaps $1.79 by the end of next year. This will please exporters, if not importers and holiday makers. Fixed rate long term mortgages 
The Prime Minister has announced that he wishes to assist the introduction of 20 to 25 year fixed rate mortgages. While this would be of great benefit to homeowners (although they may actually prefer capped rate mortgages, given today’s relatively high cost of borrowing) it would certainly not help business, because it would only apply to the housing market. The problem is that the MPC only has interest rates as a way of managing inflation. If a large proportion of consumer borrowing were to be on long term fixed rates, then increasing interest rates would have little impact on spending. It would therefore be necessary to use larger rate hikes to achieve the desired effect. This would largely hit discretionary spending on consumer goods and businesses which borrow in order to trade. In both cases, the UK’s fragile manufacturing base would be under threat and the impact on the economy potentially damaging. It is to be hoped that the Treasury will actually work this out for itself and prevent the government from launching out on short term measures to attract votes amongst homebuyers, at the expense of economic growth that helps everyone. If you require any further information about the services that we provide or would like to review your financial planning position, please contact us |
In what has been a turbulent month for equity markets, all the main indices we track are down. The rot set in across the pond in the US, where concerns regarding endemic weakness within the sub-prime mortgage market spilled over into a general fear that markets may have been be overpriced. However, as usual, when America sneezes, we (and Europe) catch a cold. So while the Dow Jones ended the month 1.47% down, the FTSE100 lost3.75% during July and the Eurostoxx50 lost 3.88%. In the case of the Dow Jones, it had actually peaked at just over 14,000 points on 19th July, before tumbling 5.63% during the last third of the month; the FTSE100 had similarly, reached 6,716.7 during July, so it also lost more than 5% during the second half of the month.