Economic review of August 2007

It has often been said that investment markets are all about confidence; if investors, particularly fund managers, are confident then markets will do well. If not, markets can react poorly. Yet it is important to be aware of the underlying fundamentals; after all, sentiment can change quickly, but economic factors are less volatile. Even when data changes sharply from one month to the next, as we have recently seen with inflation rates, if businesses are in good shape with strong order books and consumer confidence is high, then shares can be expected to bounce back.

Unfortunately there has been a dramatic drop in consumer confidence in the US, brought about largely by a “collapse” in the housing market there on the back of a 3.2% slump in the US National Home Price Index at the end of June, compared with a year previously. In the UK, sales growth is now at the lowest level for nine months.

The underlying problem

It seems likely that an aggressive culture in US business led to lending decisions based on the need to achieve targets; to “succeed” without due attention to the soundness, or otherwise, of those decisions. If people are judged primarily on sales levels, then little attention is paid to detail and it can be all too easy for excessive risks to be taken.

This is probably one of the best examples of the saying: when America sneezes, the rest of the world catches a cold.

Interest rates

Indeed, despite nerves about the economic impact of shaky equity markets, there is still a likelihood that interest rate will be increased – at least in the UK – before the end of the year. Mervyn King is generally held to be hawkish - some say far too much so. And with the CBI reporting full order books for its members, there are certainly indications that a further rise would not bring about the harm to business that we have long feared, if rates go too high. King’s view is understandable, since nobody wants to be at the helm of the Bank of England when it loses control of inflation; better to preside over a modest recession.

One sideline to current problems within financial markets is that it could bring about a reduction in tax revenue for the government. According to the Daily Telegraph (30/8/07) the shortfall could be as much as £2 billion and this could impact either on spending, taxation or the Public Sector Borrowing Requirement (PSBR), each of which would affect the economy.

Inflation

Whatever, the case, it is far too early to be confident that inflation is under control. However, there does seem to be some evidence of the so-called “DFS effect” which broadly, implies that prices were hiked in the previous month, so that even greater savings could be shown in a sale. Because furniture is a component of the indices, large movements can influence their behavious.

More important, perhaps, may be that supermarkets appear to have started competing more aggressively on price, which should keep food and clothing prices down.

It is worth noting, however, that some commentators claim that the bank’s data has been manipulated and that the “scare-mongering voice of the Bank of England has managed to persuade its audience that its recent base rate rises were justified” (Stuart Law, Chief Executive of Assetz PLC 14 August 2007).

Housing market

Extension of Home Information Packs to all three-bedroom homes from 10th September will also serve to slow the market, especially as some lenders are now saying that they will not rely on searches provided within the packs, resulting in duplication of costs.

Markets (Data compiled by the Insurance Marketing Department Ltd.)

Despite the volatility of markets during August, the FTSE100 ended the month just 0.89% down at 6,303.3 and, while this is the third successive monthly fall, the index is still 6.73% up on this time last year. The mid-cap FTSE250 also lost a modest 0.25% during August, leaving it 18% ahead over 12 months at just over 11,309. In the US, the Dow Jones managed a modest 1.1% rise, to recover a little lost ground, while the Nasdaq100 managed a creditable 1.97% uplift. In Europe, the Eurostoxx50 fell by 0.49%. All the indices we track are down over three months.

The good news is, however, that oil prices have again softened, losing 4.03% during August for Brent Crude 1-month futures, ending at US$72.69 a barrel. Sterling also eased over the month by 0.29% against dollar and 0.14% against the euro; which should please exporters.

Weather

It is not just holidays that can be damaged as the result of bad weather; the rural economy in many parts of the country is reeling from the “double whammy” of animal health scares and a loss of tourism income. Revenue from overseas visitors is vital to the UK, with foreign visitors spending more than £16 billion here last year. However, the other side of the coin is that we spend more than twice as much (£34 billion) on overseas holidays. Poor weather makes us more likely to travel abroad, which not only harms the climate, but is also bad for an increasingly weak balance of payments (the so-called current account).

The solution is not necessarily to stop taking foreign holidays, but for individuals and businesses to consider carbon offsetting and for the tourism industry as a whole to consider ways of developing more UK-based holidays where the weather is not a factor; for foreign visitors as well as for us.

And if that does not work, we have developed an infallible way to control the weather. Buy a sun hat and it will start raining; buy a water butt and it will stop! Well it worked for us.

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