A View from the Bridge - February 2014

They think it’s all over……….

With UK growth forecasts being revised upwards by the IMF, house building and house prices rising the most in a decade, exports at a record high in 2013, unemployment down to 7.1% and inflation falling below the BoE target of 2% you would have thought so!

However the BoE Governor and the Chancellor have said that the UK recovery is imbalanced and unsustainable. Looking behind the headlines, the Treasury is looking at a budget deficit of £100bn this year and despite £375bn of QE, growth is still 1.4% below that of 2008. Whilst over 1.1m jobs have been created since 2009 (up 3.6%) this has been against a backdrop of a 3% population rise and does not disguise the fact that youth unemployment remains at 20%.

In the Eurozone youth unemployment rates average 23.4% but this hides the harsh reality in Greece (59%), Spain (54.6%) and Italy (42.4%). The outlook remains benign according to the European Commission with a growth forecast of 1.2% for 2014 for the Eurozone as a whole with inflation remaining at less than 1%. Although the ECB says it is alert to deflation risks, of those Eurozone countries most at risk, 7 are expected to have public indebtedness of above 100% of GDP by 2015. This implies that further austerity measures need to be implemented to meet EU budget commitments or further bailouts will be required.

The recent focus for recovery has been centred on the US, where confidence in the last half of 2013 led to a $20bn reduction in QE. However, Q4 growth rates have now been revised downwards from 3.2% to 2.4% and with employment prospects slowing, the recovery appears more fragile than many thought. This may lead the new chair of the FED Janet Yellen, to hold back on any further fiscal tightening and look at other ways to stimulate the economy.

Of more concern to the US and the wider international community will be the outcome of recent events in Ukraine and the observation from the US that China has being doing military training in the Pacific very close to the disputed Senkaku/Diaoyu Islands.

In the markets it was a fairly benign month, near term rates continue to move sideways (3mth closed at 0.52%, 6mth closed at 0.61%). Fixed Term rates (longer than 1 year) were also static, 5 Years closed at 1.94% (0bp), 10 years closed at 2.79% (+2bp), 20 years closed at 3.26% (+4bp) and 30 years closed at 3.30% (+2bp)

UK Government Bond yields were unchanged; The 10 year UK Gilt Benchmark closed at a yield of 2.74% (+3bp) and the 30 year UK Gilt Benchmark closed at a yield of 3.52% (+2bp).

GBP future inflation expectations expressed through 20 year Inflation Swaps traded within a tight range over the month opening at 3.58% and closing at the low of 3.56%

In the Foreign Exchange Market GBP was higher against the USD$ at 1.6750 (1.6436) but slightly lower against the EURO at 1.2135 (1.2176)