Special FX Report – UK debt warning, BOE policy decision Thursday
Wednesday, December 9th, 2009Tuesday GBP traded 1% lower versus the USD and 0.5% lower versus the EUR pressured by Moody’s warning of the threat of a downgrade of UK debt rating and fears of UK bank exposure to the Dubai World debt. Moody’s said that the UK may lose its AAA sovereign debt rating if UK does not take action to reduce its ballooning budget deficit. The Moody’s warning follows similar warnings earlier in the year from Standard & Poor’s and Fitch rating agencies that the UK could lose its AAA status if UK government does not take actions to repair its public finances. GBP extended its decline Wednesday in reaction to the release of the UK budget announcement.
Wednesday, UK Chancellor Darling presented the UK budget for the next fiscal year and budget projections through 2015 along with the government GDP forecasts through 2012. Darling said that UK net public borrowing will rise to £178bln in the current fiscal year. This is £3bln higher than the government’s original forecast and is equal to 12.6% of GDP. Analysts had expected the current fiscal year GDP debt ratio of 12.4%. Darling also said that the UK government will cut its public borrowing to £82bln by 2014-15. This will represent 4.4% of GDP. Public-sector debt is expected to peak at 78% of GDP in 2014-15. In addition, Darling announced a 50% one-time tax on bank bonuses above £25k. The one time levy is expected to yield £550mln. The chancellor said he is confident that the UK economy will return to growth in Q4. Darling’s forecast for 2009 GDP was lowered to -4.75% from original forecast of -3.5% with GDP expected at 1% to 1.5% in 2010 and 3.5% in 2011 and 2012.
The Bank of England (BOE) will hold a policy meeting Thursday, December 10th. The BOE policy board is confronted with uncertainty about the strength of the UK recovery and the ballooning UK budget deficit. UK public sector borrowing rose to a record £11.4bln in October. As noted above UK public sector borrowing for 2009-10 is estimated at £178bln. UK Chancellor Darling pledged to halve the deficit over the next four years. If BOE board members see Darlings pledge as credible it could encourage the BOE to maintain current levels of stimulus and possibly consider an expansion of stimulus. The timing and pace of UK and BOE withdrawal of stimulus is key to the UK recovery. If the UK government and BOE withdraw stimulus too soon it could derail the recovery. The UK and BOE also must not allow deficit spending and expansion of central bank asset purchases to reach a level that would force a downgrade of UK sovereign debt rating and increase the risk of inflation.
At the November BOE policy meeting the BOE elected to expand the bank’s asset purchase program by £25bln to £200bln and to hold interest rates at a record low of 0.5%. The minutes for the November policy meeting show that the policy board was split three ways with one member seeking greater expansion of asset purchases, one member looking to do reduce quantitative easing and the rest of the policy board voting for expansion of quantitative ease. The minutes for the November meeting also suggest that BOE officials see signs of economic recovery in the UK and are considering slowing the pace of bond purchases and will begin to withdraw quantitative ease sometime in 2010.
Recent UK economic data has been mixed and suggests that the UK recovery remains fragile. Tuesday the UK reported that manufacturing was flat and consumer spending was lower in October. BRC reported a modest 1.8% rise in October retail sales. Housing prices have been rising along with an uptick in inflation. Halifax home prices were reported up 1.4% in November. UK consumer prices rose by 1.5% in October compared to 1.1% in September. In its November quarterly inflation report the BOE said that UK inflation is unlikely to return to target of 2% before 2012 but could rise in the short term. The UK government and BOE expect the UK economy to grow in the fourth quarter. The expectation that the UK economy will soon return to growth coupled with an uptick in UK inflation and today’s pledge by the UK government to take action to reduce its deficit spending should encourage the BOE to maintain the current level of interest rates and asset purchases at Thursday’s policy meeting. The BOE is expected to wait until the February inflation report before deciding on any change in its asset purchases or a timeframe for withdrawal of stimulus. Steady BOE policy decision would be a mild positive for the GBP.
Written by Easy-Forex
