Having just returned from a week over in the UK seeing family and friends and meeting with a couple of asset managers, it is evident that the Coalition government’s austerity programme is beginning to bite. Firstly, inflation is up to 4% in January, partially due to the increase in sales tax(VAT) to 20% from 17.5% at the beginning of the year, twice the 2% upper limit that the Bank of England (BoE) is aiming for. The Governor of the BoE, Mervyn King, was reported to be contemplating at least 2 if not 3 increases in interest rates this year from their present low level of 0.5%, and several members of the BoE’s interest rate panel are reported to be infavour of such a move.
Meanwhile, the first of the Pds 80 billion in government spending cuts that the Coalition has promised over the four years to 2014 are due to take effect this year, with reports indicating that 1 in 7 central government workers and 1 in 5 local government workers would be let go over the next year to eighteen months, primarily through attrition, but if necessary through being sacked. As central and local government, including the National Health Service, the largest employer in Europe now that the Red Army has been reduced in size, account for nearly half of employment in the UK, this will have serious effects on retail sales, average wages and particularly, housing prices, which have begun to fall again over the last few months, despite having risen 2% in 2010 on a national basis.
As much of the private sector employment growth over the previous decade came from the construction and financial sectors, both of which are under pressure despite the substantial 2010 bonuses being paid to those bankers still in employment, it is difficult to see where any offsetting growth in employment and wages will come from. The one bright spot for the economy is the revival in exports caused by the recovery in global trade and the boost given to British exports due to the 25% devaluation that the authorities engineered in the pound sterling between 2007 and 2009, when it fell from PD1=U$2.15 to Pd1=U$1.60. Company earnings being reported for 2010 show substantial growth in profits for the majority of UK companies, which is partially due to higher export sales and partially to the fact that around half UK companies’ profits come from their overseas operations, as the FTSE100 Index is dominated by energy,and resources, drugs and consumer staples such as tobaco and alcohol and global financial stocks which are not dependent upon the domestic UK economy. In fact, the announced $3.2 bn merger between the London Stock Exchange (LSE-L) and the Toronto stockmarket (X-T) is partially predicated upon their strength in the resource area, as around 30% of the LSE and over 50% of the TSX is comprised of energy and resource stocks, making the merged entity the largest exchange specializing in what ahs become a very desirable sector for investors.
Lastly, the cost of petrol, as gasoline is known in the UK, continues to bring tears to the eyes of any North American visiting England. Petrol was Pd1.29 a litre for regular, with diesel another 7-8p a litre more expensive. As I noted in my first posting back in August, the average Canadian finds it difficult to believe that gasoline could cost C$2.10 a litre, while the average US driver would have apoplexy at the thought of paying $9.30 a gallon. The cost of fuel, whether for driving, transportation of goods or heating is one of the reasons why the UK is such an expensive place to live. Outside of London, where wealthy bankers, Arab sheiks and Russian billionaires are indifferent to the cost of living, the difference with Canada or the US is less marked but everything effectively costs at least 50% more than in North America, except when it costs even more. The domestic UK economy is unlikely to be a happy place to live or work for the next couple of years, but they will not prevent portions of the UK stock market from doing well as long as global growth holds up.