20 June 2012

Economic outlook by Sarah Thi, Investment Manager

Greece – not out of the woods yet

Following the (narrow) victory by ‘pro-bailout’ party, New Democracy, the formation of a coalition government has been agreed with the leaders of socialist PASOK and the Democratic Left. Despite the clear impacts of austerity, it seems voters wish to remain in the European Monetary Union. Syriza, the party against the bailout package, came second in Sunday’s election. The coalition faces an extremely tough job but will be committed to remaining in the euro. The government is likely to look at negotiating changes to the bailout programme, the terms of which it considers are crippling the economy. The government will argue the conditions of the bailout are deepening the recession (Greece will be going into its fifth year of recession) and increasing social tension. Whilst the German Chancellor, Angela Merkel, has emphasised the importance of the new government’s commitments, other European officials appear willing to allow some flexibility with regards to the bailout.

Spain’s pain continues

Spanish bond yields eased from over 7% following a €750 billion bailout deal for Spain and Italy but soared again, indicating lack of confidence. The proposed deal is to buy bonds issued by the countries and should have shown that the eurozone was prepared to support its members, but it remains to be seen whether this will restore confidence.

Moody’s has stated that “euro area sovereigns that are dependent upon funding support from official sources represent non-investment-grade risks…unless the support is unlimited and unconditional.” Therefore, it was not a great surprise that four days after the Spanish approached the EU for support to recapitalise the Cajas (the Spanish equivalents of the UK building societies), Moody’s downgraded Spain by three notches from A3 (equivalent to A-) to Baa3 (the equivalent to BBB-), one notch above junk status, with a negative outlook for a further review to be completed within three months.

UK inflation

The Office for National Statistics released data showing the Consumer Prices Index (CPI) falling from 3% in April to 2.8% in May. A combination of factors has led to the fall from over 5% in September last year, such as reducing effects from the VAT increase, and lower energy, food and commodity prices. Whilst the Bank of England (BoE) has plans to inject cash through a lending facility to banks, with inflation falling and a weak economic backdrop, the BoE may see this as room to introduce further quantitive easing (QE). At the last meeting of the Monetary Policy Committee, four out of the nine members voted to increase the QE programme.