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Global Economic Weekly Report Sep 22



22nd September 2014

Phew... It may seem (and, indeed, is) parochial to begin with the Scottish electorate’s
decision to remain part of the UK. But if (as opinion polls had suggested was quite
likely, though the bookies – and markets - were always more sanguine) Scotland had
decided to break the 307-year old union with the rest of the country, the economic and
financial consequences might have been devastating. So many things were uncertain:
what currency would Scotland use? Would it be allowed to remain in the EU – and, if
so, on what terms? What rights would it have over North Sea oil? What would happen
to its financial services sector (which, by some counts, is one of the biggest in Europe)?
And, of course, how could the Scottish government possibly deliver on the promises of
increased social spending that it had made?

Now, the unexpectedly decisive rejection of independence (by a 55/45 margin, on a 85%
turnout) means we don’t have to worry about that – or about another referendum any
time soon, though Alex Salmond did warn (just before announcing that he would step
down as Scotland’s First Minister) that the issue is not really settled. (His likely
successor, Nicola Sturgeon, has already picked up on that threat – and the SNP is now
refining its new strategy.) But there is still plenty to worry about... It is just that it has
more to do with England than it has with Scotland.

I cannot claim any particular insight into this. To anyone who has been reading the
papers, or the blogs or Twitter, it is all pretty obvious – but no less depressing for that.

The problem is that, when it appeared that Scotland might opt for independence, all
three main UK political parties made a range of promises (‘vows’) to the Scots that the
Conservatives and Labour in particular will find it very hard to live up to – not least
because England will want similar treatment. Essentially, the Scots have been promised
something that is being called “devo-plus” (ie. something slightly less than ‘devo-max’)
– substantial devolution of political power over taxation, health and education to the
Scottish Parliament that would leave it in full control of over 50% of tax-raising. At the
same time, they have also been promised that the annual budget grant that the UK as a
whole makes to Scotland under the so-called Barnett formula (which amounts to around
£1,600 per capita) will not be cut – which could mean that taxpayers in the rest of the
country will find themselves financing the Scottish Parliament’s left-wing agenda of
increased social spending. In that sense, the SNP could be said to have scored a
substantial political victory – even if the electorate went against them.

The inevitable reaction by Conservative MPs at Westminster (led by perennial awkward
squad members like Bernard Jenkin and John Redwood) is that, if Scotland is to get
what has been promised, England must get something similar – in particular, Scottish
MPs must be excluded from voting on ‘English’ matters like health, education and
perhaps social spending. There is obvious justice to this – and it has the added appeal of
getting up Labour’s nose, because it holds out the real prospect of a permanent Tory
majority whenever ‘English’ issues are debated. After all, Labour holds 40 of the 50
(Westminster) Parliamentary seats in Scotland – and 19 of the 40 seats in Wales.
Excluding them from ‘English’ affairs would give the Tories (and specifically, Tories
from the Southeast) a virtual monopoly of power over ‘English’ affairs.

One problem, of course, is that no-one can define exactly what ‘English’ issues are –
though one assumes that precedents have been set in the Scottish Parliament’s
chequered history. Another is that no one seems clear whether there should be a
separate English Assembly (in York, perhaps?), or whether non-English MPs would just
have to pop out for a coffee when ‘English’ issues are discussed. And there are lots of
other arcane constitutional issues that our leaders seem to have missed when trying to
bride the Scots to stay in the Union.

So far, Cameron – who really ought to take responsibility for this farrago, since it all
stems from the terms of the so-called Edinburgh Agreement (which set the rules for the
referendum) - has said that he will stick by his commitments to Scotland, and I don’t
suppose he has much choice anyway. Indeed, his Labour predecessor, former PM

Gordon Brown (who emerged as a key figure in the final days of the campaign,
throwing his weight behind the Union), is due to present his own plans for increased
devolution on October 16. This is an unexpected opportunity for Brown (who is vilified
in the rest of Britain) to rehabilitate himself by ‘standing up for Scotland’, and the
likelihood is that he will insist that all the Westminster parties live up to their

Ironically, that will set Brown at odds with his own party, since Miliband seems to be
insisting that any devolution of powers in England (and Wales and Northern Ireland)
must await a full-fledged Constitutional Convention – which would certainly take
matters beyond the next General Election (which Labour still expects to win).

In the short term, the whips will do awfully well if they are able to quell a back-bench
Tory revolt. There is no doubt that most, if not all, back-benchers believe, genuinely, that
any deal on England should be worked out in parallel with the devolution of further
powers to Scotland – and that Scotland should not be allowed to get further ahead. In
the meantime, Cameron himself faces another mini-crisis on October 9, when the anti-

EU ‘fringe’ party, UKIP, is almost certain to elect its first MP to Westminster – Douglas
Carswell, a reasonably well-regarded and influential former Conservative, who quit the
party over what he saw as Cameron’s vacillation on Europe. (Ironically, that is all
Carswell and UKIP are said to share: he is not believed to be particularly attracted to
UKIP’s views on immigration.) I would have thought Cameron’s position must be close
to untenable, but one should never underestimate a politician’s desire to hang on to the
red boxes.

There is a lot more one can say – much of it on the negative side. But there are some
positives. It is reasonable to assume, for instance, that investment in Scotland will pick
up again, that house prices will get a boost, and that at least some of the money that is
said to have been pulled out of Aberdeen, Standard Life, Scottish Widows and all the
other Scottish-based financial firms will find its way back (though more slowly than it
left). It is even possible that Cameron and the Tories will eventually see this as a victory
of sorts, in that it has put Miliband into a political pickle – though I absolutely refuse to
buy the Downing St line that this was all a cunning plan to trap Labour into making
promises that would inevitably hurt its standing in Westminster.

Global economy: G20 Finance Ministers and central bankers convened in Cairns,
Australia over the weekend to prepare the agenda for a Summit meeting in November.
Their focus seems to have been on:
- corporate tax avoidance – including provision for the overhaul of three
thousand bilateral tax treaties, and alleged abuses by both corporates
(eg tax ‘inversions’) and governments (eg so-called ‘patent boxes’);
- a cost/benefit analysis of financial regulation (which may include
discussion of resolution regimes);
- the need to boost economic growth by investing in public sector
infrastructure; and, more generally,
- the precarious state of global recovery – and the danger that low
interest rates and increased asset price volatility are encouraging
excessive risk-taking.

On the last of these, the IMF produced a report earlier last week downgrading its short-
term growth forecasts, and suggesting that it will cut them further next month. In its
view, aside from the US and UK, recovery is still very fragile. Like the G20, the Fund is
also concerned that financial markets are becoming excessively risky as the ‘search for
yield’ is leading investors to take excessive bets with borrowed money.

The OECD also echoed the IMF’s concerns. It issued new GDP projections of its own
last week, showing growth next year down across the board.

There was, however, some good news last week. For instance, the BIS released its latest
survey of cross-border lending – which was up US $580 billion in the first quarter, the
first significant rise since 2011. The problem is that this was almost entirely due to a rise
in lending to China (up 49% year-on-year); lending to Europe was actually down.

Moreover, the Bank warned specifically about increased borrowing by emerging market
corporates – who issued a total of US $375 billion in debt between 2009 and 2012. Rising
interest rates and depreciating domestic currencies could easily pose serious problems.

The focus of attention in the US last week was the two-day meeting of the FOMC – and,
in particular, whether the Fed would change its commitment to keep US interest rates
low for “a considerable time” after it has wound down its QE programme (which it will
do within the next couple of months).

To some surprise, the Committee maintained the same wording on interest rates –
though Chairman Yellen insisted that there is no definition of what ‘considerable time’
means. It all depends on the data.

Despite that, the general feeling was that the Fed remains fairly doveish on monetary
policy – even though two FOMC members (Richard Fisher and Charles Plosser) voted in
favour of an immediate rise in interest rates.

As far as US economic releases were concerned, it was a fairly busy week. However, the
signals were mixed. On the positive side, for instance, it was reported:
- that retail sales were up 5% year-on-year in August, the strongest
showing in over a year;
- that durable goods orders were up 22.6% in July (albeit largely because
of lumpy aircraft orders);
- that the Empire State (NY) activity index rose in September from 14.7
to 27.5; and
- that first-time jobless claims fell 36,000 in the latest week.

In addition, it was reported that median US household income was up 0.3% in 2013 to
just under US $52,000 (rather higher than I would have expected). That was the first
annual increase since before the crisis, though it still leaves incomes 8% below 2007

On the other hand, it was also reported:
- that industrial production fell 0.1% in August (the first fall in seven
months), pushing capacity utilisation down from 80.1% to 78.8%;
- that consumer prices fell 0.2% in August – the first monthly decline
since April 2013;
- that housing starts fell almost 17% in August, while building permits
were down 5.9%; and
- that the Philadelphia Fed index fell sharply this month, from 28.0 to

Whatever, the markets have been extraordinarily strong. Through the close on Friday,
the DJIA was up 1.7% at 17,279, the S&P500 was up 1.2% at 2,010 and the Nasdaq was
up 0.3% at 4,580. In the cases of the Dow and S&P, both hit closing records on Thursday
and Friday.

That said, there are concerns that equity markets are over-confident. They may, for
instance, be putting too much weight on the Fed’s alleged ‘doveishness’, and some of
the market froth has undoubtedly been generated by share buybacks that have little or
nothing to do with the health of the broader economy. But there is no doubt about the
buoyancy of US equities. Meanwhile, bond markets have been going in the opposite
direction. Week-on-week, the yield on the 10-year Treasury bond increased from 2.61%
to 2.63%, while the yield on the long bond rose from 3.34% to 3.38%.

Meanwhile, in Europe, the rise of fringe parties (both left and right) continues...
Following on from the success of Syriza (and Golden Dawn) in Greece, UKIP in Britain,
the FN in France, and the AfD in Germany, the Sweden Democrats (a right-wing, anti-
immigrant party) took almost 13% of the vote in national elections last weekend –
forcing Sweden’s popular centre-right PM, Frederik Reinfeldt, out of office (and
apparently out of politics). It looks as though the new government will be an unstable
centre-left coalition, headed by the Social Democrats’ Stefan Lofven, a former leader of
the country’s trades union movement. That prospect worries European business –
which is equally worried abut the rise of euro scepticism in Germany and France.

As for what is going on in Brussels, euro-watchers are still trying to work out just what
message Juncker is trying to send with his nominations for the European Commission.
The general feeling seems to be that, by giving our own Jonathan Hill the financial
services portfolio and Pierre Moscovici economics, he is deliberately forcing two
Commissioners to act against their own national interests – which (if they go along)
might imply increased power for the Commission itself. Conversely, however, if they
balk, it could set the Commission against both the Council and two key member states.
Confirmation hearings start next week, and could be nasty – although it is worth
emphasising that, formally, the Parliament only has the right to approve/disapprove
the entire slate of Commissioners.

Although (as far as I know) it hasn’t been announced yet, it is believed that Lord Hill’s
No 2 will be John Berrigan, from Ireland. He is a former IMF staffer, who has worked
on financial stability issues since 2010. From the UK’s point of view, that is good news:
he is considered “market friendly”.

As far as the eurozone economy is concerned, it has been (yet) another disappointing
week. In particular, it was reported that BofA had slashed its GDP growth forecast for
the Eurozone this year from 1.0% to 0.8% and for 2015 from 1.5% to 1.3%. It was also
- that the eurozone’s trade surplus fell in July from €2.8 billion to €1.7
billion – with only Germany’s exports increasing; and
- that eurozone banks were almost completely uninterested in the ECB’s
latest attempt to boost lending, taking up just €82.6 billion of the €200
billion or more that was available under the Bank’s Targeted LTRO
scheme (which offered four-year money at just 0.15%).

The latter sounds technical, but was in fact a big disappointment, suggesting that there
is simply no demand for bank loans in Europe. The press is insisting that the ECB
should now move to full-fledged QE, but, if demand isn’t there, it is not clear that QE
would work either – or that Germany would agree, given the surge in support for the

As for individual eurozone member states, it is a very mixed picture.

In Germany, for instance, exports are strong – but the ZEW investor confidence index
fell for the ninth successive month in September, from 44.3 to just 25.4, the lowest level
since December 2012. In contrast, Ireland seems to be powering ahead. It was reported
last week that Irish GDP was up an astonishing 7.7% year-on-year in June – and by 1.5%
for the quarter. That comes on top of strong employment figures (with the jobless rate
down from 15% to 11.5%) and a 24% year-on-year rise in (admittedly deeply depressed)
house prices. The irony – which may not be lost on Chancellor Merkel – is that this has
been achieved, not by ultra-loose monetary policy, but by cleaning up the Irish banks
(eg by forcing them to off load bad loans) and by cutting the fiscal deficit from 13.7% of
GDP to 3.8%.

Meanwhile, in France, PM Valls (who was off to Berlin over the weekend) won a
confidence vote on his reform package last week – but is still unwilling to press ahead
with the budget cuts which are, in the end, inevitable. That may well give ex-President
Sarkozy the boost he needs to make his attempt to recapture control of his UMP more
plausible. As for Italy, Renzi got a little outside help last week, when the IMF’s Article 4
report concluded with a strong endorsement of his plans for (long overdue) labour
market reforms.

Turning to the UK (where any serious discussion of the economy has been on hold
pending the Scottish referendum), the recovery appears to be continuing. In particular:
- house prices were up 11.7% year-on-year in July;
- unemployment is down, with the jobless rate falling from 6.4% to 6.2%
in August, and with 774,000 new jobs having been created in the last
- home loans were up 13% year-on-year last month, and are now at their
highest level since 2008; and
- the CBI’s latest manufacturing survey saw 34% of firms anticipating
higher output in the next three months, compared with 19%
anticipating lower output.

Not all the signs are so strong, however. Export orders, for instance, appear to have
fallen sharply this month – which is a big surprise. And inflation is still falling. Indeed,
consumer prices were down 1.2% year-on-year last month, largely because of a drop in
gasoline prices.

But, all in all, the UK economy is in decent shape – and it will probably benefit from a
“relief rally” now that the spectre of Scottish independence has been lifted. Even before
the vote, the markets had been strong, and, for the week as a whole, the FTSE was up
around 0.7%. However, it is not just UK equities that are up: the CAC-40 was up 0.4%,
and the Xetra Dax was up 1.7%.
One reason for that jump is that geopolitical tensions with Russia over Ukraine have
gone off the boil.

True, the EU and Kiev ratified a bilateral trade pact on Tuesday that had the potential to
ramp tensions up considerably. However, Ukrainian PM Poroshenko himself requested
that the agreement not be implemented before December 2015 – which gives him and
Russian President Putin plenty of time to come sort of arrangement on autonomy for
Russian-speakers in the Eastern Ukrainian oblasts. Even though the rouble hit a series of
new lows last week (and is now closing in on R39/US $), and even though there were
reports over the weekend that Russia is threatening to break contact with the global
internet (does Putin understand how it works?), there is a sense that the crisis is past its

Equities have been strong in Japan too, with the Nikkei-225 closing on Friday at a seven-
year high of 16,321. The JGB market has also been firm. Although the yield on the 10-
year bond rose from 0.57% last Friday to 0.68% on Thursday, it fell sharply to end the
week art just 0.56% - reflecting a strong feeling that the BoJ will continue to ease. In
addition, it was reported on Friday that household wealth at the end of June was up
2.7% year-on-year, and is now at a record high. And, of course, the hope is that the
weaker yen (which hit a six-year at the week’s end) will mean a boost to Japanese

Turning to China, it is (at best) a mixed picture – and it is probably no surprise that,
despite official insistence that the economy is on track for 7.5% growth, the PBoC
intervened twice last week. On Wednesday, for instance, it pumped RMB 500 billion
into the banking system (via the five biggest state-owned banks); on Friday, it cut short-
term borrowing costs again.

Why? Well, in general, economic releases last week were disappointing. In particular:
- industrial production was up (officially, at least) 6.9% year-on-year in
July – which, though its sounds good to the gaijin, must be pretty close
to unacceptable;
- new house prices were down 1.1% in August, the fourth straight fall
(though they are still up 0.5% year-on-year); and
- foreign direct investment was down 14% year-on-year last month, the
third consecutive fall and the lowest since July 2010.

As a result, Barclays is the latest bank to cut its growth forecast. It is now projecting
GDP growth this year of 7.2%, down from an earlier forecast of 7.4%.

As for the emerging markets more generally, there is growing concern about what has
been a major sell-off this month, fuelled by concerns about rising US interest rates and
slowing Chinese growth. The FTSE’s emerging markets index has fallen over 5% in less
than two weeks, and most emerging markets currencies are under pressure. According
to the IMF, pre-crisis growth was around 7% a year; now, it is down to 5% or less. It
appears that investors are increasingly pulling money out of emerging markets, and
taking it back to the US in particular.

Two recent developments are likely to exacerbate this:
- the latest downgrade of Venezuela, this time by S&P, which has pushed
the parallel market exchange rate above Bs 90/US $ - compared with an
official rate of just Bs 6.3; and
- the unexpected resignation of the (generally respected) Governor of the
South African Reserve Bank, Gill Marcus – which caused the rand to hit a
seven-month low of R11.1/US $ on Friday on fears that the post could be
further politicised.

Currencies: Two weeks ago, the main concern was sterling – which looked set to
weaken sharply on the possibility (perhaps even probability) that Scotland might vote to
leave the UK. At the close a week ago on Friday, the pound was trading at US $1.627/£
and £ 0.797/€ - and it did indeed fall sharply last Monday, closing at US $1.623 (though
that also reflected dollar strength, since the pound held its own against the euro).

Since then, however, sterling has recovered. Whatever the polls may have said, traders
got it right; they did not seem to have believed for one moment that the Scots would
break away. By the close on Thursday, the pound was trading at US $1.639 – up almost
1.0% on the week – and at £ 78.9/€. In early trade Friday, it hit US $1.653, but it
subsequently eased to close at US $1.631 – up 0.2% week-on-week.

The other big mover has been the yen – which, as noted, has fallen sharply against the
At the close a week ago Friday, the yen was trading at Y107.3/US $. By last Thursday, it
had fallen to Y108.6 – and at one point touched Y109.5. On Friday, it generally traded in
a narrow range, but closed around Y108.9/US $. That means it was off 1.4% for the
week against the dollar, and is currently close to a six-year low. On a broader trade-
weighted basis, it is down 3.9% month-on-month.

As for the euro, it closed the previous week at US $1.296/€, and remained pretty much
unchanged until late Thursday. Then, it began to fall, and it closed on Friday at US
$1.284 – down 0.9% for the week. It is also down 0.9% month-on-month on a trade-
weighted basis.
Just about the only currency that appreciated against the dollar last week was the
Norwegian krone, which closed the previous week at Nkr 6.41/US $ and is currently
trading at Nkr 6.35 – largely because of a clear commitment by the central bank that it
will let interest rates rise. Other than that, on a trade-weighted basis, the dollar was up
0.4% for the week (its fifth consecutive weekly rise) and 2.9% month-on-month. Given
that sterling’s recovery is already petering out and that the Fed seems to be inching its
way towards higher interest rates, the dollar seems likely to remain the currency of

As for gold, it continues to have a tough time. It closed two weeks ago at US $1,230/oz
– down over US $11 for the week. Last week, it hit a high of US $1,237 on Tuesday
ahead of the FOMC meeting, but has since drifted down, and closed on Friday at US
$1,219. Analysts put this chronic weakness down to a drop in Chinese demand.

Energy: Spot prices have continued weak.

The Friday before last, there were fears (or hopes) that Russian sanctions might choke
off global oil supplies, but over the last week, Brent has hit a series of 26-month lows
(though it has recovered a bit in the last couple of days), while WTI has continued to
slide. At the close ten days ago, WTI was trading at US $92.23/barrel while front month
Brent was US $96.98 – pushing the “Brent premium” down to US $4.75. By the close on
Friday, October WTI was trading at US $91.71, while November Brent (the current front
month contract) is at US $98.37 – meaning the Brent premium has widened to US $6.66.

The continuing fall in the price of WTI reflects US stocks – up 3.67 million barrels in the
latest week to 362.3 million. The modest firming of the Brent price reflects another
setback for Libyan output, hit by the closure last week of the Sharara field.

In general, though, spot prices are soft – and there have been more stories of ULCCs
being hired as floating storage.

The hope of many traders is that OPEC will trim its own production, but there is
considerable scepticism – particularly over Saudi Arabia’s plans. As a result, prices are
expected to continue weak.

Banking and finance: While the politically sensitive (and extremely important) case
against Arab Bank continues in New York (with closing arguments beginning last
Thursday), three other developments are worth noting:
- The ECB’s Asset Quality Review: Early last week, Goldman Sachs
apparently polled investors, who said that they expected nine
European banks to ‘fail’ the AQR, results of which are due in late
October, and to be required to boost their capital. They are said to
include Monte dei Paschi, Commerzbank, Banco Popolare, Piraeus
Bank and Millennium BCP. Significantly, when asked about the AQR,
UBS’s chairman, Axel Weber, said bluntly that European banks are
more worried about US litigation than they are about the ECB.
- VAT on financial services: At the beginning of last week, the European
Court of Justice issued a ruling that will cost big European banks
millions. They will now, apparently, have to pay VAT (rates of which
are 15-27% depending on the country) on IT and call centre
transactions between head office and foreign subsidiaries. These were
previously considered VAT-free intercompany transfers, but will now
be treated as arms-length transactions. With the biggest financial
services sector in the EU, the UK will (as usual) be hardest hit.
- Tax avoidance: As noted, the G20 met over the weekend in Cairns,
with tax avoidance on the agenda. Ahead of that meeting, the OECD
published new rules on tax avoidance last week, emphasising
increased transparency, closure of loopholes and an end to so-called
treaty shopping. There is bound to be a big push on this, though don’t
hold your breath for significant results.

As for this week, it is expected to be relatively quiet - though ECB President Draghi
speaks to the European Parliament later today, and may give some hint of the Bank’s
next steps. And, of course, here at home, we have the beginning of the party conference
season – Labour this week, followed by UKIP, the Tories and the LibDems.

As far as US economic releases are concerned, the most important are probably:
- durable goods orders for August;
- new home sales;
- the final reading for second quarter GDP; and
- the Michigan confidence index for September.

Elsewhere, markets will focus on the IFO survey in Germany, eurozone money supply
growth and the EU’s consumer confidence index. In China, HSBC’s manufacturing PMI
is due. Here, of course, we will just obsess about whether (or how) the Union will
survive; a Federally United Kingdom (an unfortunate acronym) may be the best we can
hope for.

                                               Andrew Hilton

Government Australia Advisory Board

Simon Crean MP

John Brumby 

Kristina Keneally

Mark Vaile

Nick Greiner

Alexander Downer

Peter Charlton

Trevor Rowe

Warwick Smith


Bob Carr