UK: Outlook - July 2011

Last Updated: 6 July 2011
Article by Smith & Williamson


Collateral damage

There are two main areas of concern for the markets at the moment – euro zone debt restructuring and the status of the US economy. While there is relief that the EU and IMF support package for Greece has (for the time being) avoided a chaotic bond default that would have had global ramifications, the tortuous process in arriving at a bailout agreement has inflicted collateral damage. The sharp schism between Germany and the ECB over how to treat bond restructuring illustrated a fundamental division in views. More importantly, the whole episode has laid bare the core problem – confronting a monetary union without a commensurate fiscal union and centralized treasury function. While the provision of liquidity has bought some time, the attachment of stringent austerity and privatization conditions to the bailout exacerbates the solvency squeeze confronting Greece. Consequently, the agenda has shifted from one of whether Greece will default to one of considering the damage limitation should a default occur.

In the US, QE2 has run its course. The assessment of its impact is mixed. On the one hand it definitely did a good job in reversing the deflationary headwinds confronting the US this time last year, and also succeeded in creating wealth effects via the equity market rally in the latter half of 2010. It also produced a modest fall in unemployment. However, on the other hand, the generation of excess liquidity contributed to the surge in commodity prices that not only created problems for emerging economies but also shrank real disposable income in the US. Consequently, the negative unintended consequences of QE2 seem to have outweighed the benefits. It is disturbing to see the US economy start to lose momentum even before the cessation of QE2. The hope is that this is a temporary phenomenon resulting from supply chain disruptions. The concern is that the US economy is incapable of recovering without the intravenous drip of Quantitative Easing. The economic data releases over the next few weeks will be incredibly important.

The fundamental underpinning for equity markets remains the health of corporate cash flow and balance sheets. This is driving growth in merger and acquisition activity, stock buy backs and dividends. Valuations look reasonable with most prospective PE's below their respective 5 year averages. Consequently, although we see the summer months as a period of increased volatility with potentially more downside than upside risk we will seek to take advantage of any oversold signals to reinvest our cash holdings.


A temporary dip or something more sinister?

High frequency economic indicators have shown a sudden decline in US economic momentum. There are two interpretations behind this dip. The first is that the economy has simply hit an air pocket created by the supply chain disruptions caused by the Japanese tsunami. This view assumes that once manufacturing capacity starts to ramp up later in the year the US should be able to resume a c 3% growth trajectory. The second interpretation is less benign. The fact that after two doses of Quantitative Easing both the US housing market and labour market remain moribund is testament to the structural headwinds facing the economy. The rise in commodity prices has also eroded disposable income. The clear risk is that a self fulfilling cycle emerges whereby uncertainty produces a curtailment in incremental activity that then generates further uncertainty. This is very reminiscent of the 'double dip' that emerged this time last year. The US bond yield has pushed below the significant 3% level and is clearly ascribing a high probability to a weakening in economic data over the coming months. With the administration and congress facing 'debt ceiling' restrictions the responsibility once again falls on the Federal Reserve to consider what, if any, further stimulus plans are necessary. There is already conjecture over the shape and form of QE3.


A more dovish MPC

The UK appears so far to have avoided Greek contagion fears. The yields on UK gilts have fallen, while those of peripheral Europe have risen sharply. In fact the UK bonds have remained closely correlated to those of the US. As in the US, the concern in the UK is over the strength of the domestic economy. Recent retail sales data has shown a worrying resumption of sub par growth (having had a temporary Royal Wedding bank holiday boost).Although the labour market has performed reasonably well, with private job creation outstripping public sector layoffs, unemployment has remained stubbornly high at around 7.7%. Despite persistently high inflation with predictions that CPI will exceed 5% later in the year as utility price hikes kick in, there is little sign that the labour force is in a position to start a wage cost spiral. In fact the latest earnings data shows a sequential decline in earnings (ex bonuses). Consequently, the biggest concern for the MPC is not reining in inflation but confronting the impact to the economy from a combination of fiscal austerity, negative real disposable income and a deleveraging household. Consequently, interest rates are unlikely to rise for quite some time. Indeed, the prospect of another round of Quantitative Easing should not be ruled out.

While the FTSE index has fallen c 7% from the 6080 level established at the end on May it remains within the 5600- 6100 trading range established since last December. Given that both portfolio and corporate cash flow remain strong we think that if an oversold signal were to be triggered we should reinvest some of our cash in the equity market. The prospective dividend yield of 3.4% also lends support.


Buying some time

The attempt to reach a resolution over the provision of a Greek fiscal bailout has not only been tortuous it has inflicted collateral damage on the euro zone leadership structure. The trenchant stance taken by the ECB in stating it would not recognize 'retroflex' bonds as collateral and that at no stage could a debt restructuring trigger a 'credit event' put them in straight confrontation with the Germans who wanted to see private bond holders sharing the losses. Although the market was relieved that the Germans eventually gave way and agreed to the notion of a voluntary bond rollover that would not trigger CDS contracts, the victory for the ECB was pyrrhic. Attention rapidly turned to whether the Greek Prime Minister would win a vote of no confidence and subsequently get the Greek parliament to vote for the stringent austerity and privatization conditions attached to the IMF/EU bail-out. For a short while markets considered the potential consequences for the banking system and global economy if these votes failed and Greece simultaneously defaulted and announced its removal from the euro. Although there was some relief that this did not come to pass, the cold reality remains that the Greek economy is destined to face a regime of debt deflation for several more years. What is quite apparent is that the discordant euro zone leadership has yet again been addressing the wrong target. They have mistaken a problem of insolvency for one of liquidity. With 2 year yields at 28% the bond market is clearly telling us Greek insolvency remains the primary issue.



China continues to confront rising inflation and property prices by raising bank reserve ratios and increasing lending rates. While most of the rise in inflation is due to surging food prices, the authorities are anxious to rein in loan growth in order to curb speculative property building. M2 money supply growth has fallen from 19.7% in December to 15.1% in May. The lagged correlation between money supply and CPI inflation indicates that Chinese inflation could start to decline in a couple of months. This does not preclude further interest rate hikes but it does suggest that Chinese tightening has almost run its course. We think China will deliver between 8.5-9% GDP growths this year.


The triple whammy of an earthquake, tsunami and nuclear reactor melt down came as a heavy blow for an economy that was showing tentative signs of recovery. It now looks as though GDP will contract 1-3% in 2011. For 2012 the rebuilding stimulus should then produce between 2-3% growth. Initial concerns that supplychain disruption would be significant now look overdone. After the G7 initiated a concerted intervention the yen weakened by 8%. However it has subsequently started to rally – possibly reflecting a repatriation of capital.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.