Bill Jamieson: US lifeline snarled by Europe’s tangle

WHAT a spring would now be in our step, if only ... A year billed as an economic one-way trip to Hell with no stops has opened with a rash of better than expected news. “Encouraging” would be putting it too strongly, but it has been definitely counter to the sense of an accelerating descent into recession.

There was much to give cheer. From stronger data on UK manufacturing through company contract wins to better figures from the all-important services sector, the first week of the new year brought signs that our economy still has a pulse. There were even figures showing a rise in lending to the corporate sector.

Arguably most encouraging of all was news last Friday that the US economy created 200,000 jobs last month. As I set out here on 11 December, America’s economy is beginning to stir, with a pick up in non-farm payrolls and a cautious improvement in household confidence. This encouraging trend has continued. But the latest jobs rise was way above expectations.

This is the sixth month in a row that US employment has risen and it takes the unemployment rate down to 8.5 per cent, the lowest in almost three years. And all this matters for us because the US is our biggest single area of overseas investment and of great importance for UK and Scottish exports.

Now all these do not much change the broader picture. But it is well that these, together with news of business order successes stretching from Renfrew-based IT concern Amor Group to infrastructure group Carillion, are marked and noted, because business and household confidence desperately needs encouraging news at this time.

Yet the reception accorded these benign omens has been pathetically feeble. The hope offered that the world’s biggest economy may be on the recovery path remains overcast by – yet again – Europe.

Renewed concerns of an imminent cataclysm in the Eurozone dogged financial markets throughout last week. A weary trader summed up the bleak mood after a brief rise in stock markets on the first day of trading in the new year gave way to all-too familiar falls: “Everyone is waiting”, he said, “for something very bad to happen”.

You don’t have to look far in the Eurozone to find out how “very bad” it could be.

The amount of Eurozone sovereign bonds that need to be issued to service public debt and fund spending is set to reach ¤794 billion (£654.5bn) this year. Italy and Spain need to borrow a combined ¤592bn. Italy must issue around ¤118bn in the first three months of the year and Spain needs to refinance about ¤60bn. For the record, of the ¤338bn of property related assets in the Spanish financial system, about ¤176bn are now deemed bad loans.

These are colossal sums and public appetite for this debt is, to put it mildly, jaded.

What could possibly go wrong? The Bank for International Settlements highlights five flashpoints in the first quarter. First, Greece needs to conclude a “voluntary” bond swap programme by the end of March. But the country’s existing bondholders may be less than willing to take a 50 per cent cut in the value of their bond holdings.

Second, the Greek bail-out could end in disaster if the IMF concludes that the country can’t be saved and will extend no more money.

Then there’s the all-too-real risk that the ratings agencies, caught out in the 2007-09 US sub-prime debacle, decide to downgrade the Eurozone countries. For Eurozone banks taking advantage of huge amounts of cheap money on offer by the ECB and buying government bonds, this could be ruinous. Shares in Italian bank UniCredit nose-dived last week on fears that a ¤7.5 billion capital-raising issue may end up under-subscribed because of growing investor aversion to bank paper.

Add to all this market unease over the massive hidden monetary easing now underway by the ECB and the social anger over national austerity programmes and we have a highly inflammable mix. The good news, however short-lived, should be noted. Latest Purchasing Managers Index (PMI) survey data for construction showed a rise in December and one well ahead of the consensus.

The growth looked to be broadly-based: all three main components – housing, commercial and civil engineering – reported a positive broad-based growth not seen since last March.

The picture ahead, however, is mixed. The service sector Markit/CIPS PMI for December showed a rise from 52.1 to 54.0 (50 is the threshold that indicates expansion). This was driven largely by an increase in new business, with the index for new orders rising particularly strongly. Profit margins, however, are being squeezed.

Finally there was a flickering recovery in bank lending to the non- financial corporate sector and a modest £400 million rise in unsecured consumer credit. But net borrowing on credit cards fell, indicating consumer resistance to higher debt at this time.

The year is still set to be dominated by private sector de-leveraging, continued tightness in fiscal policy, weak investment, only a modest improvement in exports due to weak demand in Euroland, and a strengthening pound against the stricken euro. Despite much bluster and blather, the Olympic Games will not see any great recovery in domestic demand.

Citi UK economist Michael Saunders has yet again cut his overall forecast for the UK, from growth of 0.5 per cent in 2012 to just 0.2 per cent, while his forecast for 2013 is cut from 1.2 per cent to 1 per cent.

The broad picture is that the economy will be flat through 2012 and will not see output getting back to its pre-crash peak until 2015, making this the worst recession/recovery cycle of the last 100 years.

What might lighten this broader picture? This week brings a meeting of the Bank of England’s Monetary Policy Committee. A no-change decision on interest rates at 0.5 per cent looks a certainty. But the committee is already looking to step up monetary expansion through further quantitative easing. Citigroup is raising its forecast for the total QE programme from £500bn to £600bn (that is, the £200bn done in 2009-10, plus the current £75bn programme, plus a further £325bn). The figure could be even greater if sterling rises significantly.

The next expansion (of around £100bn) is expected to come at the February meeting, as the Bank satisfies itself that inflation really is coming down in the manner hoped. It has also been pursuing a policy of gradualism that allows markets to absorb BoE buying of government bonds and other assets.

This is likely to be a critical lifeline in the months ahead as the Eurozone enters its period of maximum danger. Just a few weeks ago news of an upturn in manufacturing and service sector data, combined with a marked rise in US employment, would have had equity markets jumping in relief.

But the absence of such a rally tells us all we need to know about the prevailing mood world-wide. America may be on the mend, but it is the Eurozone on which global attention continues to be tightly focused given the magnitude of potential disruption.

And the markets are still “waiting for something very bad to happen”.