Monthly Archives: January 2015

Points of View: Eurozone QE and Greek Elections

We have had two noteworthy announcements this past week.

First, the European Central Bank (ECB) launched its long-awaited quantitative easing (QE) package last Thursday.  ECB president Mario Draghi said the bank will pump a larger than expected €1.1 trillion into Eurozone financial markets at a rate of €60bn a month from March 2015 until September 2016. The market reaction was broadly positive and the hope is that this extra stimulus will increase confidence and boost Eurozone inflation back towards the ECB’s 2% target. However, the ECB’s decision to embark on large-scale QE was not universally popular and indeed strongly opposed by Germany, where political and business leaders fear it could reduce the pressure on European countries to reform their economies and leave German taxpayers unfairly exposed to any losses on national debt purchases. As a compromise, the ECB decided that national central banks are to shoulder most of the risk of losses from QE purchases of their own debt.

Second, Greeks this weekend voted emphatically against the austerity policies of the last few years by electing into government Alexis Tsipras’ left-wing Syriza party.  This in turn is fuelling uncertainty given Syriza’s pledge to renegotiate bailout and debt terms could see Greece exit the Euro if no agreement can be struck with Germany. Greek stocks plummeted on the news but wider European markets have thus far not shown a huge reaction. Looking forward, investors will be eagerly tracking progress, hoping that a sensible compromise can be reached that does not lead to a disorderly “Grexit”.


Points of View: Swiss Franc soars in value

The unexpected announcement from the Swiss National Bank (SNB) to remove a cap on the Swiss Franc’s value against the Euro and lower interest rates to -0.75% caused a shock to currency markets last week.  The SNB has subsequently been criticised for the sudden decision, which has caused the Swiss Franc to soar in value against the Euro and other major currencies.

So why did the SNB implement a cap in the first place? Following the global financial crisis, Switzerland was seen as a haven and this led to an inflow of capital from investors.  This surge of capital into Switzerland caused a huge demand for Swiss Francs and led to the currency rising considerably against the Euro.  However, a strengthening currency is damaging to exporters, who find their products becoming less competitive globally, and the SNB therefore decided to implement a cap of 1.2 against the Euro.

So why scrap the cap now?  The SNB’s reasoning is that the Euro has now fallen sufficiently against the Dollar such that the Swiss Franc is no longer looking exceptionally overvalued.  However, the decision will likely also be driven by a wish to unpeg ahead of an expected decision by the European Central Bank (ECB) to announce a program of quantitative easing, which would likely push the Euro down further.

In an attempt to offset this, the SNB has decided to cut interest rates from -0.25% to -0.75%. By forcing banks to pay even more to deposit money with the central bank, it hopes to encourage banks to move money out of the central bank, thereby helping to drive down the currency.

Points of View: Falling oil costs tip Eurozone into deflation

Last month I reported on the sharp slump in the price of Brent crude oil, which has since continued to fall and currently trades at around $46 a barrel, some 60% lower than its peak of $115 a barrel in June. All other things being equal, a falling oil price is generally seen as a stimulus for the global economy because of the extra disposable cash it leaves in consumers’ pockets. However, not everyone is a winner from lower oil prices and investors remain worried that the massive and sudden redistribution of wealth from oil producing countries to consumers will create instability.

Another side effect of the sharply lower oil prices is that it has pushed the Eurozone into deflation for the first time in five years.   Inflation in the single-currency bloc had already been trending closer to zero, far short of the European Central Bank’s (ECB) target of just under 2%, so it was not a huge surprise that recent data from Eurostat – the statistical office of the EU – confirmed that the falling cost of oil had caused consumer prices in December 2014 to fall 0.2% compared with the same month in 2013.  This in turn is putting the ECB under intense pressure to boost the supply of cheap credit to the Eurozone.  Indeed, central bankers are well aware that allowing deflation to become entrenched is an economic faux pas and it will be interesting to see how the ECB reacts at its next meeting later this month.

December 2014 Market Review

This edition of the Market Review discusses the effect that sharply lower oil prices are having on the stock market.

December 2014 Market Review

Points of View: Greek Elections

Political uncertainty in Greece has driven further market volatility this week.  Specifically, the Greek government’s failure last week to find a parliamentary majority for its presidential candidate has triggered a snap general election scheduled for 25th January that could bring to power the hard-left Syriza party.  Given that Syriza and its leader Alexis Tsipras rose to prominence through outright opposition to the international bailout that the government negotiated in 2012, this has in turn driving renewed speculation that Greece will exit the Euro.  Indeed, Der Spiegel magazine fanned the flames of speculation further over the weekend with a report that the German government was no longer committed to keeping Greece in the Eurozone at any cost.

Should Syriza gain power it is expected that they will make demands for a relaxation of austerity and a lightening of Greece’s debt load. The dilemma that will then face Ms Merkel is that whilst the German chancellor wants Greece to remain in the Eurozone, she does not want to grant excessive debt relief or other concessions sought by Greeks for fear of overburdening German taxpayers with the costs.

Speculation as to the results and ramifications of the imminent Greek elections will no doubt drive further volatility in the weeks to come. However, proximity to power seems to be tempering Syriza’s hard line stance, suggesting that successful negotiations to stay in the Euro may be possible should they gain power.

Can we survive a minority government?

The election of 2015 may be absolutely OK – but the prospects are that it will not be and that the results may be terrifying.  For more than 200 years the UK has been used to two party government being the rule, with party splits and the emergence of Labour a hundred years ago (itself almost being a split from the Liberals) being the exception. The 2015 election will go down in the history books as the first after a fixed term parliament, the first after a Lib Dem/Tory coalition and just possibly as the beginning of a period of unprecedented political instability in a country which has been widely regarded as the most stable in Europe.

The prospects for next May are, if current polls are to be believed, that we have two large minority parties (possibly three if the Lib/Dems recover) and of both of these being single issue extreme nationalist groups.  A contingent of 40 Scottish Nationalists and 40 UKIP-pers,   where the former only want to be out of the UK and the latter out of Europe, is entirely possible. Parliament may have two major parties who have no majority and two minor parties who will not join a coalition. The nature of single issue parties is that they make everything unpredictable and that every action the minority government (whether Tory or Labour) tries to take needs to be the subject of fresh negotiation.

Although no-one in their right mind would try to predict exactly how each of the two nationalist parties would vote, it is worth thinking about first how the chips might fall on some of the decisions facing the next government.

To illustrate just some of the horrors which may await us I try below to look at a list of important questions and guess in which direction each of the two nationalist parties might push, and what they might be persuaded to support.

Immigration: In a free market we would be bringing in the top students, researchers and technologists. The UK is growing today on the back of talented immigrants who bring skills, growth and demographic improvement . Any controls which stop this happening hold back all sorts of developments and push them elsewhere. This, more than any other factor, threatens the future of Cambridge, as it does the UK generally. The Scottish Nationalists are all in favour of immigration (as long as it does not involve the English moving to Scotland presumably) but this is a major UKIP issue and also one where they can further their main  anti-EU agenda. Any government will find itself under pressure to agree stricter limits from UKIP MPs and Scots Nats will happily abstain unless promised a bribe.

Drugs policy: From PM downwards all those who have researched the problem know that the current policy fills the prisons, enriches criminals and encourages crime. Drug addicts need help, not punishment. Supply, regulate and control and take the violence off the streets. UKIP has a libertarian element to it which might mean a sensible (legalise and tax) policy suddenly becomes more viable; the Sottish Nationalists (particularly in their Glasgow heartland) might be expected to agree but probably the candidates they put forward in May will be socially conservative, possibly reactionary, and so expect a division on drugs deeper than in any other party. Progress on this front requires leadership and minority governments rarely provide this.

Tax:  We have a tax system which penalises success and rewards failure. It is inevitable that it should do so at the personal level as no civilised modern society will let those who, through ignorance or improvidence, fail to provide for themselves, starve or die through exposure. But by doing it at the corporate level by taxing profits to subsidise loss makers and uneconomic enterprises, the government destroys incentives and worse it leaves trading those who can compete only because of the subsidies and tax breaks they receive. Again UKIP’s libertarian wing will want to free up enterprise but the Scottish Nationalists are very likely (particularly as they almost certainly will be the government in the North) to want to keep Corporation Tax high and weighted against the best performers. Tax reform of any sort requires a decisive and determined chancellor and a parliament which will support him. We have been lucky to have Danny Alexander and George Osborne for four years but even they could not deliver an amalgamation of National Insurance and Income Tax, despite the fact they probably both want it.

Banks:  On the right hand the current government taxes them, fines them and asks them to have ridiculously high levels of capital. On the left hand it offers subsidies to lend to people it chooses, criticises them for failing to lend more and tries to get them to expand into geographically and economically unattractive areas. This attack on the fundamentals of the finance industry is wrong and popular in equal proportions. And all the Labour party promises is to do more of the same. It is impossible at the moment to envisage either of the minority parties standing up for a policy of helping our banks to prosper and expand, even though Edinburgh is the home to our biggest banks and UKIP claims to be economically liberal.

Industrial policy:  If the government left enterprise and business to the private sector the Cambridge effect would spread much further and faster. The government will never have an industrial policy which works, it is self-contradictory and wastefully employs far too many sensible useful people who could be doing real jobs. The existence of grants and free or subsidised financing diverts effort into seeking subsidies rather than profits to all our detriment. It is possible to see the minority parties both agreeing to abolish the Department for Work and Pensions, neither is really a creature of the vested interests who have to date managed to pressure the parasitic web of interference which stifles all businesses. But it will not be important enough to either for them to make it a condition of supporting any government proposals in another area.

Local government: We have too many tiers, too much detailed regulation of building, planning and development.  A Cambridge unitary authority which zoned areas for development and then left the developers free to do entirely what they wanted within those areas would enable better and more efficient use of land than the current confused and confusing detailed control structure. Both minority parties have a strong self interest in devolving more power to local authorities. We can expect unitary authorities in several parts of the county within three years of the election. This is a win-win for any government party and for the minority parties.

Infrastructure spending: This is real Pork Barrel stuff. When it comes to funding pet projects in their constituency all MPs become staunch supporters of local white elephants, actual or planned. But genuine improvements are generally too long term or their benefits too widespread to appeal to voters today. Major rail projects are probably safe but that is about where agreement runs out. We say goodbye to road pricing or any other substantial improvement for ten years. The short term will take priority over the long term and consistency of approach will disappear.

Foreign Policy: This is the hardest area to predict but also the area where a dysfunctional and disempowered administration is really dangerous. We cannot tell what crises might arise, but the fact that there will be crises where a firm and rapid response is required is unarguable, as is the fact that a minority government could probably not give it. The sole UKIP policy would be anti-European Union, the sole Scots Nat policy anti-British Union so that if a decision on any other matter is required their first question will always be how can we turn this question in such a way as to advance our cause?

On almost all of these the minority parties’ influence will be doleful, delaying or potentially disastrous. Parliament may become an obstacle to government in a way seen rather more often in Italy and France over the last 100 years. This is not only a matter of impeding decision making or influencing decisions disproportionately. On the fiscal deficit it seems hard to see who will hold the government to account. Both major parties are committed to reducing the deficit if they form a government. All its plans to cut expenditure (whether the Tory or Labour party are in power) will remove a specific amount from a specific person. This person will always shout more loudly about his loss than most others. Minority parties are particularly prone to pursue irresponsible populist and short term positions and so any attempts to cut a specific program will be resisted. New taxes will always affect some tax payer enough to make them complain and again the minority parties will find it easy to oppose.

The prospects are horrible if we have large UKIP and Scots Nat contingents of MPs; so horrible that if it happens we may see a response unknown in peacetime, with the exception of 1930, which is a Grand Coalition with David Cameron sitting down with a Labour leader to hammer out an agreed five-year plan. If not immediately after the election then after a year or two when the two major parties begin to realise they have lots in common with each other  and that a wide gulf separates them from the nationalists. That certainly would make 2015 go down in the history books.

This article was published in the Cambridge Business Magazine – January 2015 Issue 37