Darling dancing around deficit


Daily market commentary

10, Dec 2009

Darling dancing around deficit

So the pre-budget came and went yesterday and the economists and the politicians digested it in earnest. Naturally there was a heavy focus on the report due to the impending election and also the dire health of the UK economy. We saw a one-time 50% tax on bank bonuses that exceed £25,000- this expires on April 5 and does not include contractual agreements…lots of bonus payments to be made on April 6 then! Hard to know the intention here as it is easily sidestepped and avoidable and not likely to raise a jot to reduce the deficit or deter the bonus culture going forward.

From a market perspective other measures including an increase in National Insurance and a public sector freeze on pay limited to 1%, leave the ability to reduce the deficit in half within 4 years looking very doubtful. Sterling has not reacted too badly however but going forward I feel the words "deficit", "credit rating" and "downgrade" will be heard more and more to the detriment of sterling.

The Fitch downgrade of Greece has already rattled the markets and sends a clear message that there is a line to draw in spending out of a recession- ultimately like any debt it will come back to haunt you. The implications of a downgrade simply deepen the problem as it increases borrowing costs and default risks- the euro dropped sharply on the news particularly against the USD. There is real concern on other nations within the Eurozone- especially in eastern Europe could face the same fate; this could undermine the euro further.

For the UK Darling has already confirmed that the deficit will rise before falling so he has bought some time- however the credit agencies may not be convinced that the plans set out will achieve the objective of halving within 4 years. A close eye will be cast over the health of UK finances and sterling will be vulnerable on weaker numbers than forecast; the same is true on GDP forecasts as the budget is reliant on growth of 1-1.5% next year and up to 3.5% the following year. This years GDP forecasts from Darling are looking about to come in about one percent out- such inaccuracies will not be acceptable going into 2010 and 2011; this may turn out to be the problem of the Conservatives but the credit agencies are unlikely to let new political policies shroud the economic truths.

The biggest gainer in the currency markets has been the Kiwi dollar with the RBNZ released a more hawkish statement raising the prospect of a rate rise earlier than expected. Gold and commodities fell again yesterday with the market a little fearful on the back of the downgrade.

report by Phil McHugh

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