The flight to financial quality: what are the threats to UK businesses and the economy?
10 Oct 2011 Posted by: Mark Freeman
Professor Mark Freeman is speaking at Beaumont Robinson’s annual client seminar on world debt and investing in the current climate on 11 October 2011. Mark is due to address the World Bank in New York on the following weekend.
According to the IMF Financial Stability Report, September 2011: “Financial stability risks have risen sharply in recent months, as slower economic growth, market turbulence in Europe, and the credit downgrade of the United States have weighed on the global financial system.”
Unsurprisingly, this has been associated with a significant downturn in business, consumer and investor confidence, which has led to a major flight to financial quality (movement by investors to purchase safer investments) over the last six months.
What is the impact on the sovereign debt position?
The market has become much more discerning when choosing which Government bonds it views as being “safe”. Crucially, the UK Government is seen as being a relatively safe haven, which has allowed it to borrow extensively at extremely low interest rates.
High debt and low interest rates means that the Government projects interest payments of £46.5bn in 2011-12 vs. for example £35.9bn on defence (HM Treasury Spending Review).
What are conditions like for the UK’s retail banks?
In light of the reasonably benign conditions for UK Treasury borrowing, banks are recovering from the credit crisis and are now facing the impact of a Euro-zone debt crisis. The continued high risks to banks means that they are also looking for quality both through holding Government debt and changing financial positions with the Bank of England.
What is the impact on UK businesses?
Changes in Special Liquidity Scheme repayments have meant that lenders have continued to repay more of the support funds than had been previously arranged in the voluntary repayment plan (European Mortgage Federation Quarterly Statistics, 2011 Q1).
As a consequence, conditions have remained very difficult for corporate borrowers.
However, despite this firms remain buoyant. ICAEW and Grant Thornton’s UK Business Confidence Monitor for quarter 3 of 2011 says that concerns about access to capital have reduced since the recession. Only 19% of firms said it is more difficult to access funds than it was a year ago compared to nearly 40% of firms in the third quarter of 2009.
What are the key threats facing businesses and the UK economy?
Taking all of this into account, there are a number of threats facing the UK economy
- A major European sovereign debt crisis that leads to a banking problem in France – which in turn affects the UK through contagion
- A worsening of UK Government debt management which leads to the UK no longer being viewed as a “safe haven”
- A rise in UK interest rates – both for the Government budget and firm borrowing
- A double-dip recession
My advice to investors at this time is to stay safe. Reduce your assets and don’t take on any risky investments until the European and worldwide economy is more stable.