UK Enjoys A Better Week, But Pace Of Recovery Still A Concern

UK Saves Face with Confirmation of ‘AAA’ Rating Retention

The government received a boost this week in its efforts to shore-up the UK’s fading financial reputation with the announcement by Moody’s (NYSE:MCO), the rating agency, confirming Britain’s ‘AAA’ sovereign debt rating. Moody’s described the UK as “resilient” and predicted the next elected government would take the requisite steps to improve the fiscal imbalance with spending cuts post 2010 election.

Not all UK entities ended the week with their rating unscathed. In a separate review both Lloyds Group (LLOY.L) and Royal Bank of Scotland (RBS.L) suffered under the scrutiny of Moody’s competent credit analysis team. Lloyds Group’s junior subordinated debt and preference shares were downgraded whilst RBS’s junior subordinated debt was placed on “review” for a potential downgrade. Rumours continue to circulate Lloyds Group is to announce an equity-for-debt swap to reduce its involvement in the government’s asset protection scheme. Meanwhile adding further pressure on the bank to act European regulators have voiced proposals that would force holders of Lloyds Group’s debt to suffer some of the cost of government support - as equity investors have. Debt markets, in anticipation of action, have already priced in possible losses with Lloyds Group debt trading at a significant discount to par.

Also in the UK, supporting the view the property market has past the cyclical trough in prices, the respected Halifax housing survey reported a 0.8% price rise in August. The increase was in line with analyst expectations and pushes the average home price to almost £161,000 - still 10% lower than a year ago but now on a modest recovery trend. Other data over the week included August’s data from Nationwide Consumer Confidence index. The index rose to 63 from July’s revised 61 and is now at a 16 month high.

UK Government Admits to Spending Cut Plans

For months the Labour government has been under pressure to confirm its intention to tackle the fiscal deficit. Alistair Darling has now taken the first step in preparing the country for the inevitable, and absolutely necessary, spending cuts though he refrained from detailing where the cuts would fall.

Darling hinted spending cuts would be decided in time for November’s pre-budget report and executed post-recession. The Chancellor also predicted the economy would return to growth by year-end implying the new tax year commencing in April 2010 would see the first round of spending cuts leaving most of the pain until after the election. However, the latest polls indicate the Conservatives are highly likely to regain power for the first time since 1997 forcing them to introduce unpopular measures immediately after the election in hope the economy can sufficiently recover to allow it to relieve some of the pressure on tax-payers before the party pursues re-election in 2014.

Bank of England Maintains Loose Monetary Policy as Fragile Economy Nears Recovery

The Bank of England has in line with most expectations maintained rates at 0.5%, an all-time low. The BoE also confirmed the current quantitative easing program budget of £175bn would be maintained. Sterling gained on the announcement as speculators had priced in a small chance of additional stimulus action, either a further rate cut or an expansion of the QE program.

Whilst some business groups have stepped up their calls for a 0.25% rate cut to help propel the economy out of recession most analysts predict rates will remain unchanged deep into 2010 even if GDP data turns positive. The BoE Monetary Policy Committee are also likely to need 2 more months of data before clarifying the impact of their most recent measure, the £50bn increase in QE announced last month though a further increase of £25bn to £200bn can not be ruled out and was actually proposed by Mervyn King in the July meeting, though the motion failed to secure sufficient committee votes.

With fiscal tightening inevitable in 2010, monetary policy will remain the weapon of choice for the Government and BoE in its efforts to secure growth and tackle rising unemployment.

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