Don’t blame it on the sunshine, blame it on the good times!

 

Meteorologists tell us that the heavy rainfall in the UK over the past three months is due to being on the wrong side of the jet stream. This mysterious driver of our weather, which travels west to east, usually sits much further north during the summer months - thus pushing areas of low pressure northwards and we avoid the bad weather. Not so this year. The period April to June has been the wettest on record. Repeated downfalls have caused flooding in many parts of the country. Our gardens are greener than usual for the time of year, but industries that rely on summer trading are suffering in economic conditions which are already challenging. There is nothing to be done but to sit and hope for sunny days.

 

The economic misery felt in the Eurozone for almost three years continues. In this case, the blame lies in the availability of cheap credit under a single currency which allowed weaker economies to leverage both public and private balance sheets. With the declaration in the last few weeks that both Italy and Spain need help, the Eurozone debt crisis has entered a new, perhaps more critical phase. This was the main agenda item at the most recent summit. Headlines inspired the markets for a few trading days with the apparent agreement that members’ bailout funds could be used directly to recapitalise banks rather than via governments. In principle, this is a step in the right direction, but the lack of detailed terms leaves us sceptical, with more questions than answers.

 

So the misery in the Eurozone is set to continue unless the key issues of debt, growth and competitiveness are addressed. It seems for now that the markets believe that further unity is required to resolve the Eurozone’s issues. Investors would like to see the European Central Bank act as lender of last resort and flood the market with cheap Euros to bring down the overall cost of borrowing. Yet this is highly unlikely without an agreement on further fiscal and banking unity, especially when each member faces a loss of sovereignty in following this federal path.

 

The Eurozone represents around a fifth of the global economy and has the ability to drag down the pace of its recovery. Indeed the International Monetary Fund (IMF) has recently warned of this danger. It also commented that Emerging Markets, the global growth engine of the past decade, were slowing and might be incapable of sustaining high growth rates in the future. US growth has also stalled in recent months, with unemployment remaining stubbornly high, ahead of the Presidential Election.

 

The expectation is that there will be further global stimulus. Indeed, we have already seen interest rate cuts in China and Europe, plus further money printing in the UK. However, in an environment where household deleveraging clashes with government reflation efforts, the law of diminishing returns applies. The lasting effect of each round of stimulus is diminishing. Policymakers need to tackle the structural issues of debt, growth and competitiveness to create a brighter future.

 

John Husselbee

18th July 2012