Financial Market

On the back of a bleak six months in the British economy at least one Company proved they although not recession proof, there are at the very least signs of improvement in the foreseeable future.

The search giant Google saw revenue rise and profits fall in the first quarter of last year in what is being seen as positive end of year financial results.

Net profit for Q4 was $382 million, a significant drop from $1.21 billion in Q4 2007. This 68% net profit fall was actually better than many analysts had predicted, and overall total revenue was up 18% to $5.7 billion.

“Google performed well in the fourth quarter, despite an increasingly difficult economic environment,” said Google boss Eric Schmidt.

“At least we have something to feel good about with this Google news in what has been shaping up to be a gloomy earnings period,” - Keith Wirtz at Fifth Third Asset Management.

In related news arch rival Microsoft posted lower profits on Thursday announcing 5k redundancies.

In the month of June UK inflation increased to an 11 year high of 3.8%, up from 3.3% in May, helped by increasing rising food and fuel costs.

The rise puts the countries inflation rate significantly higher than the governments 2% target and will certainly steer the Bank of England away from further rate cuts in the near future.

The UK’s central bank has said that inflation may increase above 4% in 2008, doubling the governments target, however as worries over the economies growth continue to grow the Bank of England is left with a tricky balancing acts.

The Bank of England can’t cut rates until it is convinced inflation is moving downwards,” said James Knightley, economist at ING.

Often used as a benchmark for pay negotiations, the RPI inflation measure rose from 4.3% in May to 4.6% in June.

Chancellor Alistair Downing has called for wage restraint in order to help rein in price growth.

“We saw what happened in the past when inflation got out of control and people found that every penny they got in a wage increase was swallowed up by food and fuel prices going up,” said Mr Darling.

He went on to say “Whether you are in the private sector, or public sector, whether you are sitting in the board room or working on the shop floor, we cannot allow inflationary wage increases because that would mean that everyone, especially people on lower incomes, would suffer,”

The biggest contributors to fuelling price inflation were the prices of non-alcoholic drinks and food, with prices increasing at a record pace of 9.5% in June from the same time last year. These figures were up 2.1% from May.

Increasing oil prices have also helped to drive up the cost of fuel with the average price of petrol increasing by 5.3 pence a litre.

The Bank of England held interest rates at 5% today amid increasing concern over inflation levels, despite the fact the UK economy continues to slow. The move fell in line with most analysts predictions, although a rate cut of 25 base points is now expected in June.

After a two day meeting the Monetary Policy Committee made its decision today which followed last months rate cut from 5.25%.

The continued rise in price of fuel and food has continued to push inflation above the BOE target, and this freeze in base rate demonstrates the increasing concerns of the UK central bank.

“The latest data shows the economy is slowing, albeit only gradually, and at the same time inflationary pressures continue to mount,” - Ian McCafferty, chief economic adviser to the CBI business group.

This afternoon’s move is another step in the measured response that the BOE has shown since the credit crunch hit last year. Unlike the FED the BOE has steadily reduced rates remaining reluctant to make successive cuts. The FED on the other hand has continued to slash its base rate in response to the crisis.

More base rate cuts are however expected in order to prevent the UK economy from slipping into recession. The British Chambers of Commerce had said prior to the decision to hold rates that a cut would have underpinned confidence in both businesses and consumers, helping limit any potential damage the crunch would have on the economy.

“This decision was a mistake given the serious threats to economic growth,” - BCC adviser David Kern.

Roger Bootle, economic adviser to Deloitte second those thought saying that by holding interest rates the MPC risked “presiding over the deepest and longest economic downturn since the recession of the early 1990s”.

Figure released this week showed that:

• Manufacturing output fell by 0.5% in March, the sharpest rate of decline in six months.
• The UK services sector grew at its slowest rate in nearly five years in April.
• Consumer Prices Index inflation was 2.5% in March, above the target 2%.
• April food prices were up 4.7% compared with a year ago.

The International Monetary Fund has been the latest organisation to forecast slower economic growth in the world economy over the next two years as a result of the global credit crunch.

In its forecast the IMF has suggested that the world economy would slow to 3.7% this year and 2009 which would mark a 1.25% drop in economic growth in 2007.

Predicting that the US will go into “mid recession” this year, the IMF has said that downturn in economic growth will be spurred on by the US, which will see growth in the UK slow to 1.6% in 2008/09.

The IMF also stated that the sharp decline in growth in the UK economy would come as a result of a weakening housing market, contraction of the financial sector and impact on UK exports that will come as a result of weaker growth in the US and Europe as well.

In the March budget Alistair Darling predicted UK growth figures of 2% in 2008 rising to 2.5% in 2009, optimistic forecasts that are clearly not shared by the IMF.

These figures have also been released with the warning that global downturn may be even more severe; with a 25% chance the global economy will see growth levels fall to below 3%, marking a global recession.

“The financial market crisis that erupted in August 2007 has developed into the largest financial shock since the Great Depression,” the report says.

The IMF has predicted that the countries that will be hardest in any global downturn will be those will excessive house price inflation, marking Spain , Ireland and the UK as the most venerable.

In the US house prices have fallen by around 10%, and the IMF predicts that in the UK house prices are currently over valued by as much as 20%. Further falls in the US are predicted for this year of between 14% and 20%.

Criticising past FED actions when US interest rates were kept at 1% for several years, the IMF said that in the future central banks need to take more account of rising house prices when setting interest rates, “leaning against the wind” to prevent house prices moving out of “normal valuation ranges”.

The newly nationalised Northern Rock bank today announced that the £24 billion state loan that it was granted in 2007 will be repaid in full by 2010. This comes despite the fact that the bank has warned that it may not break even for three years.

The bank also warned today that it will be primarily loss making in 2008 after a pre-tax loss of £167.6m, and this news came after stating the bank would pay former chief executive Adam Applegarth £785,000 as part of a severance package.

The payout will be split between a £760,000 payment and £25,000 in non-cash benefits which will be paid monthly.

“A lot of shareholders will be very unhappy with the size of Mr Applegarth’s payoff but it looks like legally, the company could not have avoided paying that amount,” - Roger Lawson of the Northern Rock Shareholders Association Group.

Northern Rock fell into trouble in September 2007 with the Bank of England stepping in to prevent the bank from filing for insolvency. As a result the bank lost 65.5 pence a share, around £243.5 million in overall value, compared to an increase of 394.5 pence a share the year before.

Northern Rock had £471.9 in bad loans compared to 81.2 million the previous year, and customer deposits were also down to £11.6 billion on the 31 December 2007 from £30.1 billion on June 30th the same year.

There are plans to sell off over half of the Banks assets and cut a third of the workforce to repay the loan that was issued by the government and return to public ownership. In an effort to accelerate its own mortgage redemptions the bank has ended much of its lending, including personal and commercial loans. It also intends to reduce its mortgage lending to 2.5% of the UK market down from 9.7%.

These measures, coupled with the trimming of staff numbers by about 2,000, roughly a third of the total number, over the next three years, should help the bank to cut costs by 20%.

Today Chancellor of the Exchequer Alistair Darling signalled that Britain’s economic outlook relies on events in the financial markets as he unveiled a modest first Budget, which shored up borrowing and involved raising taxes on drinkers, motorists and business in order to help fill a hole in public spending.

Even with reduced growth forecasts, Darling left an air of optimism on the lasting effects of the credit crunch. The treasury did however stress that predicted growth could be effected if the crunch was to deepen further.

With the intention of not taking money out of the economy Darling focused on taxation to raise funds needed to pass government targets on public debt and make progress towards its goals on reducing child poverty.

He did however raise government borrowing forecast over the next four year by £20 billion which would put public sector debt at 39.8% of GDP in 2010. The treasury’s ceiling is 40%.

Without the proposed £2 billion tax increase Darling would have hit his debt limit.

Among the increases in tax in this budget, alcohol saw a 9% increase adding 4p to a pint of beer, 14p to a bottle of wine and 55p to a bottle of spirits.

Vehicle tax duty also saw a hefty shake up with the most polluting car due to pay £950 in 2010, whilst the most eco friendly cars would be free of any taxation. Bio fuels will also loose its 20p a litre subsidy.

With the news this week that Virgin are the front runners in the bid to take over troubled bank Northern Rock, Financial Market looks at how the group will have to alter its tabled bid in order to cement any proposed deal.

The government has told the Virgin Group, spear headed by Richard Branson, that if it is to take over the Northern Rock the terms of its existing deal will have to be improved. The current terms are said to be more geared towards new investors than the long term standing of the mortgage specialist..

With the news that the Virgin consortiums terms are not to the liking of the government, the management-led bid to salvage the bank could still fall through. Nationalisation of the bank is still very much on the table without a better deal for taxpayers according to the treasury.

The government has stated that in return for its risk in helping the troubled bank out it wants increased exposure to any upside.

Northern Rock still owes the Bank of England £24 billion. If a successful take over offer is not made, an alternative course of action that has also been proposed involves the splitting of Northern Rocks debt into government guaranteed bonds and selling them off to investors.

Investors were further concerned when shares in Northern Rock fell as much as 8% upon news that the rescue packages tabled were not meeting government expectations, but this is a far cry from the disappointment of the zero return investors are expected to get should the bank be taken into public ownership.

Northern Rocks biggest single share holder SRM Global has also increased their stake in the company to 11.5%. As an opponent to the take over bid by Virgin, SRM would see Virgin take a majority shareholding in Northern Rock should the take over proposal be successful.

A sixteen year high, that’s the level of inflation the UK is currently experiencing for goods leaving UK factories according to January’s report released by the Office for National Statistics.

Annual output inflation reached 5.7% in January up from 5% in December, with the price of goods leaving factories up 1% and prices paid by factories for raw materials also continuing to rise, now up 18.7% over the past 12 months.

According to ONS data the surge recorded in January is due to the further increasing prices of crude oil which is up 70.3% on the year, and the spiralling costs of home grown food up 36% - a record high.

Core output inflation which strips out the effects of both rising fuel and food prices, has also risen faster than expected, up 0.8% this month and 3.2% on the year.

The report will certainly be of concern to the monetary policy committee at the Bank of England, and could prevent any further planned rate cuts being made in a bid to stave off UK recession.

“We had been expecting a further increase in output price inflation, but these figures are unequivocally awful,” said Philip Shaw, economist at Investec. “The scale of worsening of factory gate inflation highlights the MPC’s dilemma with monetary policy over the remainder of the year. It is having to grapple simultaneously with a slowing economy and a worsening inflation background.”

This news comes at a time when comparable housing market data also show continued slowdown throughout January, a sign that the once lucrative property market is beginning to loose momentum. House prices rose 9.1% in January down from 9.7% in December.

Amid growing recession concern the ONS also released figures showing Britain’s trade deficit gap in December was £7.574bn, higher than the predicted figure of £7.35bn.

On Thursday the Bank of England cut interest rates by a quarter of a percentage point to 5.25%, the second cut that the BoE has made in three months.

The monetary policy committee that votes on interest rate changes, voted to reduce the BoE’s interest rate in the face of the countries economic slowdown. The quarter point reduction was widely tipped following the decision of the FED to cut rates by three quarters of a percent in January in an attempt to stave of economic recession.

The quarter point cut did not however match that of the FED due to increasing food and fuel prices pushing inflation above the two percent target the BoE sets.

According to David Kern, “Global and domestic conditions have worsened since the MPC met last month.”

Since the last meeting of MPC members the situation had changed to a point where a rate cut was now urgently needed, and a further cut to five percent may be planned as part of a two tier rate reduction. A half point cut in one meeting may well have looked like a panic move.

With the rate reduction made yesterday cost for consumers and businesses who rely on credit will be cut, boosting confidence and act as a catalyst for economic growth. At the same time however the cut will hit savers.

Following the quarter point rate cut the BoE rejected calls from a group of influential MP’s to publish a breakdown of the voting of the MPC with each meeting.

The Treasury Select Committee recommended on the ten year anniversary of the MPC that financial markets would benefit if they could see the support for any one decision.

The BoE rejected this idea saying rate setters publish the logic behind any particular vote two weeks after the decision on interest rate changes.

‘Releasing the vote at the time of the decision runs the risk of encouraging media speculation on the reasons for an individual’s vote and increases the simple-minded tendency to portray members as ‘hawks’ or ‘doves’,’ the BoE said.

Leaked minutes today confirmed that the Bank of England’s Monetary Policy Committee voted 8-1 in favour of keeping interest rates on hold in January, although the Bank of England is still widely tipped to make a quarter point cut to 5.25% next month.

The leaked minutes demonstrate the Banks reluctance to follow suit after the FED’s three quarter point cut on Tuesday, with increased concern about the risk of spiralling inflation in the UK.

A reluctance to follow suit not only being shown by the Bank of England, but by other European central banks as well. Suggestions that European central banks are also reluctant to slash interest rates in a similar style to the FED created knock on effects in Wednesdays trading which saw US and European stocks fall further.

The worry is that slower economic growth will hurt corporate earnings, and stocks fell accordingly across all sectors. With Central Banks ruling out immediate rate cuts to boost economies, it means that slowed economic growth could be the trend for early 2008 as the US and UK fight to stave off recession.

“The uncertainty about corporate earnings growth in 2008 has risen, and not only in the financial sector.” said Matthias Schellenberg, managing director at ING Investment Management.