Britain Showing High Debt-To-GDP Ratio

Britain Showing High Debt-To-GDP Ratio

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 2nd of July.

The biggest problem plaguing the UK economy is the disproportionate government spending to boost the economy. Public sector expenses now account for more than 50 percent of the GDP and shows little sign of coming down. It’s open to debate if that’s the right number or not, but the UK public sector has stagnated for long with zero or negative growth. An economy is unlikely to grow if the single biggest component doesn’t contribute anything for the GDP’s growth.

The next problem is the high debt-to-GDP ratio. A McKinsey report suggests that Britain outstanding debt, adding personal, corporate and government debt together, exceeds 500 percent of GDP. Only Japan is more indebted than the UK while others, most notably the US, have started to cut debt at a brisk pace. The boom in last decade’s consumer spending was funded by borrowings. While high levels of debt hinder growth, the option of unbridled borrowing is no longer available. So consumers need to earn more now to spend more, which can’t happen unless productivity rises.

Finally, the BoE seems to have taken a leaf out of Bank of Japan’s books on the road to recovery. BoJ has kept interest rates to near zero for decades with liberal doses of monetary stimuli injected occasionally. Unfortunately, that didn’t put the economy on the path of sustained growth. There’s little proof that QE or low interest rates work in the long term. In fact, lower interest rates have discouraged savings, bringing down national savings rate and weakening the economy further.

UK’s problems are mostly home grown and blaming the EU won’t serve any purpose. Unless that’s recognised, investors may not wish to own British equities.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2404
GBP/US$ – 1.5665
GBP/CHF – 1.4901
GBP/CAN$ – 1.5953
GBP/AUS$ – 1.5324
GBP/ZAR – 12.8055
GBP/JPY – 124.71
GBP/HKD – 12.1468
GBP/NZD – 1.9534
GBP/SEK –  10.8702

EUR: The single currency almost jumped 2 percent on Friday after the 19th EU summit in Brussels threw a couple of pleasant surprises, far exceeding market expectations and triggering short-coverings by investors. EU leaders approved easier terms to the recently granted debt package, pushing Spain’s 10-year bond yields tumbling by 62 basis points to 6.32 percent. Much to the surprise of the markets, the European policymakers also agreed to a single banking regulator to supervise the region’s banks, pushing the GBP/EUR down to a near two-week low of 1.2354 in early afternoon trading, though Sterling recovered later to end the day over the 1.2400 handle. The manufacturing PMI from Europe is due today and a softer than anticipated report may trigger a 25 bps rate cut from the European Central Bank this Thursday. The GBP/EUR pair opens at 1.2380 this morning.

USD: The cable surged against the greenback on Friday, gaining nearly 1 percent against the USD on the back of the positive developments in the EU. Sterling however, closed lower that the day’s high of 1.5718 as investors rushed to book profits although the US closed lower than most of its major counterparts, except the JPY. The Pound seems to have already priced in an additional QE of £50 billion from the Bank of England this Thursday and any prolonged weakness for the GBP/USD pair seems unlikely. UK June manufacturing PMI data is due today and any weakness would further strengthen the case for additional assets purchase. The manufacturing ISM number is due from the other side of the pond this afternoon though prices are more likely to be decided by Friday’s optimism. The GBP/USD pair opens at 1.5646 this morning.

 

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