Draghi, Bernanke Help Markets Higher

With Europe noticeably quieter yesterday than it was on Monday it has been Asia, and more specifically Japan, that has taken the reins of the market overnight. Haruhiko Kuroda has been confirmed as the government’s candidate for the Governorship of the Bank of Japan. Unsurprisingly Mr Kuroda is very much an advocate of the loose monetary policy that PM Abe has been calling for in a bid to weaken the yen, fight deflation and get Japanese industry competitive again.

Yen has weakened a touch from its recent highs on the announcement but with current policy as it stands in Japan, the safe-haven aspect of the yen will override any new policy pronouncements – save for a change in BOJ law to allow the purchasing of foreign debt.

Yesterday’s news from Italy is the kind that will keep equities and other risky assets from getting too far ahead of themselves. As we reported yesterday, the coalition building efforts in Italy have been farcical so far and the lack of agreement was highlighted by Beppe Grillo’s announcement that his 5 star movement would not give a vote of confidence to a government run by either Bersani’s centre-left or Berlusconi’s centre-right coalitions.

These assets were seemingly rescued however, by Mario Draghi who said that the ECB would preserve the integrity of the Eurozone – which sounds a lot like a continuation of the current very accommodative monetary policy. Further comments from Bernanke in testimony to lawmakers in Washington about the velocity that the unemployment market is improving also helped equities. The Fed Chair believes that unemployment will not reach a level of 6% for at least three years; Fed’s QE is not going anywhere anytime soon.

US GDP is the major announcement of the day with markets expecting a bounce back from the surprise 0.1% contraction that the preliminary figure reported. This was the first contraction since 2009 and missed estimates of 1.1% growth annualised. Most of this was attributed to a large cut in government spending, in particular defence, although we would caveat that by saying that the large increase seen in Q3 GDP was largely as a result of big rises in the same departments.

The fact is that housing, consumer spending, software engineering and the like are still going strong and if you blend Q3’s figure of 3.1% with this for Q4 you arrive at an average of 1.5% – which is roughly where we expect the US economy to be at this point in time. The announcement is due at 13.30.

UK growth in Q4 was confirmed yesterday at -0.3% although revisions in previous quarters saw growth in 2012 as a whole rally to 0.2%. In light of recent developments a hold at -0.3% may be viewed by some as a piece of good news for the UK economy. A revision to construction sector growth to 0.9% from 0.3% is welcome and goes along with improving sector data seen since Q3, although we cannot shy away from the horrific -1.5% fall in export growth.

The recent falls in the pound are a good thing if you believe that a lower pound will lead to a rebalancing of the UK economy towards export growth. Exports can be made more attractive by pricing or by simply making them so much better than their competitors’ that there is no choice to be made.

The Bank of England cannot engineer the latter and will instead go with the former. The lack of existing infrastructure and future investment in the manufacturing sector meant that for all the competitive market conditions there is nobody to fill the gap at the moment. Metaphorically speaking, you can give an athlete great running spikes, but if he’s half as fit as the competitors he’s never going to win.

The problem is that this plan hasn’t worked over the past 4 years and I would like to know why the Bank of England think this time is different. They are certainly giving it their best shot it seems. The latest minutes from the Bank of England suggested that, alongside another round of quantitative easing, a cut in interest rates or a plan to invest in corporate debt may be forthcoming. The Deputy Governor in testimony to the House of Commons Treasury Select Committee yesterday twice mentioned the possibility of negative interest rates; a phenomenon where depositors would have to pay to hold money in a bank – a de facto incentive to spend and not save. While scary, this is unlikely to happen but the damage to the pound was already done.

The fall in imports can also be tied back to the weaker pound as companies either seek cheaper local alternatives or, more likely, are importing less from abroad in reaction to lower demand from customers. Given we are an island nation reliant on inward trade, the increased inflation from our imports will outweigh the benefit from exports massively.

Today’s figure has only really served to underline the general sloth of the UK economy and does nothing to change our expectation that the UK economy will only grow by 0.6% through the entire of 2013.