The Count Report - No. 109

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Market Update

An economic update
The big three… What have been the major economic events of the past few months?

Stephen Halmarick
Head of Investment Markets Research, Colonial First State

1. The sovereign debt crisis in Europe

In Europe, the focus has been on the Greek election outcome and the EU Leaders Summit late in June. The outcome of the 17 June Greek election was favourable for the near-term outlook for Greece and for Europe, removing the possibility of a tail-risk event (a risk posed by events that are relatively rare), i.e. a near-term Greek exit from the euro.

A coalition Government was formed between New Democracy, PASOK and Dimar, with New Democracy elected on a pro-Europe, pro-austerity, pro-bailout agenda. There are reports that this Government will look to negotiate more time to meet budget deficit targets and funding for growth initiatives.

Both Spain and Cyprus formally requested a bailout in June. Spain requires €100bn for its banking sector to be recapitalised, while Cyprus is expected to need approximately €5bn. Financial markets were initially concerned that the €100bn for Spain would be added to the government’s balance sheet, tightening the loop between banks and governments.

However, at the EU Leaders Summit on 28/29 June, several important steps in the right direction were announced. In particular, the move towards a single supervisory mechanism for European banks by the end of 2012 was a major step forward. Once this is in place, it should allow for the European Stability Mechanism (ESM) to directly recapitalise banks without these funds added to the government’s balance sheet. This is a big win for Spain and Ireland.

2. Disappointing employment growth in the US

In the US, economic data outside the housing market continued to show signs of weakness. So far in 2012 employment growth has disappointed expectations, despite the unemployment rate hovering at just above 8%. The pace of employment growth has slowed, averaging 225,000 jobs per month in January – March, with only 75,000 jobs per month averaged in April to June.

A more subdued economic outlook led the US Federal Reserve (the Fed) to choose to continue its program to extend the average maturity of its securities holdings (known as Operation Twist) until the end of 2012. An additional US$267bn of short-term bonds will be sold and long-term bonds will be bought to continue to lower the structure of interest rates. This takes the total amount of this program to US$267bn.

3. Easing in interest rates in China

In China, economic data continued to soften, leading to the two interest rate cuts. The 1-year lending rate was lowered to 6.00% from 6.56% in two separate moves. See chart below for details. Consumer Price Inflation also eased to 2.2% from 3.6%/year at the end of March. Fixed asset investment and retail sales also weakened with expectations that between Q2 and Q3 will be the trough in Chinese economic growth. GDP growth also eased, with growth of 7.6% recorded as at 30 June 2012, compared to 8.1% for the 12 months to 31 March 2012.

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