Analyze the causes and the impact of the current financial crisis on the UK economy.
The United Kingdom has maintained swift economic growth and low inflation over the past decade. The U.K economy developed 3% growth in 2007. Inflation had been under control in 2007. Further, U.Kās net debt stays well under the G-7 average. Thus, U.K can achieve this feat due to its strong policy frameworks and economic policies. This strong economic foundation has facilitated to withstand global economic turmoil and turbulence.
However, U.Kās GDP (Gross Domestic Product) growth is expected to be around 1.75% to 2.25% in 2008 as compared to 3% growth in 2007. The U.K started to witness imbalances in recent years due to global financial shocks in commodity markets, financial markets and energy prices. Thus, confronts are in the shape of declining domestic savings, overheating in the housing markets, high current account deficits, increasing inflation and prolonged decreases in international investment positions. The downtrend in U.Kās economy is evidenced by the fact that its financial results over the past few financial years came down headway under golden and sustainable rules.
Through the U.K government intervention like tightening of monetary cycle from middle 2006 has somewhat contained the imminent inflation perils and began to give a soothing effect to the housing market. However expectations over the medium-term inflations which had been on the rising trend over some period āhappened to increase and fundamental external inequity augmented with the factual efficient appreciation of sterling pounds.
Further, the recent global financial shocks have augmented the significance of transforming the policy mix and put forth new issues in the structure of policy frameworks to the surface.
In case, the upward drift and imbalances in inflations anticipations continue and the linked perils to prolonged growth that is to be addressed by employing the following strategies by the U.K government.
- The financial and fiscal policy structures required to be augmented to instill confidence in longer-term outlooks.
- There is a real risk of an excessive slowdown soon. This can be averted by prolonged nominal wage increases and further steps to deal with exposures in the financial sector. Actions should be pursued to enhance net external demand through rebalancing both monetary and fiscal policies.
- Due to the above-trend growth in 2006 and 2007, activity needs to be slow.
Economic forecasts for the year 2008:
Economic growth in the U.K during 2008 is expected to be slow. Further, whatever projected could not be achieved and this reflects indecisiveness about the present turmoil in global financial markets, affiliated overruns across markets, the likelihood of unfavorable feedback loops and tenures of trade shocks
These issues are deepened in the U.K by the economic correction perused in the housing market and its probable effect on household consumption and bank credit. At this juncture, the underlying flexibility of the economy and the major depreciation of the sterling pound which has made the real exchange rate nearer to equilibrium levels will provide offset effects.
As of now, house prices in the UK have decreased considerably. Bank of England, which is the central bank of the UK, has warned of difficult times ahead. UKās base rate has been dropped by the Bank of England repetitively immediately after the Dotcom crash that occurred in 2000.
Job loss fear is also hovering around in the UK due to the economic downturn and this has affected productivity indirectly as there has been a down in employee morale.
Following the US style, UK has to resort to bailing out the ailing banks to engage in liberal lending to boost the economy. To resurrect UKās economy, an unexpected increase in interest rates in the UK at some point in time may be initiated given the base rate has been historically low since 1999.
To forbid economic slowdown, perils like credit squeeze have to be contained by perusing actions like the implementation of the Special Liquidity Scheme and raising of capital by banks. However, despite these corrective steps, the conditions will remain tight as earlier strains endure. During the year 2008, as estimated by the Bank of England, the CPI inflation will be above the target due to the effect of the depreciation of sterling and shocks to commodity prices. However, the current account deficit is set to narrow due to slower growth and the presence of enhanced competitiveness. (HM Treasury 2008)
In recent years, the London Stock Exchange has been target of a number of unsuccessful take over-over bids. Explain the reasons for these attempts and the likely impact of a merger with a European or American stock exchange.
The London Stock Exchange (LSE) has been in the news for quiet some time with the torrent of opposing takeover proposals. It all begun in first quarter of 2000 when Deutsche Borse, a Frankfurt-based German exchange operator and LSE talked about strategies for a merger which would have involved Nasdaq at a later stage. There were wide criticism about this takeover bid and the deal failed when OM Group, which manages the Swedish stock exchange made a takeover bid by offering Ā£800m, the first ever hostile takeover bid for a stock exchange in international market. Later in the year 2006, Nasdaq, the electronic exchange of U.S.A made its offer to takeover for LSE for Ā£2.4 billion. Later, takeover bids for LSE were made by the New York Stock Exchange and Euronext, the exchange operator from Paris. Due to tightening of corporate reporting due to introduction of Sarbanes Oxley Act (SOX) in U.S.A, LSE is being considered more attractive destination for non-UK companies to list their shares.
Why LSE is being offered for bid now?
LSE has been made under the purview of the Financial Services Authority of UK (FSA) in the year 2000 onwards. However, LSE has more regulatory powers as it has its own management team that supervises the activities of the market and coordinates with FSA. By resorting to either public or private fines, the LSE can censure both companies and members and discipline them. In the year 2000, the LSE was converted into a public limited company and it had celebrated its 2nd century jubilee by listing on its own market. Since, any listed company is open for takeover or merger, LSE is also happens to be in the race.
Why LSE is being offered for takeover?
LSE is the third largest stock exchanges of the world lagging behind the NYSE and Nasdaq. If one look at the share price of LSE, its performance in the last few years is not at all attractive. The share price of LSE is always sluggish and it has shown signs of moving upwards only during the occasion of takeover speculations. LSE has failed to attract more new listings. LSE also find it difficult to convince major global MNCās to list in LSE.
Why privatisation of London Stock Exchange is advocated?
According to experts , in case of merger or takeover bid of LSE will result in decreased dealing commission charges and there is a possibility of introduction of a new trading system and probable tie-ins with other exchanges. Deutsche Boerse claimed that if its takeover bid is successful, it would minimise the tariffs for ordering through electronic order book trading in the UK. It also makes it easy for UK based investors to access overseas markets and companies. The merger proposals will make LSE as the largest stock market operator in Europe and the second largest stock market operator of the world just lagging behind the New York Stock Exchange. According to Deutsche, it aspires to minimise the cost of electronic trading and it is expected that more investors to operate from the UK market and when there is an increase in volume, the investors is likely to get a fairer price for their equity shares. In other words, it will end up in narrowing the gap between the offer price and the bid price. Further, LSE is having an attractive liquidity market and spreads happens to be thin which is attractive to investors. Further, LSE has located at a favourable junction just in the middle of North American and Asian time zones.
Impact of a merger with a European or American stock exchange with the LS
In case, if there is a merger between LSE with an American stock exchange or with a European stock exchange, the merger will foster a single larger market. Extensive reductions in the cost could be achieved. Thus, if at all merger comes to reality, it would definitely foster a single international exchange trading across different time zones. (Batchelor Charles2006)
What are the Eurocurrency markets? What are the cost and benefits of such markets? What factors have led to the growth of these markets? What are the consequences of the growth of these markets for the international financial system?
It is a specialised international baking market which engaged in the lending and borrowing of currencies outside nations of their issue. There are many number of players in the Euro-currency market (ECM) and they are government agencies , large multi-national companies , commercial banks , non-banking institutions , monetary authorities and quasi or semi governmental agencies including central bank of a country and international agencies.
Since, the major chunk of the ECM is situated in Europe and major portion of the transactions are in dollars, the market is commonly known as āEuro-dollar marketāā Due to weakened dollar in certain scenarios, other currencies like Swiss franc and the deutsche mark were used substantially as an alternative to US $ and hence, it has been more appropriately christened as āEuro-currency marketā.
Euro-currency market (ECM) was started in post era of Second World War mainly in UK and in France. The main aim of the ECM was to alleviate the panic of Soviet Bloc nations that was in the idea that dollar bank deposits made in the US might be confiscated by U.S government with financial claim against U.S.S.R and other communist governments in the cold war era. ECM market is influenced by the Eurodollar or US$. Sporadically, the Euro DM or Euro Swiss franc gained significance when dollar was weakened especially at the fag end of 1970ās and 1980s.
The main advantage of ECM is that financiers and banks are able to avoid or thwart some cost associated with the regulations and restrictions. Some illustrations are given below:
- Requirements as regards to minimum reserve.
- Recompensation of FDIC fees requirement.
- Regulations or rules that limits fair competition among banks.
ECM is said to be more advantageous when there is high incidence of taxes and continuing government monitoring and regulations. It is to be noted that ECM is not subject to official interest rate savings or legal reserve requirements in respect of their dollar transactions. This has dual benefits for banks as they could offer more attractive interest rates and to operate with lesser margins as compared to other banks either in U.S or elsewhere in the world.
Further, disparity treatment of offshore banking and national banking operations was distinctive not only for U.K but also for other nations where significant offshore banking centres came into existence. This demonstrates much of the amazing growth of Euro-currency market.
ECM can be described as a wholesale market as the majority of the final borrowers are official entities, large corporations and the average unit size of the financial transaction is said to be extensive. Due to this, the overhead costs for banks are considerably at low ebb. Further, ECM can be termed as an interbank market. About three fourth of the foreign currency assets and liabilities of the reporting European banks are always represented as assets and liabilities against the other banks. Due to increase in gross size of the market in the last few years, there is a corresponding increase in interbank deposits.
It is to be noted that in many ways, ECM is more analogues to national monetary market and the main basis difference is that ECM is a market where there is no supervision by central monetary authority and is totally free from controls.
As a way of distributing the risk existed in large scale loans, Euro-bank have resorted to syndicating medium-term loans sanctioned outside the interbank market. Syndicating loan has facilitated many medium and small āsized banks to function in the Euro-currency market. To minimise the default risk, Euro-banks has placed restrictions on the quantum of outstanding advances that they will sanction to any single borrower or borrowers in any single nation.
One another distinguished characteristics of Euro-bank lending is the use of āfloating rateā on medium term credit advances. These symbolically represent a sort of roll-over credit with determination of interest rates periodically mainly to avoid interest rate risks inherently present in these transactions.
Most of the loan agreement will contain multi-currency provisions mainly to avoid loss on exchange-rate volatility. Thus, it offers a choice of currencies in which the parts or whole of loan may be drawn upon. (Grauwe Paul de1975:14).
List of References
- Batchelor Charles (2006) The London Stock Exchange Financial Times [online]
- BBC Home (2004) Q&A: Stock exchange takeover [online]
- Grauwe Paul de (1975) āThe development of Euro-currency market.ā Finance & Development ABI/INFORM Global, 12 (9), p 14
- HM Treasury (2008) IMF Reports āUK Economy- UK Article IV Consultations 2008 [online]