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September 2011
Market levels (23 September 2011)
10 year Govt. bond
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2.37%
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3 month money
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0.933%
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20 year Govt. bond
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3.27%
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Exchange Rate Vs US
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1.5438
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20 year index linked gilt
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0.22%
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Exchange Rate Vs Euro
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0.8757
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2011 is drawing to a close, and we can start to look at what 2012 might have in store. In general, 2011 has been a disappointing year. Growth has been lower than expected and inflation has been higher. Price rises have drained consumers’ spending power, and the continuing crisis in the eurozone is sapping confidence around the world.
Looking ahead to 2012, there is a good chance that it will be a better year for the UK. Commodity prices are starting to fall in response to lower growth around the world. This means that people will have a little more spending power left over after their wage increases, providing a more solid base for the economy. Inflation has been a steady drain - in August retail sales were down 0.1% on a year earlier, but retail prices were up 5.2%. So in cash terms, spending has been going up, but it is just buying the same amount of goods at higher prices.
In addition several high-profile events - the Olympic Games, the Queen’s Diamond Jubilee, and the European football championships – are likely to boost spending in 2012.
Overseas, the eurozone crisis has been growing since early 2010, with eurozone political leaders unable to respond effectively. This crisis now seems to be coming to a head, and the close interest being shown by the USA, the IMF and other overseas governments could help provide the money needed to bring an effective solution.
Overall, UK growth is expected to be 1.6% in 2012 - not strong but not disastrously weak. While the media and the markets swing between gloom and euphoria the real economic outturn will be something in the middle.
Inflation has stayed stubbornly high, and has consistently exceeded forecasts over the last few months. Given the economic slowdown it might have been expected to be falling already, but firms have been surprisingly ready to pass on cost increases. The VAT rise from 17.5% to 20% last January added 1-1.5% to the inflation rate. In the New Year this will drop out of the annual figures, and the CPI inflation rate should drop back below 3%, and then continue to fall during the year, to around 2.0%.
Interest rates should stay low for some time, but will eventually rise. The inflation target range for the Monetary Policy Committee (MPC) is 1-3%. The reported inflation rate has been above the top of the 3% ceiling since March 2010, and the MPC are keen to re-establish their credibility by getting inflation back within the range and keeping it there. The bank base rate of 0.5% is seen as too low, and the MPC will push rates up once the economy is seen to be on a sound footing. However, the minutes of their September meeting show that in the near term the MPC is concerned that the UK economy has been weakening, and that if this continues it is likely to make fresh purchases of bonds (Quantitative Easing), in the hope that this will give the economy a boost.
Finally, a few words on gilts. At the time of writing 10 year gilt yields stand at 2.40% - close to the lowest for about 60 years. This is mainly due to a flight to quality from the upheaval in the eurozone, and to the slowdown in growth. As the eurozone crisis moves to a resolution, and as growth starts to recover, gilt yields should go up. However, this is expected to be a slow process, and yields are only expected to have reached about 3% by the end of 2012.
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