Thursday, 3 July 2014


Equity markets retreated slightly during the past week as the second quarter of 2014 draws to an end and investors are nervously awaiting whether the Q2 economic results will have made up for the poor winter quarter. Meanwhile the big news for the British public was (not football) that UK's central bank, the Bank of England (BoE) walked the talk and introduced what we had been expecting for a while: A set of direct mortgage lending restrictions on banks, with the objective of slowing the further rise in UK residential property prices without having to begin raising interest rates. The restrictions will only apply if house prices continue to rise at a rate which would amount to more than 20% over 3 years (roughly 6.3% p.a.). Mortgage lenders would then not be allowed to lend more than 15% of their mortgage book to mortgagees where the LTI (loan to income ratio) exceeds 4.5%. They will also have to make sure borrowers would be able to afford a 3% rise in mortgage rates from their discretionary income component. On the basis that not a single lender currently breaches these limits, they are more a message and warning from the central bank, than an outright market intervention. However, I noted with great interest the threshold level of an additional 3% for the mortgage affordability stress test. This strongly suggests that the BoE is not expecting that they will be raising interest rates above 3.5% during this economic cycle – well below the long running average of 5%. During a BBC Radio4 interview on Friday morning the bank's governor Mark Carney became even more explicit and said that their expectation was for interest rates not to exceed 2.5% at the end of the cycle. The implication of this is that the public's rate expectations are probably too high, while the markets are potentially now for the first time underestimating the potential for rate rises over the coming years. This would also explain what seemed to many observers as confusing and apparently contradictory statements by the bank's governor Mark Carney over the past 2 weeks (more on this below).

I was delighted to learn that UK business investment is further accelerating, exceeding last year's levels by a strong 10.6%, having now grown for a consecutive 5 quarters back to pre-recession levels. Reviving business investments into productive capital is very important for the longevity of this economic cycle and I have stated since the end of last year that only a meaningful pick up in company investment will extend this recovery into a meaningful expansionary cycle in which equity valuations can gain far more headroom than they have had so far. Economic news flow in the US continued to be strong for the current environment, which is to some extend a catch-up and rebound from the economic contraction the frozen out first quarter produced. Europe has no such excuse and the fact that the recovery there has begun to lose momentum, gives me hope that the Eurozone's central bank (ECB) will pick up the courage and engage in similar extraordinary monetary support that has lifted the US and the UK out of recession. This will be good for the Eurozone economy and by virtue of our high trade volumes also provide a further boost to the UK – watch this space! 

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