10/02/2008
SUCCESS MAGAZINE – 10th February 08
Many businesses are concerned about the outlook for 2008. After all, recent weeks have seen a plethora of bad news stories about the UK and global economies, with siren calls for a possible recession. What issues will matter most for businesses? I suggest three inter-related issues: the cost and availability of credit, pressures on companies to bring costs under control, and the inflation backdrop. Insights in all three will be vital for businesses to survive the coming year.
Since August, credit markets have been front page news. Central banks have responded with a series of interest rate cuts, and in December high profile, co-ordinated injections of liquidity into money markets. Their problem has been that although official interest rates, such as base rate in the UK, have been lowered, actual money market rates which business and consumers pay have not responded, indeed in some cases risen again to the alarming levels seen in the late summer.
Our analysis emphasises that these issues are simply part of a wider problem: the cost of credit is being re-priced, and the availability of credit reduced, for a whole range of households, companies and financial institutions, not just in the US but globally. The current situation is not like the last crisis in 1998 but will take longer to sort out. This stems from the wide array of financial institutions who hold risky assets, the opaque nature of many of the new credit instruments which were invented in recent years, and the growing recognition of the interaction between weak housing markets and the broader economy, especially in the US and parts of Europe. Credit markets will de-leverage, both for corporate and consumer borrowers. Eventually the banking sector will bring balance sheets back into order, for example by raising new capital, but this will take time. A period of overly easy credit has ended. Central bank actions to inject liquidity will help in some respects, but businesses should be aware that access to capital will be very different going forwards.
A second issue for firms is the risk the corporate sector begins to cut costs. Profits are under pressure from a variety of factors, including higher raw material costs, higher debt servicing costs and slower productivity growth, while the constant stream of competition from overseas limits the ability to raise many consumer prices. In this respect the outlook for the US economy is vital. The US was slowing noticeably even before the recent credit tightening or the jump in oil prices. We are very cautious about the outlook in coming months, and also warn that businesses should pay attention to developments in Europe and Japan in 2008. A co-ordinated downturn would be very serious.
Can interest rates be reduced? The problem is that central bankers face a dilemma: do they focus on headline inflation or on core inflation? In recent months inflation expectations have deteriorated. The cause is obvious: the rise in commodity prices, especially oil, grains, meat and dairy prices. The outlook is poor into spring 2008, with headline inflation in all the major economies likely to rise by another ½% or so. The recent announcement by nPower, for example, of much higher electricity and gas prices will bring the point firmly home for many people. Oil prices above $100 per barrel would seriously complicate decision making for some of the central banks. In contrast, we are forecasting a noticeable slowdown in growth rates in all the major economies in the coming year, more than is proposed by the market consensus. This should restrain labour markets, allowing wider output gaps to keep core inflation under control.
The key issue for many businesses in 2008 will be their ability to create positive earnings growth, directly related in turn to whether the current liquidity crunch turns into a wider credit crunch. The consensus currently expects global profits growth of over 10% pa. We expect this figure to be downgraded significantly, bearing in mind our forecasts of below trend activity in most regions. Although company profits on a global basis look set to remain in positive territory, a combination of credit problems and uncertainty for some time to come about the economic backdrop, mean that a more difficult business environment is still expected for 2008.
Andrew Milligan, Head of Global Strategy at Standard Life Investments.
This was published in Success magazine on 10th February 2008
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