Will the UK be OK in 2014?

Written by: Steve Ruffley, Chief Market Strategist InterTrader.com

There has been much talk towards the end of 2013 that the UK economy is getting back on track and that we are set to see gains of up to 20% in the FTSE in 2014. It certainly seems that the main indices will finish the year towards the highs, so I guess the question is what could possibly go wrong for the UK?

Well, here it is. The fact that the BOE seem to have no real idea of how to deal with ‘real inflation’ or interest rates is the main one. Yet again we see the re-introduction of 95% mortgages in the UK. It seems the UK’s love affair with property is not going to end any time soon. I personally blame the culture in which people today are growing up in. Unfortunately knowledge is passed down through the generations, and the majority of people who have had children and who are coming to retirement, or are retired (probably well below the current retirement age) are still encouraging and facilitating their children’s debt. While interest rates remain at this historic low people will continue pay over inflated houses prices at the top of the market. As soon as interest rates rise, and let’s remember that they move in cycles, and have done since man invented them. What will happen then? Simple, another property/credit crunch.

Personally the UK housing bubble is like watching a train crash happening in slow motion. There are simply too many people relying on over inflated priced property funded by unsustainable debt levels facilitated by ‘old’ money and cheap finance.

The here and now problem is with Inflation. It is systematically eroding people’s standard of living and invariably hits the poorest the hardest. This is why we are seeing the politicians talking about freezing (an appropriate term as we approach winter) the frankly disgraceful hikes in prices we have seen across the board from the energy companies. A sly tactic, by both political parties to get some cheap reactions.

With all that said, It’s not all doom and gloom. GDP is expected to rise next year seeing a rise of up to 2.7% (2.2% predicted) which will take us back to levels seen in 2008, pre crunch. Unemployment is falling and we are getting ever closer to the 7% threshold that the BOE set to link interest raises to. So good news? It is if you think the BOE will drop rates! I personally however don’t and see the UK to be the 1st to hike rates and see them doing this well before the FED in 2015. I think I have more than explained the problem with raising rates above, so the question is, what is it going to give?

BoE's forward guidance policy – good or bad for the economy?

Mark Carney and forward guidance. I had high hopes for the UK after the break in the BoE’s traditions and bringing someone in from outside the normal hiring pool. This did not last for long. After Carney opening speech and wanting to address inflation, I felt sure that Carney would address the underlying issues within the UK and not fall into the trap of FED following. However very much in line with the FED and the ‘will they won’t they taper QE’ question, the problem for Carney and his waning credibility is what will he do, and what is his actual stance for forward guidance?

Carney fell into the trap of ‘wait and see’, which the FED started and the ECB and BoE whole heartily followed. The general consensus was that by keeping the base interest rates low this would encourage growth. The marginal growth we have seen in the UK has been from consumer spending, once again fueled by increasing house prices and the availability of credit. The growth has not come from businesses or from any of the measure set out by the BoE to stimulate growth. All that has happened is we have recapitalised the banks (that we now own) and they are still not lending to small business, which is probably the best way to sustain job creation and growth.

So what measures does Carney have at his disposal for forward guidance? Not a lot. We are rapidly approaching the 7% unemployment rate, and his decision to link a rates debate to this figure was one you could instantly see him regret. Other measure are more asset purchase, but again with the FED talking of tapering as early as Jan 2014, the BOE will certainly be more likely to reduce this than increase it.

The main measure the BoE has is that the UK now own the banks. Now we have bailed them out we need them to work for us. The BoE have to pressure the banks to lend to small and medium business in a structured and responsible way. This is how the BoE will stimulate sustainable UK growth.

I don’t want to sit here and talk about hindsight and what could have been. The fact of the matter is there were tough calls to be made and although Carney has not waved a magic wand and fixed the UK economy, we are still here. In 2014 I believe we will see a raise in rates. The UK has a very large aging population, with inflation linked pensions, cash and equity in houses. For the greater good the younger generation in the UK are set to suffer further. With rates definitely going up (at some point in the next few years) there will be some heavy casualties in the housing markets and also a large number of people who will simply be unable to sustain their debt levels. 2014 is a key year for the UK and my underlying thought is that if you are in the UK and struggling with debt now, the next few years will not be kind.

The direction for the pound in 2014

In keeping with my fundamental view that the UK will be the first to raise rates, I believe we will see the GBP/USD weaken towards the end of the year, but gain strength in the 1st quarter of 2014 and rising to 1.73289 by the end of the year. We see string support at 1.5648 and I do not foresee the USD being strong enough to test the 1.53122 so again after initial dips I would be buying the GBP on any significant lower levels.



Similarly with the EUR/GBP I see the strength we have seen in the Euro this year remaining until we hit resistance of 0.85270, but then I see the Euro losing against the pound and 0.82343 will be a key down side target with 0.79060 being a realistic level for the EUR/GBP by the end of 2014.