It’s funny how words come and go. Before 2008 few outside of the financial world had heard of sovereign debt, quantitative easing or securitisation. They were part of a world that seemed futuristic. Advanced even. Now however it seems like a word steeped in historical resonance will become the buzzword for 2010. The word is austerity.

The Oxford English Dictionary defines austerity as ‘a situation in which people’s living standards are reduced because of economic difficulties’. In times past this was normally due to a war or a natural disaster; famine or some such. Prominence has been given to the word due to the recent travails in Greece with taxes and excises rising while workers have seen pay dramatically cut and pensions frozen. The hoped end result is of course that the increase in government takings will swell the coffers and allow them to pay down the huge amount of debt that they are saddled with. What would it look like in the UK however? What’s currently being talked about?

Most of it will be laid out in the next Budget which is expected on March 17th. Plans that were put forward last year are still being debated however and the campaign to have them postponed is increasing. The most prominent is a planned 0.5% increase in National Insurance for both business and individuals from April 2011. This has come under fire from business groups as a potential ‘handbrake on growth’ but looks likely to come into force.
Public sector workers are likely to see pay frozen and pension contributions severely diminished.

One think tank came out with the idea last week of charging the full 17.5% VAT on food, gas, electricity, child’s clothing and books; items that in the UK are currently zero-rated or taxed at a lesser rate. Obviously in an election year in which politicians are kowtowing to the electorate this particular change would be deeply unpopular. All blanket taxes are regressive i.e. they affect people on a low wage more than those on a higher wage as a larger proportion of their income is taken up by the tax. Naturally this suggestion came from a right-wing think tank. According to their report this would raise an additional £8.3bn in 2011-12 and £8.4bn in 2012-13, providing a decent injection into the government coffers. But then again so would a poll tax and that isn’t going to happen.

Some people think that those of us who should be the most austere are those who have been earning the big bucks. According to initial reports it looks like the Treasury has managed to raise £2.5bn against an initial estimate of £550m which may be used for “small targeted measures” that could be laid out on March 17th.

It’s being whispered that Alistair Darling would, were Labour to be returned to power, no longer be living at 11 Downing St. It seems that Gordon Brown is looking to get rid of the moderates who have been unwilling to walk the line completely. Hopefully Darling gives us a bullish budget and leaves the government with his head held high. Austerity can be started by one man’s bravery.


Trade of the week

The use of leverage is looking increasing good in the current high volatility environment as the below trade idea will show.

We were able to provide a client with a worst case rate above the current market. He was able to achieve a worst case rate of 1.5250 (1.50 cents above the rate available for forward contracts) and he can benefit up to 1.72 (nearly 12% above where the market currently lies).
Should the rate touch 1.72 during the barrier period (1 month before the expiry date) then he reverts to a forward at 1.5250. In this structure he has leveraged himself by a factor of 2: should the rate touch 1.72 he has to buy £200,000 worth of dollars as opposed to the original £100,000.

This strategy is premium free and is also relevant for buyers of sterling and sellers of other currencies.

Have a good week.