Banks are at the centre of stock markets crisis

Mar 19 2008 by Alex Turner, Liverpool Daily Post

THE world’s stock markets endured another anxious day yesterday as the United States Federal Reserve moved to slash US interest rates by 0.75% and UK inflation figures rose sharply.

Monday’s positive finish by the Dow Jones Industrial Average, buoyed by expectations of the US rate cut, boosted early trading in Europe.

London’s FTSE-100 Index, which closed on Monday night at a two-year low of 5,414, leapt above 5,500 in early trading yesterday morning.

By the end of the day it had clawed back 191 of the 217 points lost on Monday to finish on 5,606.

Monday had seen the FTSE-100 Index fall nearly 4%, a drop that followed similar falls in Asia and was largely matched by other European exchanges.

The trigger for this latest market turbulence was the crisis at Bear Stearns, which resulted in the US investment bank being bought by its rival JP Morgan Chase for a cut-price £116.4m.

Bear Stearns was heavily exposed to the mortgage-backed investments hit by the credit crunch and last week rumours of problems at the business swept the market, leading to a cash crisis at the firm.

Billionaire British businessman Joe Lewis, whose Tavistock Group owns Tottenham Hotspur as well as a host of other worldwide investments, said he has lost more than £500m after the cut-price buyout of the bank.

The US investment bank is being seen as the American equivalent of Northern Rock, and yesterday the next stage of the effects of the Newcastle-based bank’s nationalisation became clear when it announced that 2,000 jobs would be lost over the next three years. However, most of the cuts would take effect this year as the bank reduces its workforce by 30%.

And just as it had been the banks that had borne the brunt of Monday’s market falls, led by Halifax Bank of Scotland and Barclays, it was also the banks that led Tuesday’s recovery. Alliance & Leicester finished up 8% and HSBC rose 7%, while HBOS and Barclays gained 4% and 5% respectively.

ANDREW Morris, who heads up Rathbones investment management business in Liverpool, believes that trading will remain turbulent until the size of the banking crisis becomes clear.

“I still don’t feel that we know the true extent of the banking crisis,” he said.

“We can expect continued volatility in the market until we get a clear indication of how deep the banking crisis is, but we have had a clear display that the central banks are there to be supportive.”

Swift action over Bear Stearns and last night’s 0.75% US interest rate cut, has seen the Federal Reserve try to get on the front foot.

“It is a message of support to the banking system as a whole, a willingness to keep the economy moving forward,” said Mr Morris.

“To a lesser degree we saw that with the Bank of England on Monday. It’s quite a co-ordinated approach from central banks.

“It’s clear to see how pro-active the Fed has been. They have dealt with Bear Stearns in a weekend when Northern Rock seemed to drag on for months. We have seen it in the past that the Americans have been very quick to react.”

But he sounded a note of caution for those wanting the Bank of England to follow the lead of its American counterpart.

“Over here, more people are seeking advice on their mortgages and we are seeing inflationary pressures in their shopping baskets and energy bills.

“That does create a dilemma for central banks when looking at interest rates, they are in a very difficult position.”

The US Federal Reserve has now slashed interest rates from 5.25% in September, as the bank seeks to divert the economy off its path which seems headed for recession – if it is not already there.

But last night’s cut was not as much as markets had been hoping for, after speculation of a 1% cut had buoyed markets throughout the afternoon.

On Wall Street, the Dow Jones Industrial Average had been more than 300 points ahead at one stage yesterday afternoon, but gains gave way swiftly as investors digested news of the decision.

In a statement accompanying its decision the Federal Reserve said: “The outlook for economic activity has weakened further”.

It added: “Financial markets remain under considerable stress and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

‘TODAY’S policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity.

“However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.”

While the Fed has injected liquidity and cut interest rates, it may soon run out of room to manoeuvre, at which point the US could be forced to take its recessionary medicine.

Neil Blankstone, a director of Liverpool investment managers Blankstone Sington, said: “There was a lot of rumour-mongering on Monday which wasn’t based on any kind of fact, as we have had inflation numbers that are in line.

“Its indicative of the climate we are in. No-one is sure who else is exposed, and to what extent, to the fall-out of the sub-prime mortgage market.

“The volatility is likely to continue. There is a strong two-way pull taking place and this is going to take some time to play out. For short-term traders it will be a very bumpy ride, for long-term traders they will start to see value emerge.”

And Mr Blankstone was wary of expecting too much from the central banks, despite the focus on the action of the US Federal Reserve and the inaction of the Bank of England monetary policy committee.

“Things are being done and liquidity is being provided,” he said. “But central banks can only do so much, therefore it is going to take the wider market to digest what it is seeing at the moment and come out with a determined view of the future.”

Commodities and currencies have also been reaching new levels. On Monday oil prices spiked at a new record near $112 a barrel as fears over the US economy grew. The dollar sank to a record low against the Euro and hit a 12-year low against the Japanese yen, while gold prices rose to another record high.

Also yesterday, energy bill hikes sent the UK’s rate of inflation soaring to a nine-month high in February, official figures showed.

Recent double-digit price increases saw the Consumer Prices Index (CPI) – the official measure of inflation – rise to 2.5% in February from 2.2% in January, according to the Office for National Statistics (ONS).

Households have been hit by increases in gas and electricity tariffs from all but one of the six main suppliers this year as providers have sought to pass on rises in wholesale energy costs.

The ONS confirmed that this spike in inflation was largely down to a change in the way it calculates inflation to reflect the trend for price increases to come into effect sooner.

Instead of phasing in increases over a four-month period, the ONS last month moved to include gas and electricity rises from the day they are introduced, which saw all of this year’s bill increases kick in in the February data.

The ONS said CPI inflation would have remained unchanged at 2.2% last month if it had not made the change in methodology.

A rise in the cost of beer and cigarettes also had an upward effect on CPI last month, as did higher price tags for food.

Cheese, milk and bread prices rose by 17.6% on an annual basis last month – the largest rise since records began in 1997.

But there was a small downward effect from drops in the cost of fruit and vegetables compared with a year ago, with strawberries in particular seeing a decline in price.

The ONS said petrol rose by 0.1p between January and February to 104p a litre compared with a fall of 0.3p a year ago.

The Retail Prices Index (RPI) – often seen as a more representative measure of inflation as it includes the cost of housing – remained unchanged last month at 4.1%.

Howard Archer, chief economist at Global Insight, said the February inflation spike could tie the Bank of England's hands in making another interest rate cut before early summer.

He said: “Significantly higher consumer price inflation in February reinforces belief that the Bank of England would prefer not to cut interest rates by a further 25 basis points to 5% until at least May.”

Minutes due out tomorrow on the Bank’s decision earlier this month to hold rates at 5.25% are expected to show a near-unanimous vote as inflationary pressures loomed large.

alex.turner