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Tuesday 23 September 2014

UK austerity measures will lead to weak sterling vs euro as US steps back from cliff

Published 10/01/2013 | 05:00

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Sterling will weaken against the euro this year as Britain faces a potentially testing triple cocktail of destructive factors, says HSBC.

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"The pound's fiscal credibility is under threat as a sovereign downgrade looms," the bank said in its 2013 HSBC View published this week.

Alongside that, the bank says austerity is now kicking in at a time when the Bank of England appears less activist, which could see a 'what's wrong with a weaker currency' attitude prevail.

And the UK's failings will start to "grab attention" as the US steps back from the fiscal cliff, momentum grows in China, and eurozone break-up fears diminish.

"The pound looks set to lose the contest of the uglies," the HSBC report said, as its "frailties emerge from the shadows".

HSBC forecasts the pound will be trading around $1.52 against the US dollar by the end of the year, down 5pc from $1.60 at present.

A falling sterling will boost the cost of Irish exports, making it more difficult for Irish companies to sell their goods in Britain.

HSBC expects to see big swings up and down for British shares this year but ultimately eking out a decent return of around 15pc, against 5pc-6pc in bonds.

Like other fund managers and economists, the bank believes that investors who have piled into bonds over the past four years, could switch to shares in search of higher returns.

"Investors now are paid very little for owning bonds: 10-year US inflation-protected securities now yield -0.8pc, and credit spreads are at their lowest level since 2007. As equity volatility continues to fall, we think investors will slowly appreciate again the merits of equities," HSBC said.

This view is echoed by a number of large fund managers such as Fidelity, Black Rock, and Goldman Sachs Asset Management, who have seen signs that investors could start to switch from high-priced "safe haven" assets into shares.

Equity strategists at Investec expect Britain's FTSE 100 index of leading shares to end the year up nearly 10pc at 6,650 as investors dump bonds for equities.

"We are particularly bullish on dividend-yielding stocks. Growth stocks should also benefit from a sustained negative real interest rate environment as a lower discount is applied to the longer-dated cash flows of such stocks", said Andrew Fitchie and Roger Cursley.

From a macro perspective, Investec foresees sustainable growth from the US, and a more encouraging turn in economic momentum in China will buoy stock markets. They expect no sudden rebound in the "chronically ill" eurozone.

The UK is a "mixed picture; but on balance, recent data indicates very modest, but nonetheless positive, momentum in the economy".

"Amid talk of a 'triple dip' recession, we see an economy that has been bumping along around 0pc growth (plus or minus a little) as fiscal tightening and spending cuts have played a tug-of-war with quantitative easing. Of late, we see some encouraging signals.

"There have been some positive indications from housing market transactions and the consumer picture has been better than expected. No one is pretending it will be an easy road ahead. However, momentum, whilst slow, in our opinion, is positive for the UK in 2013."

Investec forecasts GDP growth on 1.5pc in 2013 and 2.2pc in 2014, up from -0.1pc in 2012. It also predicts a weakening of the pound against the dollar.

Investec is positive about the prospect for consumer goods. In financials, it sees real estate benefiting from the flow of funds into equities.

However, the analysts are neutral on banks – "The sharp rebound in the shares during the second half of 2012 has eliminated much of the upside and continuing low interest rates are not conducive to earnings upgrades". They are bearish on oil and gas producers, but see growth in companies supplying oil equipment and services. Other sectors regarded as out of favour are retailers, particularly food, and mobile telecoms "given structural challenges".

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