Thursday 2 June 2011

The UK conundrum - Stagflation redux and other housing/banking issues

UK mortgages approval fell to their lowest level in April since record began in 1993.

As I pointed out in relation to the US housing mess in my recent posts, this will directly affect the UK Banking system where the "Extend and Pretend" game is still very much alive in relation to the increase in non performing loans.

There is a direct correlation in how the economy is doing and housing and bank earnings. UK banks face big headwinds.

Forecasters predict that 25% of the most affected Lloyds Banking Group's mortgage book, GBP 90 billion, will be negative equity by the end of 2012. The UK taxpayer has a 41pc stake in Lloyds Banking Group
Source : - Market Data
For RBS, impact is expected to be GBP 11 billion and GBP 6.1 Billion for Barclays according to an article from the Telegraph:

"UK mortgage approvals hit record low in April"

The Telegraph also reported this week that "up to 300,000 cash-strapped households have switched more than £60bn of home loan debt from repayment to interest-only loans to help cover their living costs".

"Banks accused of using mortgage debt leniency to flatter numbers" - Philip Aldrick

Extend and pretend, UK style...

"Lender forbearance – where banks shift homeowners onto interest-only deals, extend their mortgage term, or even permit payment holidays – now accounts for 63pc of all troubled home loans, according to the Financial Services Authority (FSA)."

Philip Aldrick goes on in his article:

"According to research by Fathom Consulting, write-off rates on lending to UK households – currently a fraction of one percent – are no higher than in 2001 despite the recession and a 20pc fall in house prices. In the US, write-off rates have increased fivefold to 9pc since its housing bubble burst in 2007."

"Banks should be making much larger provisions because the current status is artificial," Danny Gabay, a Fathom director, said. "We have lower foreclosure rates than during the boom. It's just not plausible." UK banks are currently holding about £1.6bn in provisions against the country's total £1.2 trillion mortgage book.

With prices going up with inflation at around 5%, interest rates close to zero at 0.5% and Real Wages getting squeezed, no wonder why households finances are stretched to the limit and beyond and switching to interest only mortgages with banks much obliged to accomodate.

"Cash-strapped families switch £60bn-worth of mortgages to interest-only" - Philip Aldrick

"With the average UK mortgage at £109,000 and average borrowing costs at 3.5pc, switching from repayment to interest-only saves households roughly £230 a month. But although the move may help families with their immediate cash-flow problems, concerns have been raised about how the debts will be repaid. Darren Winder, UK economist at Oriel, said: "For someone who's trying to alleviate monthly cash flow pressure, moving to interest-only makes sense. But it does raise questions about how that loan gets repaid."

There you go, same for US banks with "squatter rent", UK banks are doing as much as they can to avoid foreclosures and recognising losses. As I posted recently, "squatter rent" in the US is boosting US consumption artificially. By switching struggling UK households to interest only mortgages, the same recipe is in fact being applied in the UK, to maintain UK consumption to some "acceptable" level.

Banks are also racing to shed their commercial real estate exposure according to the FT:

"Banks in race to shed commercial property debt"- FT

Like in the US, like for Greece, in the UK, you can call this strategy "kicking the can down the road".

You can add to this situation, the rising risk of importing inflation from China, in the US, in the UK and in Europe. This will cause in the very near future margin compression to corporate earnings.

SocGen: "The China Domino Has Fallen!", Big-Time Inflation Coming All Around The World

Read more:

Slow Growth, rising inflation, high unemployment = Stagflation for the UK.

This is what I had forecasted for the UK previously and it is all working according to plan so far :

Fixed Income - Floating Expenses - Inflation still creeping up in the UK

UK inflation for December: 3.7% - QE is creating inflation as I expected.

Current inflation picture in the UK:

UK GDP Growth Rate:

UK unemployment, a longer perspective, 1990 to today:
Not has high as in 1992 but not falling fast enough yet.

"The unemployment rate in the United Kingdom for the three months to March of 2011 was 7.7%. From 1971 until 2010 the United Kingdom's Unemployment Rate averaged 7.22 percent".
Source -

Bank of England wil have to stay accomodative for longer than expected, given two thirds of UK mortgages depend on short term rates. This mean that the UK households will continued to be battered by a declining real income, meaning an absolute decline in the standard of living.

At the same time UK banks are piling on Gilts like US banks are piling on US Treasuries, not lending, shrinking their balance sheet but earning a nice spread in the process by borrowing close to zero and locking the spread on Government bonds.

There is a clear negative outlook for the UK economy and GBP currency.

EURGBP, trending up again:

Bank of England Paul Fisher said in an interview with the Daily Mail newspaper that he would consider voting for another round of QE if the economy worsened: "I would consider it and I've said I still hold that possibility open".

I still believe GBP could fall to parity with the Euro.

So QE2 for the UK and QE3 for the US?

The race in debasing the currency is still on. The ECB hasn't capitulated yet:

"The arrogance of officialdom should be tempered and controlled, and assistance to foreign hands should be curtailed, lest Rome fall."
Marcus Tullius Cicero

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