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UK Economy Shrinks Unexpectedly – Financial Post

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The UK economy shrank in April at the sharpest pace in more than a year as the government wound down Covid testing, highlighting risks that a broader contraction is under way.

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(Bloomberg) — The UK economy shrank in April at the sharpest pace in more than a year as the government wound down Covid testing, highlighting risks that a broader contraction is under way.

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Gross domestic product fell 0.3% from March when output declined 0.1%, the Office for National Statistics said Monday. A gain of 0.1% was predicted by economists.

The figures underscore a dimming outlook for the UK economy, with manufacturing, services and construction all contracting together for the first time since January 2021. That may persuade the Bank of England to move cautiously in fighting inflation. It’s expected to deliver a quarter-point rate rise on Thursday.

“The fall in output is unlikely to be short-lived,” said Yael Selfin, chief economist at KPMG UK. “The overall outlook remains downbeat as the squeeze on consumer income is expected to weaken demand.”

What Bloomberg Economics Says … 

“We expect momentum to remain subdued in the following months, with output to decline by a marked 0.4% in the second quarter as the real income squeeze starts to bite. Still, with inflation remaining stubbornly high and a red-hot labor market showing no signs of easing, it won’t be enough to prevent the Bank of England from hiking rates. Given the risks to the economy, a 50 basis point move this week looks highly unlikely — we expect a 25-bp hike, with rates climbing to 2% by November.”

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—Ana Luis Andrade, Bloomberg Economics. Click for the REACT. 

The pound slid as much as 0.6% to $1.2238, reaching the lowest level in about a month. Some investors reined in bets the BOE will announce a half-point rate increase this week.

The GDP report showed services dropped sharply due to a 5.6% decline in health spending. Test and trace activity fell almost 70% in April. Excluding test and trace and vaccines, the economy would have grown 0.1% in the month, the ONS said.

Households showed signs of resilience in April, the month when energy bills jumped 54% and payroll taxes went up. Consumer-facing industries expanded 2.6%, led by a strong rise in retail sales and personal services such as hairdressing. 

However, more recent data show households cutting back on non-essentials items in response to the cost of living squeeze. 

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Manufacturing fell 1%, with businesses reporting the impact of price increases and supply shortages. Construction fell by 0.4%. 

An extra bank holiday for the Queen’s Diamond Jubilee means Britain may dodge a technical recession — two consecutive quarter of falling output — but it could come close. April marks the third month in which GDP hasn’t grown, a clear sign that the economy is weakening rapidly in the face of inflationary pressures.

Separate figures showed the UK trade deficit excluding previous metals narrowed marginally in April to £20.6 billion as exports rose 7.4%, significantly outpacing a 0.7% rise in imports.

Exports to the EU rose for a third straight month to their highest level on record.

Political Impact

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The precarious state of the economy presents a headache for both Bank of England Governor Andrew Bailey and Prime Minister Boris Johnson.

The CBI, Britain’s biggest business lobby group, downgraded its growth forecast for next year to just 1%. It called on the government to boost business investment “to spare the country from dipping into recession.”

With inflation set to peak in double digits in October when energy bills are due to surge again, Bailey and his colleagues have little option but to keep raising interest rates, even if means making the cost of living crisis worse in the short run. They are worried about the risk of a 1970s wage-price spiral unless inflation is brought under control.

Not Immune

“Countries around the world are seeing slowing growth, and the UK is not immune from these challenges,” Chancellor of the Exchequer Rishi Sunak said. “I want to reassure people, we’re fully focused on growing the economy to address the cost of living in the longer term, while supporting families and businesses with the immediate pressures they’re facing.”

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For the BOE, a quarter-point move, as forecast, would take the benchmark rate to 1.25%, the highest since 2009. Money markets are now pricing in rates climbing above 3% next year.

For Johnson, who came close to being ousted by his own Conservative Party in a confidence vote on Monday, rescuing the economy is vital if he’s survive much longer. 

A new £15 billion support package to subsidize energy bills will only go so far to help households, who had been on course for the biggest fall in disposable incomes since the 1950s.

Figures this week are expected to confirm surveys showing that retail sales fell in May. Even the housing market, which defied the economic slump during the pandemic, is showing signs of cooling. However, the labor market remains tight and a potent source of inflation, data tomorrow is predicted to show. 

(Updates with market reaction and comment from the fourth paragraph.)

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Javier Milei: Argentina's new president presses ahead with economic 'shock therapy' as social unrest grows – The Conversation

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Only weeks into his term, Argentina’s new president, Javier Milei, seems to be making good on his promise to put a chainsaw to the country’s crisis-ridden economy. In his inaugural address, Milei told the nation: “There is no alternative to shock.” He dissolved half of the country’s ministries days later, and implemented a 50% devaluation of the peso.

But amid massive spending cuts, prices continue to spiral. Argentina’s annual rate of inflation has reached a three-decade high of 254.2%. Milei blames the poor economy on years of mismanagement, and has warned his compatriots to expect more pain before any gains will be felt.

While many support his measures, there are clear signs of disconnect. His government suffered the earliest general strike in history, conceding the streets to masses of protestors. More alarming for Milei, his all-reaching “omnibus law”, which ranged from economic policy to the privatisation of state entities, failed to get sanctioned by a divided National Congress in which he lacks a majority.

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However, this resistance seems only to be emboldening the president. His plan to dollarize the currency, which some dismissed as mere electoral strategy, now seems likely to come sooner than expected. Milei has also launched a “cultural war” against his critics including Lali Espósito, a well-known Argentine pop star. But unless the economy picks up soon, he may be fighting a growing mass of unhappy citizens.

Argentina's president, Javier Milei, draped in the Argentinian flag and speaking into a microphone.
Argentina’s president, Javier Milei, addresses a crowd from the balcony of the Casa Rosada in Buenos Aires.
Juan Ignacio Roncoroni / EPA

Echoes of the past

Shock therapy – involving the sudden removal of trade barriers and labour protection, and the implementation of drastic fiscal policies – is not new in Argentina. It was integral to the last dictatorship’s economic plan (1976-1983), who had learned from the pioneer in shock therapy: Chilean dictator Augusto Pinochet. In both cases, an eventual debt crisis followed.

In the 1990s, the then-Argentinian president, Carlos Menem, announced “major surgery without anaesthesia” on the economy. Failing to curb escalating inflation, it took currency “convertibility” – pegging the peso to the dollar – to break that cycle. But this generated new public debt, chronic stagnation, high levels of unemployment, and provoked the largest sovereign default in history.

Shock therapy is not only a Latin American phenomenon. The collapse of the Soviet Union led to a rapid transition from state-based to free market economies for a large part of the world’s population.

In Poland, the Balcerowicz Plan provoked an initial hike in inflation before eventually stabilising the economy based on free market capitalism – although new inequalities and social problems were on the way.

Milei’s challenge

Two features distinguish Milei’s shock therapy. First, he has a comparatively weak political position – particularly in Congress. Second, it is unclear how much of Argentina’s population is prepared to support his measures, as memory of the crisis looms close in the public imagination.

Milei has already introduced massive spending cuts, including a reduction of salaries and pensions via both inflation and suspending funding to subnational governments to pay salaries and subsidies. He has also launched an ambitious project to reset the Argentine economy, which includes the privatisation of all public companies, liberalisation of trade, and deregulation of labour.

Social opposition was immediate. Despite the government discouraging mobilisation by banning road blocks and large public gatherings, spontaneous protests took place in cities across the country. Labour organisations and trade unions have provided the largest resistance, through declarations, protests and legal claims.

Then, on January 24, when Milei was barely a month into office, a general strike was called. The strike, which included even Argentina’s more conservative unions, brought the country to a standstill.

Aerial picture showing people gathering to protest in a large city square.

People gathering in Buenos Aires to protest during the general strike.
Juan Ignacio Roncoroni / EPA

Meanwhile, Milei has faced resistance in Congress. His omnibus law was expected to collect support from centre-right parties and subnational governors in need of national funding. However, Milei’s dogmatism prevented the government from accepting the changes requested by its potential allies, and the bill collapsed.

Since taking office, Milei has had a fragile relationship with governors and deputies, calling lawmakers a “delinquent cast set out to get bribes and perpetuate the decadent status quo”.

Instead of taking advantage of his strong electoral victory and fragmented opposition parties, he has provoked confrontation and ever-unified resistance. Public opinion also seems to be turning, as the proportion of people living in poverty has shot up from 45% to almost 60%.

With a sluggish economy, it is difficult to imagine how the president will find the necessary support for his shock therapy.

Dollarization: Milei’s big gamble

The most ambitious, yet unpredictable, element is Milei’s well-publicised plan to dollarize the currency. He claims this will generate hope and reboot a competitive economy, with the middle class able to travel and buy imported goods at ease.

But, based on current exchange rates, the average wage is set to be just US$218 (£171) per month, and this is likely to fall further following expected devaluations in the coming months.

If the plan fails, Milei can expect resistance to be mighty. Argentina has a deep history of popular uprisings. In 2001, five presidents resigned in the space of two weeks, with one of them escaping the Pink House (the president’s official workplace) in a helicopter.

Since then, despite regular protest and crisis, all governments have finished their terms and pursued their economic policies. Will Milei break the mould and be thrown out of office early? Or will he be able to show Argentinians a real economic turnaround before patience runs out?

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Canadian economy is already in recession by this measure – Financial Post

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Car Loan Review Entangles Banks and the Wider UK Economy – BNN Bloomberg

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(Bloomberg) — Britain’s banks gave investors reasons to be optimistic in their earnings over the past few days. But one key unknown won’t go away anytime soon: the ultimate cost of potentially mis-sold car finance. 

The Financial Conduct Authority’s review of commissions for car loans remains a major drag on domestic lenders’ valuations, according to UBS analyst Jason Napier. Uncertainty around the application of UK rules on this issue is one of the reasons that British banks trade at lower valuations than their peers in the euro area, Napier said in an interview.

Lloyds Banking Group Plc, the UK’s biggest auto finance provider, on Thursday set aside £450 million ($570 million) for possible compensation and other costs linked to the review — the first major firm to take a charge. Barclays Plc, which exited its motor finance business in 2019, hasn’t taken a provision due to “uncertainty” around the FCA investigation’s outcome and the “very low” level of complaints the bank got, Finance Director Anna Cross told reporters on a call Tuesday. 

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Close Brothers Group Plc has a smaller total car loan book than Lloyds but it represents a larger portion of its business. The firm has canceled its dividend amid the FCA review, and this week got downgraded by credit rating firm Fitch to two notches above junk. Its shares have shed more than half their value since the beginning of the year as hedge funds Millennium Capital and Marshall Wace held and then exited short positions in the stock. 

Smaller non-listed players expected to be affected by the FCA review include private equity-owned Blue Motor Finance, whose corporate lenders included Goldman Sachs Group Inc. 

The FCA has said it will update on its review in September. The uncertainty has stirred speculation in the industry that some lenders might be forced to exit the market. 

How It Worked

In an era of near-zero interest rates that made credit plentiful, nearly 90% of new car purchases in the UK were made on finance, according to the FCA when it examined the industry in 2018. Car dealers could often earn thousands of pounds for themselves, and the bank, by pushing up the interest rate they offered buyers, in a practice known as discretionary commission arrangements. 

Before the FCA banned this approach in 2021, every loan rate would have its own assigned commission rate, a person with direct knowledge of the practice said. This setup systematically incentivized dealers to pick a higher rate, the person said, declining to be identified discussing private information. 

The FCA has estimated that its ban is saving customers £165 million a year. Now, though, it’s been forced to take further action after a spike in complaints to the Financial Ombudsman from customers who were sold these loans. It’s reviewing loans dating as far back as 2007. 

The legal industry is already compiling multiple country court cases in order to construct a class action case, according to Henry Farris, partner at law firm Withers LLP.“The class action has a much broader scope than what Lloyds has set aside,” Farris said in an interview. He estimated that 50,000 to 100,000 people could be enough to build a substantial class action — which were until recently a rarity in English law. 

Pogust Goodhead, another law firm, has set up a portal for customers to submit claims. Global Managing Partner Tom Goodhead said it was a “watershed moment” for borrowers. “It’s high time that lenders are held to account over unfair practices that have left consumers unnecessarily out-of-pocket,” he said in a statement.

Economic Fallout

Along with the regulatory review, a mix of high interest rates and falling used car prices might spell trouble for banks — especially those who lend to less affluent customers. 

“In the pandemic, interest rates rates were low, people got loads of stimulus and delinquencies were very low too,” said Aidan Rushby, founder and chief executive officer of Carmoola, a London-based car finance firm that lends directly to consumers, rather than through dealers. “Now we’re in a recession, delinquencies will go up and car prices will go down. This means some lenders will recoup less value when a borrower defaults.”

Some industry watchers see banks potentially slowing down lending, which could lead to fewer used car sales. Banks might also decide to further trim their workforces in this space. To be sure, Lloyds reported this week that motor finance continued to grow last year, and it now has £15.3 billion on its loan books. 

“Undoubtedly the future products and services of banks and non-bank lenders may be influenced by the FCA’s decision,” said Isabelle Jenkins, who leads the financial services practice at PwC UK. But “it remains to be seen what this may look like.” 

–With assistance from Katherine Griffiths, Ellie Harmsworth, Joe Easton, Harry Wilson and Aisha S Gani.

©2024 Bloomberg L.P.

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