More than a month on, it is obvious the 11 September terrorist attacks on the US have profoundly cha...
More than a month on, it is obvious the 11 September terrorist attacks on the US have profoundly changed the economic outlook. The US economy is widely expected to fall into recession as industry retrenches and consumers react to rising unemployment and greater insecurity. Policymakers have already reacted to mitigate the impact by cutting interest rates and will cut further, if required, to avert a slump.
In the UK, the Monetary Policy Committee (MPC) reduced interest rates by 0.25% to 4.75% in an unscheduled meeting on 17 September and by a further 0.25% at its scheduled monthly meeting in the first week of October.
The initial move on 17 September was a smaller cut than enacted by overseas central banks and reflects the UK economy's relative strength before 11 September.
The August inflation data, released shortly after the cut, showed inflation moving up to 2.6% on the RPI excluding mortgages measure. This is the first time it has been above the 2.5% target since March 1999, although it has subsequently fallen back to 2.3% with the release of the September data.
It remains too early to gauge the full economic impact of the terrorist attacks and subsequent retaliation in Afghanistan. For the UK, growth will be slower than had previously been expected with unemployment expected to increase as firms shed workers.
The data is already beginning to reflect this with the more reliable Labour Force Survey measure of unemployment on a rising path, although this is not yet evident in the more widely reported claimant count unemployment number.
However, with interest rates at generational lows, a resilient housing market and significant increases in government spending in the pipeline, the UK is unlikely to suffer a prolonged economic downturn. It is conceivable that the monetary easing and fiscal boost currently taking place around the globe will lead to a sharper recovery in 2002, albeit from a lower base than had previously been expected.
The outlook for UK and overseas bond markets is more difficult than usual to assess at this time. In the short term, emerging evidence of significant economic weakness and further interest rate reductions will likely support markets. Shorter-dated bonds already reflect interest rate cuts and are vulnerable once rates are deemed to have troughed. This may not occur until next year, however.
In the medium term, a rebound in economic activity, the so-called V-shaped recovery, is likely to undermine bond markets but this is more likely a story for 2002 rather than the end of 2001.
The UK bond market has, for the past few years, exhibited a large degree of seasonality. Prices have risen significantly in the last few months of each of the past four years, driven in large part by insurance companies buying bonds to improve their solvency margins.
With the falls in equity markets in the year to date, this influence could be at work again this year, enhanced by big redemptions and coupon payments providing investors with cash to re-invest.
Potential for further interest rate reductions.
Widespread evidence of slowing growth.
Cashflow into bond market in final quarter.
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