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David at the double...so buy UK large caps

Sunday September 12th 2010

The politics:
It is just 14 weeks, or if one prefers 98 days since the UK General Election that led to the curious phenomenon of a coalition Government. After several days of political posturing and negotiating the Conservatives reached an agreement with the 3rd party, Liberal Democrats. The new Prime Minister, (PM),David Cameron, lost no time in setting forth his new agenda.

The UK economy is in dire financial straits; the true level of debt to GDP is over 100% as against the 60% the outing Labour administration suggested, however, one feels inclined to ask if the coalition really needs to be in such a hurry. I believe they do, still it is only right to examine the facts.

Firstly, the PM is aware that the party at a grass roots level did not want to be in cahoots with the Lib-Dems whom they regard as soft on core Tory values and too left wing for any Conservative to be comfortable with. At a higher party level many believe they were ignored as jobs were handed out to the Party leadership’s new best friends. To stave off any revolt that could threaten to end the coalition before the year ended the PM has pushed a hard line agenda with zeal. Even in allowing the Lib Dems the chance to push for political voting reform the condition is that the Conservatives will oppose such a move.

The message from Number 10 is clear. There is no time for getting ones seat settled, the policy warship has set sail and it is firing broadsides in many directions. Reform is being pushed at a harder and faster pace than that followed by the Conservative poster Girl, Margaret Thatcher in 1979. To quote Francis Maude this government "had hit the ground running."

The need for greater financial efficiency is driven by the urgent need to start closing the £240Bn gap in the budget. This is the largest state deficit in any of the larger West European nations. In essence we are seeing real Conservative dogma rise to the fore as it is determined that local is better than central and that the government has to learn to like and trust the people. This proves that the election campaign mantra of the "Big Society" is to be taken seriously.

Of course many policy proposals produced thus far are not the finished article. Many will require more work before they are at the Green Paper let alone the White Paper stage and they will need approval from the Commons. Still this is more than just a glance at “Cameron A La Carte”. Here is a new philosophy that is permeating every aspect of national and local government.  The impact at a social level will be enormous as the welfare state; National Health Service and education system are all in the cross hairs. Not that they are to be scrapped, rather benefit cheats will be stopped and all state services will have to deliver greater value for money.

Naturally these restrictions in the state come at a cost, consider the Ministry of Justice. Under Gordon Brown’s administration it employed 80,000. It is now likely to have to cut 19% or 15,000 jobs. Once the summer recess is over the anger and protests will become louder and more visible as the publication of the "Comprehensive Spending Review" approaches in October.

The question will be whether or not the PM will hold his nerve or be blown off course by rising public opposition, increased union militancy and falling popularity in the polls. Better for Britain he does hold true to his political compass for now is the time to strike. The opposition Labour party are leaderless and if he should learn one thing from Mrs Thatcher it is "do not delay". Of course there will be pain and pressure, however, this is a time when the British need a "Bulldog" ... so stay true Prime Minister and see the job through.

The "Old Lady" disagrees:
Dr Mervyn King, Bank of England Governor said on Wednesday 11th August as he presented the Quarterly Inflation Report, that inflation will probably decline below the bank’s target in 2012 and growth will be weaker than previously forecast. This implies that rather than cutting spending the UK economy may need more emergency stimulus.

Inflation is projected to be 1.5% by 2012, i.e. less than the 2% target even if the Base Rate is held at 0.5%. GDP growth is forecast to peak at 3.0%, less than the 3.6% that was projected in May. It is clear that amount of surplus capacity in the economy will fetter inflation for months ahead. “...The overall outlook is weaker than that presented in the May inflation report...”

He also noted the persistence of tight credit conditions and planned budget cuts as risks to growth. It is clear that the policy bias in the UK is toward accommodation and further easing.

Sterling slipped on these comments as the soft rate policy looks set to continue and an extension of the £200Bn QE programme is certainly on the cards. (This is a course of action I have persistently argued for when contributing to the Reuters Bank of England polls. I look for an extra £25Bn in 2010). That was taken as encouraging for Gilts as the 2 year Gilt yield fell 4 basis points to 0.703%.

The economy:
There has not been a consistent pattern in recent UK economic data as a report on the 11th August indicated employers added jobs in Q2 2010 at the fastest rate since 1989, however, jobless claims dropped less than economists forecast in July. Indicators that measure manufacturing, services and construction activity declined in July and Nationwide Building Society said on 11th August that consumer confidence dropped to the lowest point in 15 months. The outlook for the UK economy is patchy at best.

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