Evercore Pan Asset

This week’s bad news on UK gas prices reinforces the depressing news of the most recent inflation figures. They showed there is clearly more to come after that. UK RPI inflation stayed over 5%, and CPI inflation rose to 4.5%. Transport and energy were important components in the annual rises, with more to come. Producer Input prices rose 17.6%, reflecting commodity price pressures and the weaker pound. These figures confirm a continuing squeeze on the UK consumer, as wages lag prices by a large margin. They do not presage an early rise in interest rates, as the Bank still believes inflation will fall into next year. Activity is not strong across the board.

There are two hotspots in the UK economy. The one is manufacturing, where UK manufacturers have joined in with the global recovery. They are by and large generating good profits and cash-flow, but still not putting in large amounts of additional capacity. The trade deficit remains obstinately high, as some exporters prefer extra profit to extra volume. The other is London.

The central London residential property market is awash with money, mainly from foreigners who are keen to have a place in one of the world’s great cities. Commercial property voids are filling up quickly, and rents are rising. One agent’s report I was reading commented on the high demand for residential properties in the over £30 million bracket. Another featured a £12 million river-view flat in Battersea as one of its available choices. The Mayor’s spending includes numerous projects designed to smarten up the well heeled areas more, and to prepare London for its Olympic tasks in 2012.

The state of the London economy illustrates the strains within a single currency scheme. London shares a currency with Sometown in the north of England. At current interest and exchange rates central London is very competitive. It is acting as a magnet for foreign capital, who think the high prices in London are still good value owing to the fall in the pound. Sometown is still struggling, despite the low level of sterling and official interest rates. Talented people and investors are leaving Sometown and moving to London. Sometown cannot devalue against London to change that.

Because the sterling single currency is backed by a single government substantial transfer payments are sent from London to Sometown, to pay for public services and benefit payments to the out of work. London accepts its obligations to Sometown, so the system survives. There are arguments about the scale of the aid and how Sometown can join in with London’s growth, but no arguments to split currencies. Both places borrow on a common government guarantee for their share of the national deficit.

Meanwhile over in Euroland, the current level of the DM and ECB rates leave Germany competitive and Greece uncompetitive. Unlike Sometown, Greece does not receive large payments direct from Germany to pay for public services and benefits. Greece has to pay far higher prices to borrow than core Euroland, which she cannot afford. Something has to give. The next few weeks will see a solution of sorts to the conundrum of how to pay for Greece’s services and lack of competitiveness within the Euro. I fear it will be another temporary fix. They are still arguing over how much the bondholders have to pay up, how much Greece can do for herself, and how much the taxpayers of other Euro states have to find. One way or another someone has to pay for the past excesses, and someone has to work out how to cut the deficit for the future.