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ISEQ lower-Implications of UK downgrade

Monday, February 25 09:00:04

The ISEQ is down a little following days of yo-yo activity in the Equity markets, (3,685, down 10 points) as the UK lost it's AAA status over the weekend.

The implications of the UK downgrade are examined by Davy Stockbrokers:

Stock indices bounced back on Friday, paring back some of Thursday's sharp losses. The Euro Stoxx 50 rose 1.9pc and the S&P500 gained 0.9pc. The catalyst was a surge in the German IFO business confidence survey.

The IFO expectations survey rose to its highest level since July 2011, adding to evidence that the German economy continues to recover.

Indeed, the Bundesbank expects the German economy to expand in Q1 following the 0.6pc quarter-on-quarter decline in Q4 2012. Nonetheless, the EU Commission announced on Friday that it had cut its forecast for the euro area in 2013 to -0.3pc GDP growth.

Today markets will digest the news that the UK has lost its Triple-AAA credit rating from Moody's. The pound is currently trading around E1.145, one cent down from Friday, having fallen steadily from E1.22 at the beginning of 2013. Similarly, 10 year UK gilt yields have increased by around 30 basis points since the beginning of 2013 to 2.11pc at the close on Friday. So the prospect of a ratings downgrade may have already been largely priced-in by markets. However, the lack of any adverse market reaction may only intensify the pressure on Chancellor George Osborne to relax the pace of fiscal consolidation, perhaps with 'shovel ready' capital expenditure projects.

It may now become clear that low UK gilt yields largely reflect the poor growth expectations rather than the Triple-A rating and credibility of the government's fiscal austerity plan.

The other key concern for markets this week is the outlook for Federal Reserve policy.

The Fed had seemed committed to open ended asset purchases of $85bn per month.

But the minutes of the January FOMC meeting cast doubt on this commitment, indicating that the FOMC would review the efficacy and risks on additional asset purchases even without materially improving labour market conditions.

These sentiments chime with recently voiced concerns that on-going asset purchases could lead investors to mis-price risk, dangerously distorting financial markets and urging caution on the part of Central Banks. On Friday, anonymous reports indicated that Ben Bernanke does not share such concerns. Markets will now look to the Fed Chairman's congressional testimony on Tuesday and Wednesday for clarity on the future path of Fed policy.

Irish labour market data released on Friday indicated that the annual growth of average weekly earnings fell to -0.3pc in Q4 2012, back into negative territory. A disappointing feature was that the 1.1pc annual pay growth recorded in Q3 2012 was revised down to 0.6pc. So the pace of nominal pay growth through 2012 is weaker than we had thought - bad news for the outlook for consumer spending in 2013.

Nonetheless, calendar year earnings growth in 2012 was 0.6pc, the first positive year since the recession began according to Davy Stockbrokers.