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Broadgate: Weekly Briefing

18 November 2011

Spain – Spain’s borrowing costs have risen at its latest bond auction, as Spaniards prepare to vote for a new government to tackle its financial crisis.

On money borrowed today, payable in 10 years, Spain has to pay an interest rate of 6.975percent, the highest since 1997.

A high rate or yield indicates investors may not have confidence in a government to fully repay its debts.

The figure is perilously close to 7percent, the level at which other eurozone countries have had to seek bailouts.

Japan – The Bank of Japan (BOJ) has warned that the country’s economic growth may be hurt by the eurozone debt crisis, flooding in Thailand and a strong yen.

It said the euro crisis was stifling demand from Europe, while disruption to supply chains due to the Thai floods was affecting Japanese manufacturing.

The warning comes just days after Japan reported that its economy grew by 1.5percent in the third quarter.

“Japan’s economy continues to pick up but at a more moderate pace, mainly due to the effects of a slowdown in overseas economies,” the central bank said in a statement.

China – China will continue to open its economy and engage “more proactively” in globalization after 10 years in the World Trade Organization (WTO), Assistant Commerce Minister Yu Jianhua said.

“As a Chinese saying goes, it takes 10 years to make a good sword,” Yu said in a statement from Beijing on Thursday. The Chinese government will keep opening its consumer goods, financial, logistics and medical services markets, he said.

While China’s grown into the world’s second-largest economy during the decade after joining the WTO, it has faced disputes with trade partners over products including tyres, solar cells and X-ray security inspection equipment. The nation’s currency policy has also been criticized, with President Barack Obama saying on 13th November “enough’s enough” on what the U.S. views as a too-slow strengthening in the yuan.

U.S. – U.S. retail sales rose again in October, offering further signs of hope to the country’s economy.

Sales were up by 0.5percent over the previous month, beating economists’ forecasts, and following a 1.1percent rise the previous month.

U.S. Department of Commerce figures showed sales rose in a number of sectors, including motor vehicles, electrical goods and groceries. It was the fifth straight month that sales had increased.

The data is closely watched because consumer spending accounts for 70percent of U.S. economic activity.

“The economy seems to be in solid shape,” said Alex Hoder, an economist at FTN Financial in New York. “Growth is not strong, but it is not too bad either, and much better than the fourth-quarter recession many were expecting just a few months ago.”

U.S. – U.S. banks face a “serious risk” that their creditworthiness will deteriorate if Europe’s debt crisis deepens and spreads beyond the five most-troubled nations, Fitch Ratings said.

“Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen,” the New York-based rating company said on Thursday. Even as U.S. banks have “manageable” exposure to stressed European markets, “further contagion poses a serious risk,” Fitch said.

The “exposures” of U.S. lenders to major European banks and the stressed nations of Greece, Ireland, Italy, Portugal and Spain, known as the ‘GIIPS’, are smaller than those to some of the continent’s larger countries, Fitch said.

Italy – Mario Monti was sworn in as the new Italian prime minister during a ceremony in Rome this week.

Monti has unveiled a new, technocratic cabinet meant to steer Italy through its debt crisis after the fall of Silvio Berlusconi’s government.

The new prime minister appointed a banker to lead a super-ministry of development, infrastructure and transport.

Mr Monti, a former E.U. commissioner, has sought to reassure markets that Italy will overcome its debt crisis. Despite reports that Mr Monti had sought to include politicians in his cabinet, there are none.

“The absence of political personalities in the government will help rather than hinder a solid base of support for the government in parliament and in the political parties because it will remove one ground for disagreement,” he said.

Commodities – Gold will lead a rally in commodities in 2012 as Europe’s sovereign-debt crisis continues to roil financial markets, spurring demand for the metal as a haven asset, according to Morgan Stanley.

“There’s a very strong chance that gold will successfully challenge the all-time high,” said Peter Richardson, chief metals economist at Morgan Stanley Australia Ltd., who has studied the metals markets for more than two decades. Bullion may climb to a record USD2,200 an ounce in the first half, he said.

The euro-zone crisis shows no sign of being “close to a resolution” and the contagion risk spreading across Europe is just the beginning, Richardson. “A significant withdrawal of credit, write-downs on balance sheets, these are not good developments for financial markets generally and it’s very hard to see how this can end well.”

Spotlight on: BlackRock’s confidence in the China economy

BlackRock, the world’s largest asset management group, is not convinced on a so-called China ‘hard landing’.

“While there are undoubtedly some significant risks to growth brewing in China’s economy, such as with: local government funding vehicle debt levels, a credit growth slowdown, the possibility of a property price bubble, and the negative impacts on exports from developed world troubles, but a hard economic landing, or severe financial crisis, in China is not our base case,” BlackRock Investment Institute said in a recent report.

The Institute provides market intelligence reports for BlackRock fund managers and high net worth clients.

China’s strong fiscal situation and implicit government support for the banking system, provide ample cover from a hard landing.

BlackRock economists said there was a very low likelihood of economic hard landing in at least the next 6 to 12 months. “We believe that inflation, while perhaps understated by official statistics, has likely peaked in China, and should trend down to more manageable levels.” Inflation fell below 6percent this month, its lowest level in the year. Inflation in China is the lowest of all of the larger emerging markets.

Additionally, since the Chinese government’s top officials are going to be replaced next year by new leaders within the Communist Party, there is an incentive to keep the status quo and avoid social unrest. Interest rates could come down as early as the first quarter of 2012, with the new leadership offering up targeted fiscal incentives for small and mid-sized companies to encourage job growth as the economy slows from 10percent-plus growth to around 9percent next year, according to International Monetary Fund GDP forecasts.

BlackRock said that based on its evidence, local government debt levels should be manageable even if state banks were forced to write down significant amounts of non-performing loans because of real estate. The banking sector would likely be supported materially by central government resources if commercial real estate developers defaulted on loans.

Those commentators that predict a hard landing point to China’s housing bubble as one reason for their call. There has been a tremendous amount of discussion of a property bubble hurting China’s banking system and the economy overall. BlackRock said that, “We acknowledge that there are material risks embedded in segments of the real estate markets, and in the lending that supports it, we also think some of the rhetoric on this issue has been overdone. There does appear to be a property bubble in China’s Tier 1 cities such as Shanghai and Beijing, but this must be understood in the broader context that many other regions of the country are not experiencing analogous bubble-like conditions. The often repeated stories of empty apartment buildings and whole cities have been exaggerated and there is little evidence of exceptionally high vacancy rates.”

China’s central government has enacted policies to curb housing price inflation, including raising interest rates and the amount of money required for a down payment on first, second and third homes. Housing prices have been declining as a result of these policies, but on balance, home prices in nearly all of China’s mid-sized to large cities have risen by at least 1percent to as much as 10percent over the last 12 months ending in September, according to the country’s National Bureau of Statistics.

The genuine challenge to China’s economy is future demographics. China’s economy added more than 100 million people to its working population over the past decade, but it will add less than 20 million over the next ten years due to an aging population. Those retirees will need China’s working age population to pay taxes to support the country’s fledgling social safety network, putting it in a similar boat as the U.S. in 2015.

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

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