Fall in markets should not have been a surprise

As I write, the FTSE 100 has hit a four-year low and the FTSE 250 (a better barometer of UK plc) is approaching a 30-month low. The problem is not the fall itself, but that the market is reacting to factors that it has or should have known about.

Tuesday, 16th February 2016, 12:00 am

I could argue, therefore that markets shouldn’t be this low. Conversely, markets and commentators don’t appear to be considering potentially the biggest economic uncertainty facing the UK in living memory, EU membership, and therefore I can make an argument that markets have further to fall. Confused?

Let’s look at the reasons for the recent fall in global markets. They centre around lowering growth rates around the world. Looking at China, growth rates dropping from nine per cent to say six per cent is, on the one hand still pretty good growth but critically did anyone really think that Chinese growth was going to remain at nine per cent through the medium term? Well the markets clearly did even though now it seems to be unrealistic. Fundamentals in the two fastest growing economies in the world, India and China are still pretty strong so why are the world’s markets taking a battering?

The next key factor is commodities, in particular oil. Whilst one can clearly understand why oil producing companies and countries are taking a battering, many argue that lower oil prices are good for the global economy. Supply and demand have not moved so dramatically so as to give rise to a drop in crude oil prices by 80 per cent. Some suspect that a modest move by OPEC on the supply side would have a fairly dramatic effect on the oil price both in terms of the supply and demand equilibrium but also the psychological effect that re-engagement by OPEC would have.

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Global interest rates are expected to stay lower for longer. The yield curve is flattening. The increase in interest rates in the US appears isolated and premature and may have to be reversed at some stage. A 0.25 per cent move in interest rates will have a minor impact on interest costs and the economy but may have a significant psychological impact.

In the UK, the world seems pretty similar to two years ago and a lot better than maybe four years ago when facing the fragmentation of the European Union. Alternatively, a ECB led rescue required much closer fiscal management across the continent with the recognition that this was likely to involve greater political convergence. Uncertain and very unpopular in the UK.

Today the UK and Europe seem stable, with moderate growth, declining unemployment, minimal inflation and pretty good economic visibility, with one big exception - our involvement in Europe.

Hardly any economic commentator is talking about the European debate as the reason for market turmoil. I am 55 and I don’t remember life outside the EU. I don’t really remember the debate about the benefits and costs of membership of the EU when we joined in 1973. I barely remember the European Free Trade Association (EFTA) which seemed to allow the benefits of European free trade without the burden of bureaucracy and regulation. In the 30 years I have been in business, the headlines have been about the excessive bureaucracy and regulation than they have been about the benefits of membership. The Common Agricultural Policy provides some benefit but I don’t know how much. For most, the benefits of free trade with Europe are now ingrained and I don’t really understand, in practice, what would happen if that benefit was taken away. The levies, tariffs and other protectionist policies adopted by some are, I assume, what might arise if we leave the EU.

But how severe, how real and how expensive is that threat? The majority of people I talk to just don’t know, but they do know that the reduction in what we pay the EU would make a substantial dent in our annual deficit.

Polls show a substantial number of respondents are undecided and there needs to be a healthy, factually based debate over the next few months so that we can all make an informed decision.

Certainly it will make a greater difference than a quarter per cent movement in interest rates.

Markets may therefore become even more volatile. Up or down? I am still confused.