FTSE retreats from eight-month highs, rates in focus

FTSE retreated from 8-month highs on Wednesday, with strong jobs data raising the spectre of interest rate hikes, and with analysts highlighting concerns about companies' weak earnings and high valuations.

Data showed the unemployment rate dropped to 7.1 percent in the three months to November, below even the most optimistic analyst forecast and just a decimal point above the threshold where the Bank of England has said it may think about raising interest rates.

Although the strength in job creation is good news for British business, the prospect of higher rates is not, as it will increase borrowing costs for companies and consumers alike and reduce the appeal of equity investments.

"We are in the phase of the economic cycle where you are recovering with spare capacity. But at some point you will run out of slack. We are approaching that period but we are not there yet," said Steven Bell, director of global macro at F&C Investments.

"It's still positive for equities but we are moving into the space where the biggest space is to be short bonds."

Bell's own positions include a modestly long one on global equities and a short one on British gilts, whose prices fell on Wednesday as the market moved to price in a hike sooner.

The FTSE share index, meanwhile, edged lower after the jobs data, to trade down 7.66 points, or 0.1 percent, on the day at 6,826.60 points by 1139 GMT.

The retreat came after the index, which is in overbought territory according to the 7-day relative strength indicator (RSI), hit an eight-month high of 6,867.42 points on Tuesday.

Analyst downgrades were behind most of the key single stock fallers, as they raised concerns about the weak start to the earnings season and the stretched valuations.

Royal Bank of Scotland fell 3.1 percent after UBS downgraded the stock to "sell" from "neutral", saying that the share price already reflects much of the progress that they think the group will make in the next 18 months.

While company specific, such concerns underscore a broader trend of stretched valuations, with analysts saying that company earnings now need to show strong growth to justify any further gains in share prices.

So far, though, the company updates are not really delivering. Brewing giant SABMiller fell for a second day as Tuesday's disappointing sales figures translated into price target downgrades from the likes of Credit Suisse, Exane BNP Paribas and Deutsche Bank.

Meanwhile shares in William Hill, which issued a trading update last week, suffered after HSBC cut its price target to 350 pence, which was below current levels.

"Valuation is not compelling given threats to earnings and we see little to attract the marginal buyer," it said in a note.

Overall, Thomson Reuters StarMine SmartEstimates predict that FTSE 100 companies will on average miss consensus 2013 earnings expectations by 0.8 percent, based on the up-to-date forecasts from the historically most accurate analysts.

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UK unemployment: challenge for Carney as jobless rate expected to fall

Falling unemployment has raised speculation the Bank of England could alter or abandon its forward guidance policy

Britain's unemployment rate is expected to have come down again when official data are released on Wednesday morning, bringing cheer to the government but a challenge to the Bank of England.

Economists forecast the jobless rate edged down to 7.3% in the three months to November from 7.4% in the three months to October, according to a Reuters poll.

That would be the lowest rate for more than four-and-a-half years and continues the trend of unemployment falling faster than BoE policymakers had been expecting. That has raised speculation the Bank will alter, or even abandon, its forward guidance policy, under which it vows not to consider an interest rate rise until unemployment has fallen to 7%.

The improving headline figures on the labour market from the Office for National Statistics echo business surveys indicating many firms are more optimistic about hiring now the recovery is picking up pace.

"We believe that it should be very easy for the unemployment rate to fall to 7.3% in this week's November reading and more likely will fall to 7.2%," says Alan Clarke, economist at Scotiabank.

James Knightley at ING said the labour market data was likely to show "broad strength".

"The UK has created nearly 1.3 million jobs since the nadir of the labour market in early 2010, 250,000 of them in the past three months alone. Initially they were largely part-time jobs focused in London and the south-east, but increasingly they are full-time positions and located all around the country," he said.

The latest manufacturing sector survey from the CBI on Tuesday showed a bigger proportion of companies expect to lift their employment over the coming quarter. Howard Archer, economist at IHS Global Insight, said that "fuels belief that the unemployment rate could very well get down to the critical 7% threshold level, under which the Bank of England could raise interest rates, by the middle of this year".

But not everyone believes the jobs recovery is evenly spread across the UK. The TUC trade unions group this week said the recent pickup in jobs had failed to reach the north-east, the north-west, Wales and the south-west, leaving them in the same situation or worse at providing jobs than they were 20 years ago.

At the same time, although employment has picked up, wage rises have remained on average below inflation, meaning many workers are worse off in real terms.

Economists forecast Wednesday's data will show annual average earnings growth of 1% for November, excluding bonuses. That marks an increase from 0.8% growth in October but is still well below inflation which came in at 2% for December.

At the same time as the unemployment data, the Bank of England releases the minutes to its latest policy meeting. Policymakers held rates at their record low of 0.5% at the meeting but economists think there was probably a discussion among members of the monetary policy committee (MPC) as to whether the unemployment threshold should be lowered.

Samuel Tombs at the thinktank Capital Economics said: "Some of the more hawkish members might be in favour of sticking to the original guidance. But we suspect that a majority will have begun to consider how they could alter their guidance in order to get market interest rates and sterling down from present levels that, if left unchecked, could soon begin to take some of the pace out of the recovery. Indeed, we believe that there is a strong chance that the MPC will lower the unemployment threshold next month to coincide with the Inflation Report."

Some economists say it is time to move on from forward guidance.

Rob Wood, chief UK economist at Berenberg bank, says the Bank should "let forward guidance wither" and return to targeting inflation.

"When the BoE introduced forward guidance just six months ago, they saw only a 50% chance that unemployment would fall to 7% by mid-2016. That is now likely in the next few months," he said.

"Lowering the unemployment threshold would unnecessarily tether the BoE to a dangerously low target. A rate rise is not needed now, but it will be needed before unemployment gets to 6.5%."

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UK pay squeeze worst for public sector and manufacturing

Workers in Britain's public sector are £23 a month worse off than a year earlier in real terms

The squeeze on real wages for UK workers has been toughest for those in public sector jobs and manufacturing, according to new figures.

Workers in Britain's public sector are £23 a month worse off than a year earlier in real terms, according to VocaLink, the company processing salary payments for much of the British workforce.

The figures show a divide between sectors when it comes to who is worst affected by the failure of average pay growth to keep pace with inflation.

Public sector workers' take-home pay in real terms – adjusted for inflation – was down an annual 1.4% during the three months to the end of December. That was a slightly softer pace of decline than the 1.8% drop in the three months to November. In comparison, annual real wages grew in the services sector, albeit by just 0.5%.

Real take-home pay in the manufacturing sector fell again in December but at a slower pace. The annual decline was 1.1%, after a 1.6% fall in the three months to the end of November.

David Yates, VocaLink chief executive, said: "When taking into account inflation, thousands are worse off in comparison to salaries 12 months ago. The experiences of those in the public sector come in stark contrast to above-inflation wage increases in the services sector."

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IMF set to upgrade UK growth forecasts as global economy expands

Forecast growth of 1.9% this year expected to be raised to 2.4% with IMF chief Christine Lagarde declaring 'optimism is in the air'

The International Monetary Fund is widely expected to raise its outlook for the UK on Tuesday, pushing up the country's growth forecasts by more than for any other major economy.

The Washington-based fund has been a critic of the UK's over-dependence on consumers as well as the government's Help to Buy housing market scheme. But it will bring a welcome boost to chancellor George Osborne when it updates its World Economic Outlook from last October's forecasts.

Back then it predicted UK national output would rise 1.9% in 2014 but is now expected to predict growth of 2.4%, according to a Sky News report. The IMF said it did not comment on leaks.

The fund is also expected to upgrade its outlook for the global economy, which in October it said would expand by 3.6% this year. That would reflect the cautiously optimistic tone in a New Year's speech from its managing director, Christine Lagarde, last week.

"This crisis still lingers. Yet optimism is in the air: the deep freeze is behind, and the horizon is brighter. My great hope is that 2014 will prove momentous … the year in which the seven weak years, economically speaking, slide into seven strong years," she said.

If confirmed, the substantial upgrade to the UK is likely to be seized on by Osborne as further proof the coalition's "economic plan is working" – an oft-used phrase in recent weeks as indicators have largely pointed to growth picking up.

The fund has in the past been highly critical of the coalition's austerity drive. In a damning indictment of the British chancellor's economic policies last year, the IMF's chief economist Olivier Blanchard warned Osborne would be "playing with fire" unless he eased the pace of budget cuts.

The IMF has also echoed other economists, including experts at the UK's own Office for Budget Responsibility, who said that the UK remains over-dependent on debt-fulled household spending to grow.

The latest crop of official data underscored those concerns, with weaker outturns for construction and manufacturing and a jump in Christmas retail sales.

Economists generally feel, however, that overall growth will pick up this year and the IMF is just the latest of a string of forecasters to raise the UK's outlook.

The business group CBI has pencilled in 2014 growth of 2.4%, the British Chambers of Commerce expects 2.7% and the OBR forecasts 2.4%.

A report from EY Item Club on Monday forecast UK economic growth would pick up to 2.7% this year from 1.9% in 2013. It too warned the recovery was not built on solid foundations, however, due largely to the pressure on household incomes.

Peter Spencer, chief economic adviser to the EY ITEM Club said: "It is hard to find another episode in time where employment has been rising and real wages falling for any significant period of time. The weakness of real earnings is proving to be the government's Achilles heel and could prove to be the weak spot in the recovery.

"Consumers have reduced the amount they save to fund their spending sprees. But they cannot continue to drive growth for much longer without an accompanying recovery in real wages or a rise in their debt to income ratio."

There have also been warnings that the recovery is not being felt throughout the UK, and is instead largely benefiting London and the south-east.

A study by the TUC trade unions group on Monday said the recent recovery in jobs had failed to reach the north-east, the north-west, Wales and the south-west, leaving them in the same situation or worse at providing jobs than they were 20 years ago.

The overall unemployment rate for the UK has been coming down faster than policymakers and most other forecasters had expected. Official data on Wednesday are expected to give a jobless rate of 7.3% for November, down from 7.4% the previous month.

Many economists expect the continuing drop in unemployment will prompt the Bank of England to tweak its forward guidance. At the moment, the BoE's guidance is that, barring various exceptions, it will not consider raising interest rates from their current 0.5% until a threshold of 7% unemployment is reached. The Bank may well lower that threshold for considering a hike to 6.5% unemployment, economists say.

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City leads way in economic growth race

Optimism throughout financial services sector rose at its fastest rate since the start of the survey in 1989 in the final three months last year

An upsurge in optimism, business and jobs is turning the City into the fastest growing part of the economy it is shown in new survey data released on Monday.

Optimism throughout the financial services sector rose at its fastest rate since the start of the survey in 1989 in the final three months last year. For the fifth quarter in a row profitability was higher and employment is growing at its fastest rate since 2007.

City firms recruited another 10,000 staff in the October-December period and are forecast to add a further 15,000 to the job total in the first quarter this year. That would take employment to 1.16m, only 52,000 below the peak in the Square Mile at the end of 2008 just before the financial crisis began to bite.

The latest insight into the way recovery is feeding into the financial services sector, produced by the CBI and business advisers PwC, shows strong volume growth in all key customer categories with the exception of financial institutions and a notable pick-up in activity with industrial and commercial companies.

There are no signs of a slowdown with the volume of business predicted to grow further in the first quarter and profits set for “robust” improvement. For the first time since the financial crisis all sectors plan to increase capital spending over the next year.

Fee, commission or premium income jumped 36pc in the quarter, the fastest since June 2012. Trading income was up 20pc and while total costs rose 23pc they were almost cancelled out by volume growth.

Banking optimism is continuing to “rise briskly” with business volumes heading for strong first quarter growth. The survey suggests banks are beginning to get a grip on new regulations which are seen as “less of an obstacle” to growth and priorities shifting to retaining customers.

Building societies are feeling more optimistic about the business outlook than at any time during the past seven years after a lower than expected growth in volumes in the final quarter last year.

Private investors provided a business fillip for finance houses while optimism among life insurers jumped faster than at any time over the past decade. General insurance is enjoying a gradual recovery in confidence and although optimism among insurance brokers has risen moderately business volumes increased at their fastest in four years.

Matthew Fell, CBI director for competitive markets, feels the survey shows “things are starting to look more ‘normal’ after five years of volatility.” He is encouraged by the strength of longer term confidence indicators with marketing spend, employment and investment rising strongly.

Kevin Burrowes, head of PwC’s financial services operations, said regulation is now seen as a lesser obstacle to growth in the banking sector and although compliance remains a major concern “it is slightly less all-consuming than it was.”

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UK jobless falling faster than thought, to hit target early - Reuters poll

British unemployment is falling faster than previously thought and will reach the Bank of England's 7 percent threshold for considering a rate hike well before the central bank envisages, a Reuters poll found.

The poll of 50 economists, taken this week, suggests it will fall steadily in the coming quarters and reach 7 percent early next year. A December poll had pointed to this happening in the second quarter of 2015 and a November poll even later.

"Recent sharp falls in unemployment will probably continue over the next few months. It will still take a year or so to reach 7 percent but growth in the workforce should remain strong," said Samuel Tombs at Capital Economics.

The BoE has pledged not to discuss hiking interest rates from their record low of 0.5 percent until the goal is met.

Britain's economic recovery picked up pace last year and some economists say the Bank will lower its target and hold borrowing costs low until the country's turnaround broadens out.

The bank's actions will also be closely watched by the country's politicians, who are beginning to gear up for an election in May 2015 which could hinge on the economy.

Thirteen of 35 economists in the poll expect a lowering of the threshold, probably to 6.5 percent, a similar proportion to that in a Reuters poll taken earlier this month ahead of the Bank's January policy meeting when it left policy unchanged.

"The BoE needs to review whether the 7 percent unemployment threshold is appropriate for the use of forward guidance, especially as the unemployment rate is quickly approaching 7 percent," said Azad Zangana at Schroders.

"Hitting the threshold will give the impression that the BoE will then consider raising interest rates, which we think it has no intention of doing in the near term."

Some pressure on the Bank has eased - data on Tuesday showed inflation had fallen to its 2.0 percent target for the first time in four years during December, but may nudge up again as utility and transport price rises are factored in.

With growth picking up and unemployment falling, economists are now narrowly predicting a rate hike in the second quarter of 2015, albeit one of only 25 basis points. The is the first time in nearly two years that the Reuters poll has signalled a tightening of monetary policy.

Britain's economy is still 2 percent smaller than before the financial crisis began but its growth rate is far outstripping the neighbouring euro zone, its main trading partner.

The economy is expected to grow 0.6 percent per quarter through to the middle of next year, the end of the forecast horizon and the highest forecasts to date, compared to just 0.2-0.4 percent in the common currency bloc.

Recovery in the now 18-member union remains fragile, with unemployment running at a record high and an increasing threat of deflation.

"There are still significant risks from any renewed flare-up in the euro zone crisis," said John Hawksworth, chief UK economist at PwC.

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FCA launches review into RBS's small business lending

Britain's financial regulator has appointed two outside firms to review part-nationalised Royal Bank of Scotland's treatment of struggling small business customers.

RBS, which is 82-percent owned by the government, has been accused by government adviser Lawrence Tomlinson of pushing struggling small firms into its Global Restructuring Group (GRG) "turnaround" unit, so it could charge higher fees and interest, and take control of their assets.

The Financial Conduct Authority (FCA) said on Friday that consultancy Promontory Financial Group and Mazars, an accounting firm, will conduct the independent review which will be paid for by the bank.

The review will consider allegations of poor practice set out in two reports, and publish its findings in the third quarter.

"The review will also consider whether any poor practices identified are widespread and systematic. If this is the case, the second stage of the review will identify the root cause of these issues and make recommendations to address any shortcomings identified," the FCA said in a statement.

Jon Pain, head of conduct and regulatory affairs at RBS, said that in addition to the FCA's review the bank has commissioned lawfirm Clifford Chance to further investigate loans to business customers.

"Any customer with concerns about their experience with GRG can contact Clifford Chance to have their case examined," Pain said.

The FCA said that while commercial lending is not a regulated activity, if the findings reveal issues which come within the FCA's remit it will consider further regulatory measures.

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