U.K.: slowly going under

UK economic growth was unexpectedly revised down to 0.7% in the three months to June, official figures show.

An overestimation of the impact of the World Cup on the UK's gambling industry partly led to the downwards revision in gross domestic product (GDP).
The Office for National Statistics (ONS) had previously estimated growth of 0.8% for the second quarter.
However, the year-on-year rate of GDP growth remained at 2.6%.
The ONS said the downwards revision in second-quarter growth was also a result of new health service figures, which showed that hospital admissions had been lower than expected.

'Marginal revision'

The downwards revision came as a surprise to economists, many of whom had expected the second-quarter figure to remain unchanged.
The ONS also revised down the GDP deflator, which is a key measure of inflation, to an annual rate of 2.2% from 3.4%.
"The marginal downward revision to quarter-on-quarter growth does not materially change the outlook for interest rates," said Howard Archer, chief UK and European economist at Global Insight.
"However, we believe that growth is likely to lose some momentum over the coming months as consumers continue to face significant headwinds and exports are limited by a slowdown in global growth."
Separately, the ONS said Britain's balance of payments deficit reached £6.986bn in the second quarter, lower than forecasts for a deficit of £8.0bn.

US loses top competitiveness spot

The U.S. has lost its status as the world's most competitive economy, according to the World Economic Forum. The U.S. now ranks only sixth in the body's league table of global competitiveness, behind Switzerland, Finland, Sweden, Denmark and Singapore.

Risks attached to the large U.S. trade and fiscal deficits prompted its fall. The UK has retained its place among the world's 10 most competitive economies but China, Russia and Brazil have all fallen down the rankings.

Imbalances

Countries were judged on how conducive their business climates are to sustaining economic growth.
Publishing its Global Competitiveness Index, the World Economic Forum (WEF) said the best performing countries were distinguished by their competent economic stewardship, investment in higher education and a emphasis on technological development and innovation.
Although the U.S. remained the global engine of technology, WEF said its business environment was being endangered by the fragile state of its public finances.
The U.S. has seen its budget and trade deficits spiral in the past few years as a result of heavy government spending and rising trade imbalances with countries such as China and Japan.
The U.S. trade deficit is expected to top last year's record level of $717 bn ( £378 bn; 565 bn euros) in 2006, while the budget shortfall, although expected to be significantly lower than last year, is still forecast to be close to $300 bn.

U.S. competitiveness is threatened by large macroeconomic imbalances, particularly rising levels of public indebtedness associated with repeated fiscal deficits. Its relative ranking remains vulnerable to a possible disorderly adjustment of such imbalances.

World Economic Forum, Global Competitiveness Index´s report

Swiss peak

Switzerland is now regarded as the world's most competitive economy, with Nordic countries holding three of the five top rankings.
The WEF praised the UK for its flexible labour markets and low unemployment rate compared to the rest of continental Europe. But it said the UK, in common with Germany and Italy, was afflicted by public sector deficits and rising levels of public indebtedness.
China, Russia and Brazil, among the world's fastest growing economies, all suffered a decline in their relative competitiveness.
China fell from 48 to 54 in the ranking, its rapid economic growth and low inflation offset by an over-regulated banking sector and low penetration of mobile and internet technology outside urban areas.
Russia slipped from 53 to 62, with concerns over the independence of the country's legal system and safeguarding of property rights singled out as key concerns, the WEF.

"The private sector in Russia has serious misgivings about the independence of the judiciary and the administration of justice," it said.

The U.K. growth story: an unhappy ending?

With sterling trading near levels not seen in 16 months against the dollar, investors are beginning to fret about a foreign-exchange trend they fear may spell an unhappy end to the growth story for U.K. shares.
The U.K. currency briefly touched $1.90 in May and had held around that level for around the last month. Compare that with five years back: sterling hit a low of around $1.3678 against the dollar in June 2001, and has staged a steady recovery since.
If this strengthening trend continues, it could significantly impact revenues at some of Britain's biggest and best-known companies. And it would threaten to undermine the M&A story that's been helping to drive U.K. equities since 2003.
"In the case of the U.K., there is a significantly large proportion of companies in the benchmark FTSE 100 index whose receipts are denominated in dollars -- when (those dollars are) converted back into sterling (for instance to pay costs or dividends), they'll have less sterling receipts to show for it," said Mike Lenhoff, chief equity strategist at London-based stockbrokers Brewin Dolphin Securities.

Robert Parkes, a U.K. equity strategist at HSBC Bank, said that around 25% of sales from U.K. companies are into the U.S, which, when coupled with the high dollar exposure of the commodity sector, brings the total dollar exposure of the FTSE to between 35% and 40%..

Feeling the pinch

Central banks and interest rates have largely been behind the currency moves.
"Interest rates are the dominant driver in the (currency) markets at the moment," said Geoff Kendrick, a senior currency strategist at Australia's Westpac Bank.

"The key in the short term is whether or not the Federal Reserve is really finished (tightening rates) now, or whether they'll need to tighten again," Kendrick says.

The U.S. rate now stands at 5.25%, while in the U.K. it's 4.75%.

The Bank of England surprised investors with a rate hike in early August of a quarter percentage point, which sent sterling spiking upward. The central bank said the pace of economic activity had quickened, with higher energy prices sparking greater inflationary pressures.
If the Bank of England tightens rates again, it raises the possibility sterling could strengthen towards the magic $2 mark. That's when the impact would really kick in, experts say.
"If you're aiming for a target like $2 in cable (as the cross rate is known), you'll probably need the Federal Reserve to stop (raising rates), the market to think about current account balances and the Bank of England to hike again. Then you may start getting close," said Kendrick.
The pound at $2 could undermine the export position of many U.K. companies, which earn revenues in dollars that would be subject to a negative translation effect. And it could knock about 1% off earnings for U.K. companies, said Richard Batty, investment director at Standard Life Investments.
HSBC's Parkes said of all the companies in the U.K. stock market, pharmaceuticals record the most sales in the U.S market at about 44%. Following close behind are aerospace, with 41% sales exposure, and general industrials, with 37% of sales in the U.S.

How much movement's ahead?

However, a move to $2 probably isn't coming anytime soon: the consensus twelve-month view on dollar/sterling is for a level of $1.8734, according to FX Week.
Dresdner Kleinwort heads up that list, forecasting $2 in twelve months, while Westpac expects the dollar to hit $1.97 and HSBC sees it at $1.86. HBOS Treasury Services has the lowest forecast, with a twelve-month view of $1.68.
And even if the cross rate reached $2, the move would have to be sudden and sharp to have a significant detrimental effect, Lenhoff said.
"The trigger would be if the market is convinced that the Fed has stopped tightening, and not only stopped tightening, but that the next move in interest rates would be downward," he said.
If earnings started to fall off, it could be critical for merger and acquisition activity in London. Many companies traded on the London Stock Exchange, and on European exchanges too, have been the subject of intense M&A speculation and deals.

Since May 2005, the FTSE 100 index has increased in value by around 20%, rising from 4,986 points at the close of trade on May 27 last year to 5,959 points on Monday. It's a gain to which "M&A has definitely contributed," said Parkes.
Year-to-date in 2006, a total of 8,231 deals worth $987 million have involved European companies, according to data supplied by Thomson Financial. Separate figures were not supplied for the U.K.
Many of these deals have involved company buyouts by private-equity consortiums, which rely on using high earnings yields to repay debt used to fund acquisitions.
"If the equity market were to weaken because earnings are no longer reckoned to be as forthcoming now that the dollar has weakened... the idea of borrowing in sterling to finance acquisitions and to use earnings to pay off loans and service debt is no longer quite as attractive a proposition as it once was," said Lenhoff.