Guernsey’s captive scene – reasons to be cheerful

16
CAPTIVE GUERNSEY REPORT 2014
GUERNSEY | RLAM CHANNEL ISLANDS
In late 2012 many City of London analysts
were predicting a ‘triple dip’ recession,
voicing fears that 2013 would be another
grim year for UK PLC. While economic
activity in 2013 didn’t shoot out the lights,
estimated consecutive quarterly growth of
0.3%, 0.6% and 0.8% for the fi rst three quarters
illustrates that the UK economy fared a lot
better than many predicted and that activity
accelerated as the year progressed. The Bank
of England predicts that Q4 GDP growth will
be 0.9% and, while the fi nalised total 2013 GDP
fi gure will not be known for another 18 months
or so, if the current estimates had been offered
to the Chancellor a year ago I think that most
bookmakers would have offered short odds
that would have been gratefully accepted.
2014 appears to start from a much better
position, although the problem is of course
that the starting point a year ago was so low
that almost any positive news was treated as
a surprise. Perhaps the issue now will be that,
while the recovery will continue to gather
pace, the momentum may cool as quarterly
GDP fi gures in 2014 do not match those of late
2013, although the overall growth rate for 2014
should exceed 2013. Assuming that the Bank
of England is correct and the recovery has
“fi nally taken hold”, the other issue to be grappled
with in the coming year or two will be how
Central Banks can “normalise” their monetary
operations, which will obviously mean higher
interest rates at some point or other and will
involve balancing the threat of stifl ing the
recovery with preventing another build up of
cheap credit.
First of all, let’s continue the positive theme
with some more upbeat economic statistics.
Aside from the continuing encouraging economic
indicators, there have been several
recent positive surveys which are worth highlighting.
122 CFOs were recently asked about
prospects for 2014, and nine out of 10 reported
that they expected revenues to improve and
also anticipated increasing investment and
hiring in the year ahead. Separately, another
survey reported that the willingness of companies
to invest is currently at a 19-year high
with higher optimism than at any other point
Jonathan Pope of RLAM Channel Islands takes a look at the UK’s economic themes for 2014 which will set the
investment scene for Guernsey’s captive market this year
Written by
Jonathan Pope
Jonathan Pope is a director of RLAM CI and part
of a team with responsibility for the management
of approximately £1bn of client funds, which are
mainly invested in segregated cash portfolios. Jon
is a member of the Chartered Institute for Securities
& Investment.
REASONS TO BE
CHEERFUL...
17
Captive Guernsey report 2014
RLAM Channel Islands | guernsey
since 2007. The main reasons given for this
optimism are improved access to funding and
greater confidence in the Bank of England’s
policies.
Our internal base forecast (i.e. the scenario
to which we attach the highest probability)
for UK GDP growth for 2014 is 2.7%, which
is very slightly ahead of the 2.5% forecast by
the MPC. Our base case continues to assume
no disorderly euro break up and is cautious
on global growth relative to pre-crisis conditions.
Our base forecast for inflation has been
reduced slightly over the last few months to
2.0%; the reason for this is due in part to the
likely impact of the recent rise in sterling. We
expect oil prices over the next year to remain
broadly stable with the potential increase in
demand caused by growth in the world’s largest
economies being matched by an increase
in supply.
Inflation has been trending downward over
the last few quarters and, while it is still above
the 2.0% target, the margin of overshoot has
reduced dramatically since the days in 2011
when CPI stood at over 5.0%. This reduction
in inflation together with a more robust economic
outlook might offer the beginnings of
an answer to the “cost of living crisis” – the
fact that wage increases have not kept pace
with inflation. While the Office of National
Statistics’ monthly figures are reporting that
pay increases were on average 1.1% over the
last year, there is some hope that the gap with
inflation will narrow further and may even
close completely assuming inflation remains
closer to target and the confidence of the various
CFOs reported above is not completely
misplaced. Of course, although this development
would be welcomed, the actual improvement
in real wages (i.e. inflation adjusted) is
not likely to be anywhere close to the 2% per
annum which used to be considered normal
and so households are not likely to feel very
much better off in the near term, and then
of course the cost of servicing debt will rise at
some point.
Looking further ahead into 2014 there is
growing optimism that another milestone in
the UK’s economic recovery will be reached. In
December 2013 the British Chambers of Commerce
announced its latest forecasts, which
suggested that in the third quarter of 2014
the overall size of the UK economy will finally
return to positive territory. In other words the
economy will surpass its previous peak which
was reached in the first quarter of 2008. While
much has changed in the intervening period,
the resumption of fresh growth will be welcomed
by all.
As previously mentioned, the challenge for
central banks is to remove stimulus without
derailing recoveries. To that extent, the Bank
of England has tried to provide some clarity
with the new ‘Conditional Forward Guidance’
(CFG) policy, which was unveiled in
August 2013 and stated that the MPC would
not even consider raising interest rates until
unemployment was below 7.00%. At the time
this announcement was made, the MPC was
forecasting that this rate was unlikely to be
reached until 2016. However, the stronger
economic data has meant that unemployment
has fallen far faster than was expected and
when the next round of MPC forecasts were
published in November 2013, the Bank of England
attached a reasonable possibility of the
7.00% target being reached in the last quarter
of 2014. This of course poses a problem for the
MPC; it appears that the introduction of CFG
was designed to delay market expectations
of a UK interest rate rise in 2015 until 2016.
However, the stronger than expected data
threatens to do exactly the opposite and stoke
expectations of an earlier rise.
MPC reaction has been to state repeatedly
that the 7.00% threshold is only the point at
which they will start to assess whether a rate
rise is necessary and they continue to reiterate
that they are unlikely to sanction a rate rise
for a considerable period of time after this
point has been reached. Some commentators
think that the Bank may underline this message
further by amending the unemployment
threshold to a lower figure; 6.5% has been
mentioned by some. This course of action
would buy the MPC more time but it may cost
them a loss of credibility. On balance then, it
is likely that rates will remain on hold in 2014,
although a move in 2015 is becoming more
likely. Of course, this is when official interest
rates will rise; we would expect longer term
market rates to rise in advance of this and so
are hopeful that the sterling yield curve will
steepen as 2014 progresses, which should provide
opportunities to begin to improve returns
for actively managed cash portfolios.
Finally, lest this article should be considered
too optimistic, we have to consider
what may go wrong in 2014. Starting from a
macro picture, the eurozone must still feature
towards the top of most people’s list of potential
problems. While conditions have definitely
improved and there are even tentative signs of
improvement in the peripheral economies,
there are still problems which could yet cause
further disruption. The ECB cut interest rates
in late 2013 over deflationary fears and the
French economy is perhaps giving the most
cause for concern at present. However, given
how important France is to the EU it would be
assumed that should support be required it
would be given quickly.
Back in the UK it is possible that economic
data will start to disappoint which will cause
this fragile sense of optimism to evaporate.
On the other side of the coin, there is a danger
that interest rates will rise more quickly than
the MPC ideally want them to; if perhaps fears
grew of a house price bubble coupled with an
early rate rise in the U.S. In this scenario, the
fear would be that the pace of interest rate
rises was being dictated by forces other than
the strength of the UK recovery.
In conclusion and to return to the slightly
hackneyed theme of economic forecasts and
bookmakers, on current estimations, the outlook
for 2014 and 2015 would again have been
gratefully accepted by the powers that be if
offered a year ago.
“122 CFOs were recently asked about prospects for
2014, and nine out of 10 reported that they expected
revenues to improve and also anticipated increasing
investment and hiring in the year ahead”
“Back in the UK it is possible that economic data
will start to disappoint which will cause this fragile
sense of optimism to evaporate”