London Financial Experts Anxious for Conclusion of U.S.

UNCLAS SECTION 01 OF 02 LONDON 002460

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD ENRG IR EINV UK
SUBJECT: London Financial Experts Anxious for Conclusion of U.S.
Support Package, Pessimistic on UK Outlook

LONDON 00002460 001.2 OF 002


Summary
--------------


1. (SBU) Uncertainty about the fate of the USG proposed $700 billion
support facility has paralyzed UK financial markets, senior HMT
officials told Econoffs on September 25. There is no inter-bank
lending at the moment, and all the big players are waiting for news
about the plan before making significant market moves, Steve
Pickford, Director International Finance, commented. While the
Treasury is concerned about the bleak macro-economic picture in the
UK and the dim prospects for a quick recovery, HMG is not planning
any wide-reaching financial support package. Bankers share the same
pessimistic view about the UK economy. U.S. bank representatives
told econoffs on September 23 that the UK economic outlook is likely
to get worse. The UK is likely to be in a technical recession by the
end of the year, compounded by a severe slump in the housing market
and weak public finances. Sterling will continue to fall against
the dollar, stabilizing at around $1.74 by December 2009, they
predicted. The political response to the economic crisis has been
inadequate, argued the bankers. A 'surreal' Labour party conference
exposed a political set detached from the realities of the financial
crisis. While in Brussels, EU Commissioner McCreevy is pursuing new
proposals that seem as much an effort to create a personal legacy,
than to address market failures, they stated. End Summary

HMT Welcomes USG Proposed Support Facility
--------------


2. (SBU) While there might be questions about various details of the
U.S. facility, a flawed plan is better than no plan, argued Steven
Pickford, Director International Finance, HMT. The absence of a
plan would just worsen investor jitters and could create panic that
would prove near impossible to mitigate. He added that unlike the
U.S., the UK is not considering any wide-spread financial support
package at this moment, though several short-term and intermediary
steps have been taken - such as banning the short-selling of stocks
until the end of January. Pickford suggested that better cooperation
between U.S. and UK authorities on these measures, and more advance
warning about steps under consideration, would be desirable.

Gloomy Economic Outlook Gets Gloomier
--------------


3. (SBU) The UK's economic outlook will remain gloomy through the
medium-term, according to economists at JP Morgan. Negative growth
of 1 percent in both Q3 and Q4 of 2008 will indicate a technical
recession. Their outlook is shaped by the drag on the economy from
the housing market, with prices forecast to fall by a further 10 to
25 percent by 2010. Citigroup analysts believe a total decline of
30 percent is not improbable, but it is unlikely that default rates
will be as bad as 1991, during a similar housing slump. While they
expect the U.S. housing market to recover in early 2009, problems in
the UK will persist because homeowners are more highly leveraged.
Housing price declines are likely to be relatively uniform across
the country, according to analysts at Morgan Stanley.


4. (SBU) The bankers were pessimistic about HMG's outlook of
recovery by 2010. They believe the shape of the outlook will be
dependent on the fiscal deficit, which will be hurt by a significant
reduction in corporate tax revenue. They noted that infrastructure
projects, such a Crossrail (a train line running east to west across
London),will be postponed, if not cancelled, due to lack of
funding.

Sterling Has Further To Fall Against The Dollar
-------------- ---


5. (SBU) While Sterling has experienced a large correction over
recent weeks, it has a little further to fall against the dollar.
JP Morgan analysts expect the pound to fall to $1.74 by the end of
2009 (from approximately $1.855 currently). This weakening will be
assisted by a likely turn in the interest rate cycle. Interest rate
cuts are increasingly likely following speeches by Sir John Gieve,
Deputy Governor of the Bank of England, and Kate Barker, a Member of
the Bank's Monetary Policy Committee, in which they indicated that
the dampening effect of the credit crisis on the economy could be
bigger than anticipated - hinting that they may vote in favor of a
rate cut. Morgan Stanley holds to its "smile" forecast for the
GBP/USD rate. While Sterling may continue to weaken slightly, it
should slowly recover by the end of 2009.

"Surreal" Labour Party Conference
--------------


6. (SBU) One banker had received feedback from the Labour party
conference, held in Manchester, that the atmosphere was "surreal",
with politicians and Labour delegates detached from the reality of

LONDON 00002460 002.2 OF 002


the financial crisis. Another commented that the crisis has caused
significant friction between Number 10 and government departments.
When Number 10 introduces proposals, such as the suspension of stamp
duty (a tax paid when buying property),the departments fight back,
arguing that the funds are not there to support the project.

Action in Brussels, the view from London
--------------


7. (SBU) There was consensus among the bankers that Charlie
McCreevy, European Commissioner for the Internal Market and
Services, is taking a tough line to push through proposals for
regulating Credit Rating Agencies (CRA) and revising the Capital
Requirements Directive (CRD) prior to the end of his term as
Commissioner. The proposals will need to be passed by the beginning
of next year which, the bankers argued, will mean little
consultation with business will be conducted. Parliament will also
have little time to debate the proposals. One bank representative
said that McCreevy has changed from a light-touch, laissez-faire
liberal to more of an "interventionist" - looking to have
international organizations address the causes of financial market
instability. Some of the bankers argued that McCreevy is looking to
create a personal legacy, by seemingly addressing the problems
without giving sufficient consideration of long-term effects.


8. (SBU) The bank representatives said the Commissioner's CRD
proposals are extreme and one quoted him as saying "I'm going to
kill the originate to distribute model" when speaking of his
proposals to require originating banks to hold 10 percent of all
securities they underwrite. Another roundtable participant was
critical of the proposal given that it had not been subject to the
usual impact assessment procedures. One banker stated that among
Member States, eleven, including Spain, France, Italy, Germany and
the UK were opposed to the proposals. However, it is unclear what
states will voice their opposition if the Originate to Distribute
rules are only applied to Collateralized Debt Obligations and not
traditional bond instruments.


9. (SBU) While Brussels is seeking to assume greater influence in
responding to the crisis, there is no unanimity on how to deal with
the immediate fallout, said Pickford from HMT. Nor is there
consensus about whether a new regulatory framework should be
created. Member states are being affected differently, with several
of the smaller countries still measuring positive growth rates.
There might be one unintended result of the crisis: a fracturing of
the consensus about deficit spending. While the UK has already
exceeded the target the Growth Stability Pact 3 percent fiscal
deficit target, Pickford ruefully admitted, other countries might
use the crisis to push for a loosening of this target.

TUTTLE