The Business News Source

Memo to Bank of England – 31st August 2006

Today the Nationwide building society announced yet more sharp increases in house prices in the UK. The Nationwide noted that the recent increase this month by the Bank of England had little or no effect in cooling the property market.

Nationwide, the largest building society in the UK announced that property prices had leapt another 0.8 percent in August, bringing annual housing inflation to 6.6 percent – the fastest growth rate for one and a half years.

Fionnuala Earley, Nationwide’s group economist stated that ‘while we expect base rates to reach 5 percent by the end of the year, above the peak of the last rising cycle, we do not expect the market to slow as sharply as before.’

She outlined a few reasons; the fact that fewer rate rises were expected, the fact that fixed mortgage rates have moved more gradually and strong demand from the overseas investment sector.

It seems that the London property market in particular has become a ‘safe harbor’ for foreign cash over the last few years. In many parts of London houses are lying empty as foreign capital seeks investment opportunities driven by one of the few, still rising markets. Pity the poor Londoner, who is now suffering from the same problem they bestowed upon the country with second homes.

The current wealth in the economy is driven by debt based on asset price increases - at some point something will give.

Housing industry is defiant about the courage of the Bank of England to do something about the increases – even openly taunting the Bank.

Some are now calling for a bigger rise than expected, a shock to the system that will halt the inflationary growth in property prices in its tracks, now.

Memo ends

Strap yourselves in for a bumpy ride this winter. It seems that the surprise rate increase by the Bank of England earlier this month hasn’t been enough to hold consumer spending or an increase in house prices in the UK. What’s the Bank of England to do?

According to the CBI today, retail sales in August grew at their fastest pace in 18 months. In its quarterly distributive trades survey, the CBI found that more retailers said sales were higher than lower – a positive balance of 12 percent. This is the highest Since December 2004, when the balance was 33 percent more positive.

Money markets sent sterling higher as analysts predicted the new figures would increase the likelihood of further interest rate increases from the Bank of England in order to slow the growth of inflation suggested in the report.

It seems that grocers and brown goods stores were the main beneficiaries of the growth – with sales of high ticket items such as Flat Screen Televisions leading the way.

Much of this could be put down to increases in borrowing as house prices have defied predictions and continued to increase over the summer holiday period.

Households borrowed $10.9bn net in July, up from £9.8bn in June. Mortgage lending increased from £9bn in June to £9.8bn in July – the highest level for 3 years. This included both new and ‘re-mortgaging’.

All of this is quite bad news for the Bank of England, which is chartered to keep inflation at 2 percent.

Worse still, it seems that British consumers are getting the ‘Australian bug’ and spending like there’s no tomorrow. With the long run of house price increases over the past few years, and a market awash with money, it seems that the consumer has got into the habit of spending the gains from the property market. Lenders have obliged as the assets consumers own have increased in value – therefore lowering lending risk – however, this has led to high levels of exposure to debt and a real risk that asset values may at some point collapse.

If the government and the Bank of England are going to slow growth and the risks of inflation then it may be time to remind the consumer that spending has got out of control. The Bank of England needs to reign in spending over the next few months – we may see the return of the ‘short sharp shock’ treatment of the old days. Certainly, runaway house prices and spending are not good for the economy in the long term.

Interest rates are surely on the way up – we suggest by more than the expected 25 points.

It’s beginning to look like Microsoft’s Zune player is more hype than substance and may be a dud before it gets out of the gate. Originally the ‘leaked’ specs of the product were impressive, but as we get closer to the release date of the product the market is getting less and less impressed with what it sees. Now according to analysts it seems that the long awaited Zune player is little more than a repackaged Toshiba Gigabeat player – which itself has only enjoyed marginal success.

Analyst Shaw Wu at American Technology Research reported that - ’While we have great respect for Microsoft, we are frankly under whelmed by the much-hyped Zune device, it appears that the Zune is essentially a repackaged Toshiba Gigabeat that has seen limited success.’

 In his research report, Wu states that Zune shares similar characteristics to other would-be iPod contenders, which have not managed to eat away at Apple’s massive share of the digital media player market. In particular he notes that the Zune replicates the ‘look’, but not the ‘feel’ of the iPod’s thumbwheel.

It neither rotates, nor is it touch sensitive – effectively it’s a cover for the four nav buttons found on cheaper players. As such the elegance of the navigation found on the Apple iPod is missing, so the experience is lower grade. Wu goes on to say that Apple has patented most of the unique elements of the iPod and that getting around these patents may be impossible in the short term. The other elements of the success of the iPod are its eco-system – the so-called ‘halo effect’ that allows customers to select from thousands of additional accessories that attach and enhance the iPod.

Resellers love these items as they generally have higher margins and encourage ‘up-sell’ and return purchases. Of course the success of the iPod itself is another reason that pushing against it will be a formidable challenge – with market share comes economies of scale and sheer availability of choice, it will be hard for anyone to dislodge an installed base of 58 million iPods and 300 million iTunes users.

The more likely losers from the launch of Zune will be Creative, Sony, Sandisk, Samsung and iRiver. The fact that the Zune will be initially manufactured by Toshiba may mean that the other players in the market will target Microsoft directly, get pushed into joining forces, or – as in the case of Creative – join forces with Apple and focus on increasing the value of the Apple eco-system. Either way the sure winner will be Apple.

A final thought for those of you convinced that Microsoft will seize the day – over two years ago Microsoft attempted to jump past the audio end of the player market with the launch by various Korean manufacturers of its Portable Media Centre standard, based on Windows Media Player 10 – this has effectively been consigned to the gadget junk heap in the sky.

It looks like we could see US interest rates on hold for a little longer, even though the decision by the Fed to pause rates was a close call last time. The market rose after the release of the minutes of the Fed meeting.

The Financial Times of London reports that:

...The minutes said the Federal Open Market Committee’s decision to hold rates steady earlier this month had been ‘a close call’, and emphasised that further rate rises could be necessary to fight inflation.But most committee members also thought inflationary pressures would ‘ease gradually’ and that current policy could prove ‘consistent with satisfactory economic performance’.

Ian Shepherdson, chief US economist at High Frequency Economics, said: ‘The FOMC appears to think it has done enough, though it is far from certain.’

Over at BN they view the report as a mixed bag. Calling for need to probably lower rates in the face of a potentially slowing economy. BN suspects that the last 17 rises may be enough and that there may be call to lower rates -

The real problem is the threat posed by inflation. That the Consumer Confidence Index has fallen to a seven month low is hardly a sign of an economy which is seeing pressure come off the inflation pedal completely. For the Fed to conclude the time for a rate fall is upon us, the index will probably need to fall a good deal further. So, we will have to wait another month to see if things get any clearer.

With the housing slowing down in certain parts of the USA one worry is that the economy is fragmenting quickly and that any move, up or down, will affect certain areas and sectors more than others. In effect, the USA is behaving very much like Europe was a few years back, with some regions in very different economic cycles - generally what was good for one area or sector would be painful for another.

The jury is out on the next Fed meeting because of this - expect the market to generate high volatility close to the next meeting, with every facial expression and vocal intonation of the Fed Chief measured and played back to read signs.

Vivendi Universal has signed a deal to make its music catalogue available for a free download service. Vivendi is the world’s biggest music group and this new model could be the biggest challenge to Apple’s paid for iTunes services to date.

Under the agreement Universal’s songs will be available to a start up Spiralfrog, with the service launched in December. Spiralfrog will make its money by placing adverts on the site.

The challenge is how the revenue will be split by artist, and if the adverts can generate the required revenue to pay the expected fees. Secondly, details of the DRM approach are yet to be outlined. We suspect that this won’t simply be an advert on the download site, but some form of intrusive adverts injected into the songs themselves, either before or at the end of the song – similar to radio stations in the 50’s. Worse still, the DRM may require you to ‘charge up’ you viewing rights by subjecting yourself to adverts to release the DRM periodically.

If it’s simply a case of running an ad on the download site then its already been done and the ‘pay back’ is too low to pay the artists fees. Also, this kind of model would expose the company to too much competition – let’s not forget that both Apple, Google and MySpace already have millions of customers – and could do this in a few days, killing off any advantage Spiralfrog has.

Microsoft is preparing to enter the market itself, so Spiralfrog is in for a competitive time over the next few months, let’s hope they have deep pockets.