With Christmas approaching, many high street stores will be hoping for a big increase in sales, but that seems unlikely to be enough for Arcadia, whose brands include Top Shop, BHS and Dorothy Perkins. Arcadia’s profits have decreased to £133m, which is a fall of 38% and, based on this data, it is planning on closing many stores across the country over the next few years. With leases expiring on many of their stores within about 3 years, the current plan, according to Sir Phillip Green, is to close about 250 stores. Speaking to the BBC, he commented:
‘Now, there may be other opportunities that turn up that we might want to open. But certainly, in terms of our existing portfolio, currently that’s our thinking.’
The economic climate has obviously played a key role, but so has the weather. With the hottest October and November for decades, people have been delaying their shopping and purchases of winter clothing and this has put increased strain on many high street traders (see the news item Dreaming of a white Christmas).
What is perhaps of more concern than one company’s profits being significantly lower is the impact this may have on unemployment. With over 2500 stores, Arcadia is one of the largest private employers in the UK and if 250 stores are closed, there may be severe consequences for the labour market and this may have further adverse effects on aggregate demand. A key factor that may partly determine the future of firms such as Arcadia is how much consumers spend this Christmas. Perhaps for these stores, they really may be hoping for a white Christmas – at least that may encourage people to stock up on winter clothes – if they can get to the shops!
Arcadia to close stores after reporting loss Financial Times, Andrea Felsted (24/11/11)
Arcadia and Dixons post profit loss BBC News (19/4/10)
Retail slowdown hits Arcadia stores Guardian, Zoe Wood (9/5/11)
Arcadia set to close up to 260 stores as profits fall BBC News (24/11/11)
Has Sir Phillip Green lost his Midas touch? Independent, James Thompson (25/11/11)
Arcadia suffers 40% slide in profits The Press Association (24/11/11)
Questions
- Explain why the current economic situation has caused a slowdown in retail sales.
- Illustrate the way in which a firm will maximise profits. If profits are declining, is it because sales revenue has fallen or that costs have risen? Adapt your diagram to show a fall in profits based on your answer.
- According to the article by the Press Association, margins were ‘squeezed by 1.8% as it took a £53 million hit to absorb price increases’. What does this mean?
- How might the unseasonably warm weather be an explanation for a weaker trading environment?
- If 260 stores are closed, what impact might this have on unemployment?
- If more workers lose their jobs, how might this have a subsequent adverse effect on sales? Think about the multiplier effect here.
When governments run deficits, these must be financed by borrowing. The main form of borrowing is government bonds. To persuade people (mainly private-sector institutions, such as pension funds) to buy these bonds, an interest rate must be offered. Bonds are issued for a fixed period of time and at maturity are paid back at face value to the holders. Thus new bonds are issued not just to cover current deficits but also to replace bonds that are maturing. The shorter the average term on existing government bonds, the greater the amount of bonds that will need replacing in any one year.
In normal times, bonds are seen as a totally safe asset to hold. On maturity, the government would buy back the bond from the current holder at the full face value.
In normal times, interest rates on new bonds reflect market interest rates with no added risk premium. The interest rate (or ‘coupon’) on a bond is fixed with respect to its face value for the life of the bond. In other words, a bond with a face value of £100 and an annual payment to the holder of £6 would be paying an interest rate of 6% on the face value.
As far as existing bonds are concerned, these can be sold on the secondary market and the price at which they are sold reflects current interest rates. If, for example, the current interest rate falls to 3%, then the market price of a £100 bond with a 6% coupon will rise to £200, since £6 per year on £200 is 3% – the current market rate of interest. The annual return on the current market price is known as the ‘yield’ (3% in our example). The yield will reflect current market rates of interest.
These, however, are not ‘normal’ times. Bonds issued by many countries are no longer seen as a totally safe form of investment.
Over the past few months, worries have grown about the sustainability of the debts of many eurozone countries. Bailouts have had to be granted to Greece, Ireland and Portugal; in return they have been required to adopt tough austerity measures; the European bailout fund is being increased; various European banks are having to increase their capital to shield them against possible losses from haircuts and defaults (see Saving the eurozone? Saving the world? (Part B)). But the key worry at present is what is happening to bond markets.
Bond yields for those countries deemed to be at risk of default have been rising dramatically. Italian bond yields are now over 7% – the rate generally considered to be unsustainable. And it’s not just Italy. Bond rates have been rising across the eurozone, even for the bonds of countries previously considered totally safe, such as Germany and Austria. And the effect is self reinforcing. As the interest rates on new bonds are driven up by the market, so this is taken as a sign of the countries’ weakness and hence investors require even higher rates to persuade them to buy more bonds, further undermining confidence and further driving up rates.
So what is to be done? Well, part of the problem is that the eurozone does not issue eurobonds. There is a single currency, but no single fiscal policy. There have thus been calls for the eurozone to issue eurobonds. These, it is argued would be much easier to sell on the market. What is more, the ECB could then buy up such bonds as necessary as part of a quantitative easing programme. At present the ECB does not act as lender of last resort to governments; at most it has been buying up some existing bonds of Italy, Spain, etc. in the secondary markets in an attempt to dampen interest rate rises.
The articles below examine some of the proposals.
What is clear is that politicians all over the world are trying to do things that will appease the bond market. They are increasingly feeling that their hands are tied: that they mustn’t do anything that will spook the markets.
Articles
Bond market hammers Italy, Spain ponders outside help Reuters, Barry Moody and Elisabeth O’Leary (25/11/11)
German Bonds Fall Prey to Contagion; Italian, Spanish Debt Drops Bloomberg Businessweek, Paul Dobson and Anchalee Worrachate (26/11/11)
Rates on Italian bonds soar, raising fears of contagion Deutsche Welle, Spencer Kimball (25/11/11)
Brussels unveils euro bond plans Euronews (23/11/11)
Germany faces more pressure to back eurobonds Euronews on YouTube (24/11/11)
Bond markets Q&A: will the moneymen hit the panic button? Guardian, Jill Treanor and Patrick Collinson (7/11/11)
Why we all get burnt in the bonfire of the bond markets Observer, Heather Stewart, Simon Goodley and Katie Allen (20/11/11)
Retaining the confidence of the bond market is the key to Britain’s success in the EU treaty renegotiations The Telegraph, Toby Young (19/11/11)
Boom-year debts could bust us BBC News, Robert Peston (25/11/11)
UK’s debts ‘biggest in the world’ BBC News, Robert Peston (21/11/11)
Markets and the euro ‘end game’ BBC News, Stephanie Flanders (24/11/11)
The tricky path toward greater fiscal integration The Economist, H.G. (27/10/11)
The tricky path toward greater fiscal integration, take two The Economist, H.G. (23/11/11) and Comments by muellbauer
Data
European Economy, Statistical Annex Economic and Financial Affairs DG (Autumn 2011) (see Tables 76–78)
Monthly Bulletin ECB (November 2011) (see section 2.4)
Bonds and rates Financial Times
UK Gilt Market UK Debt Management Office
Questions
- Explain the relationship between bond yields and (a) bond prices; (b) interest rates generally.
- Using the data sources above, find the current deficit and debt levels of Italy, Spain, Germany, the UK, the USA and Japan. How do eurozone debts and deficits compare with those of other developed countries?
- Explain the various proposals considered in the articles for issuing eurobonds.
- To what extent do the proposals involve a moral hazard and how could eurobond schemes be designed to minimise this problem?
- Examine German objections to the issue of eurobonds.
- Does the global power of bond markets prevent countries (including non-eurozone ones, such as the UK and USA) from using fiscal policy to avert the slide back into recession?
This autumn has been one of the mildest on record. Whilst this may be very nice for most of us, certain industries have been suffering. For example, gas and electricity consumption is down as people delay turning on their heating. One sector particularly badly hit has been clothing. Sales of winter clothes are substantially down and many retailers are longing for colder weather to boost their sales.
Of course, this is not helped by consumer incomes. With inflation at around 5% and average (pre-tax) weekly earnings currently rising by less than 2%, real incomes are falling. In fact over the year, even nominal disposable incomes are down 2.1%, given the rise in national insurance and income tax. And the problem of falling incomes is compounded by worries over the future state of the economy – whether it will go back into recession, with further falls in real income and rises in unemployment.
It’s no wonder that retailers are longing for some cold weather and for their customers to return from the seaside or their garden barbecues to the shopping malls. Look out for the ‘sales’ signs: they’re beginning to spring up as desperate retailers seek to attract wary customers.
Webcast
Retailers slash prices in Christmas build-up BBC News, Tim Muffett (25/11/11)
Articles
Winter woes: warm weather means shoppers aren’t buying as much Guardian, Zoe Wood (21/11/11)
Shoppers urged to be savvy as Christmas sales last for weeks The Telegraph, Victoria Ward (21/11/11)
Data
Earnings tables: Labour Market Statistics ONS (November 2011)
Personal Income and Wealth ONS
Price Indices and Inflation ONS
Personal Inflation Calculator (PIC) ONS
Questions
- Identify the determinants of demand for winter clothing.
- How responsive is demand likely to be to these determinants (a) over a period of a few weeks; (b) over a period of a few months?
- What factors should a retailer take into account when deciding whether to make pre-Christmas discounts?
- Assume that you are employed but are afraid of losing your job in a few months’ time. How would this affect your consumption of (a) seasonal goods; (b) durable goods; (c) day-to-day goods?
- What longer-term strategies could retailers adopt if they predict tough trading conditions over the next two or three years?
With pressure on household incomes, many have had to forego spending on luxuries and travel is seen by many as just that – a luxury they can no longer afford. Add on to this some unexpected external shocks and it’s unsurprising to see a company such as Thomas Cook, the second largest holiday business in the world, in talks with banks. It provides some 19 million holidays per year, but has seen a relatively rapid deterioration in its finances.
Its debts total in September 2011 was some £900 million and the value of the company has declined significantly in recent times. However, the most notable decline has been since it emerged that Thomas Cook was in talks with its banks in preparation for tougher times to come. It is hoping to receive £100 million from a range of banks including HSBC and Lloyds, but on this news Thomas Cook share prices fell by some 75%. However, Thomas Cook has said that the company is simply requesting money as a cushion and that it is not in a desperate financial situation. As the Acting Chief Executive, Sam Weihagen said, ‘I think investors should have confidence in Thomas Cook’.
Many factors have contributed towards Thomas Cook’s current situation – volcanic ash clouds, political unrest and unkind weather, but also some internal strategic decisions, such as their continued focus on package holidays, despite the fact that data suggests 2 in 3 people that go to Spain (a popular package destination) are actually not on a typical package holiday. The key thing with travel is that it is very much based on confidence (as we have also seen with the banking sector). If confidence in a company declines, people stop booking holidays with them and so further financial issues are created. This issue is even more significant when a well known brand name, such as Thomas Cook is the company in trouble. Nothing else makes such great headlines as a well known brand in trouble. So, should holiday makers be concerned? The following articles consider the situation that Thomas Cook faces.
Thomas Cook makes it hard to see the funny side Telegraph, Alistair Osborne (22/11/11)
Thomas Cook dives on bank talks BBC News (22/11/11)
How Thomas Cook shares dive 75% on new of bank talks BBC News (22/11/11)
Thomas Cook reassures holiday makers after shares plunge Guardian, Simon Bowers and Patrick Collinson (22/11/11)
Thomas Cook risks customer exodus during bank talks after stock plunges Bloomberg, Armorel Kenna and David Altaner (23/11/11)
Fears for Thomas Cook after shares sink 75% Independent, James Thompson (23/11/11)
Thomas Cook shares crash after default warning Reuters, Matt Scuffham (22/11/11)
Questions
- Explain the reason why share prices have fallen for Thomas Cook. Use a diagram showing the demand and supply of shares to support your explanation.
- Distinguish between the internal and external factors that have contributed to Thomas Cook’s current position.
- Under which aspect of PEST and STEEPLE analysis would you place the above influences?
- In the Telegraph article, an industry source says: ‘In a business like this you need a very conservative capital structure because you don’t know what’s going to come and bite you.’ What is meant by ‘a very conservative capital structure’?
- What action can Thomas Cook take to try to improve its current financial position? Think about both costs and revenues.
- What type of good would you class a holiday as? Based on this, what sort of figure would you place on the income elasticity of demand for holidays?
- How likely do you think it is that other travel companies are also experiencing similar financial issues to Thomas Cook?
UK unemployment is rising. According to figures released by the Office for National Statistics, in the third quarter of 2011 the unemployment rate was 8.3%, the highest since 1986. The number unemployed was 2.62 million, up 129,000 on the previous quarter.
The figures for those aged from 16 to 24 are particularly worrying. If you include those in full-time education but who are looking for employment and are available for work, the unemployment rate in this age group was 23.3%. If you exclude those in full-time education, the rate was 20.6% (up 1.8 percentage points since the previous quarter).
The government was quick to blame the eurozone crisis for the rise in unemployment. The Minister of State for Employment, Chris Grayling, said, “What we are seeing are the consequences of the crisis in the eurozone.”
But is this true? Unemployment is a lagging indicator. In other words, it takes time for unemployment to respond to changing economic circumstances. Thus the rise in unemployment from quarter 2 to quarter 3 2011 was the result of the economic conditions at the beginning of 2011 and earlier – a time when growth in the eurozone was faster than that in the UK. The eurozone economy grew by 2.4% in the 12 months to 2011Q1, whereas the UK economy grew by only 1.6% over the same period. Even taking the 12 months up to 2011Q3, the eurozone economy grew by 1.4%, whereas the UK economy grew by only 0.5%.
Of course, if the crisis in the eurozone leads to another recession, then this will almost certainly lead to a rise in unemployment. But that’s to come, not what’s happened.
The following articles look at the rise in unemployment and especially that of young people. They examine its causes and consider possible solutions at a time when governments in the UK and around the world are concerned to reduce public-sector deficits and debt.
Articles
Youth unemployment breaks 1m mark Independent, Alan Jones (16/11/11)
UK unemployment increases to 2.62m BBC News (16/11/11)
Youth unemployment reaches 1986 levels The Telegraph, Donna Bowater (16/11/11)
Over a million young people are jobless BBC News, Hugh Pym (16/11/11)
Unemployment figures rise ‘related to eurozone crisis’ BBC News, Employment minister Chris Grayling (16/11/11)
Labour’s Liam Byrne: Young jobless paying ‘brutal price’ BBC News, Shadow Secretary for Work and Pensions Liam Byrne (16/11/11)
UK unemployment ‘nothing to do with eurozone’ BBC News, Lord Oakeshott (16/11/11)
Coalition sheds crocodile tears over young jobless Guardian, Larry Elliott (16/11/11)
Is youth unemployment really rising because of the eurozone crisis? Guardian, Polly Curtis (16/11/11)
Eurozone and the UK: A tale of two crises BBC News, Stephanie Flanders (15/11/11)
Data
Latest on the labour market – November 2011 ONS on YouTube (16/10/11)
Labour Market Statistics, November 2011 ONS (16/10/11)
Harmonised unemployment levels and rates for OECD countries (annual, quarterly and monthly) OECD StatExtracts
Economic Data freely available online Economics Network
Questions
- What are the causes of the UK’s rise in unemployment in quarter 3 of 2011?
- Why is unemployment particularly high for the 16 to 24 year old age group?
- Find out the unemployment rates for the 16 to 24 age group for other European countries for both females and males. How does the UK rate compare with the rest of Europe?
- What are meant by a ‘lagging indicator’ and a ‘leading indicator’? Why is unemployment a lagging indicator?
- Identify some other lagging indicators and some leading indicators and explain why they lag or lead the level of economic activity.
- What solutions are there to high unemployment of young people (a) in the short run; (b) in the long run?
