BoE Cuts Rates, GBP Headed Above 1.55?

Daily Forex Fundamentals | Written by GFT | Jan 08 09 14:34 GMT |

As you may now, the Bank of England cut interest rates by 50bp to 1.50 percent, an all time record low for the 300 year old central bank What I found most interesting about the BoE Monetary Policy Statement is the credit that they are giving to the weak sterling. "But the substantial depreciation in sterling over recent months may help to moderate the impact on UK net exports of the slowdown in global growth." This is one of the arguments that I gave in my 2009 British Pound Outlook about why we expect the UK to be one of the first countries to recovery from the global economic downturn. As for further rate cuts from the central bank, more is likely given the pessimistic tone of the BoE statement. Inflation is also expected to ease sharply. However the GBP/USD has broken above the 50-day SMA and entered our buy zone as the rate cut confirms the aggressiveness of the central bank. As long as the currency pair remains above 1.4245 on a closing basis, we could see a move to 1.5585. Kathy Lien http://www.gftforex.com DISCLAIMER: GFT refers to Global Futures & Forex, Ltd. and all of its divisions, branches and subsidiaries, including Global Forex Trading and GFT Global Markets UK Limited. GFT Global Markets UK Limited is authorized and regulated by the United Kingdom Financial Services Authority. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful. Trading of foreign exchange contracts, contracts for differences, derivatives and other investment products which are leveraged, can carry a high level of risk, and may not be suitable for all investors. It is possible to lose more than the initial investment. In Australia, GFT means Global Futures & Forex, Ltd. ARBN 103 508 461, AFS Licence 226625. A Product Disclosure Statement (PDS) is available at www.gft.com.au. You should read and consider the PDS before making any decision to deal in GFT products. © 2008 Global Futures & Forex, Ltd. All rights reserved.

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Keeping an Eye on GBP after the BOE

Daily Forex Fundamentals | Written by Black Swan Capital | Jan 08 09 14:20 GMT |

Currency Currents Key News South African Manufacturing Drops Most in Nine Years (Bloomberg) Obama Warns of Irreversible Economic Decline Without Action (Bloomberg) Buiter Says BOE Must Stoke Lending, Rate Cut Not Enough (Bloomberg) Quotable "Roosevelt did not come into office with a detailed program based on a firm ideological foundation. Rather, he saw himself as a pragmatist ready to try anything, an approach that engendered stultifying uncertainty. First, he mandated anticompetitive cartels; then he brought antitrust prosecutions against firms for monopolistic activity. Businesses were afraid to make long-term investment plans under such circumstances. Economic historian Robert Higgs writes in Depression, War, and Cold War, "Taken together, the many menacing New Deal measures, especially those from 1935 onward, gave business people and investors good reason to fear that the market economy might not survive in anything like its traditional form and that even more drastic developments, perhaps even some kind of collectivist dictatorship, could not be ruled out entirely." The New Deal did not, therefore, end the Depression. Yet as Higgs shows, neither did World War II. If by "depression" we mean falling living standards as a result of economic inactivity, we can hardly count the war years, with their rationing and shortages of consumer goods, as years of prosperity. The draft is a bogus way to reduce unemployment. The Depression ended after the war, when labor and industry could turn to satisfying consumers, not government. What can we learn from all this? That money is too important to be left to the state. One way or another, government mismanagement of the monetary system wrecked the U.S. economy. It's happening again now. The only permanent way to avoid a repetition is to place the system where it belongs: in the free market. Second, efforts to prevent liquidation of malinvestment caused by inflation bankrupt companies and only prolong economic agony. Bailouts are counterproductive. Assets must be revalued and rearranged in the light of reality. Third, government stimulus spending, borrowing, taxation, and public works commandeer scarce private resources and prevent entrepreneurs from shifting them to investments aligned with consumer, not political, preferences. As Price Fishback of the University of Arizona points out, even FDR didn't try to stimulate the economy with extraordinary budget deficits, something for which Keynes criticized him. Fourth, individual liberty is the first casualty when bureaucracy expands to manage the economy. President-elect Obama would do well to take note, but we hardly have grounds for optimism. Obama has declared his intention to spend, New Deal-style, hundreds of billions of dollars - perhaps a trillion - to rebuild infrastructure, modernize schools, retrofit public buildings for energy efficiency, and expand the broadband network. No matter how meritorious these projects, they do not constitute a genuine recovery program. Government cannot escape the fact that it cannot create wealth. It can only transfer wealth from the private sector or create the illusion of wealth through inflation. Jobs created under inherently politicized programs will displace jobs the private sector would create if the burden of government were lifted and investor confidence restored." -- Sheldon Richman, Editor of the Freeman (writing in The American Conservative) FX Trading – Keeping an Eye on GBP after the BOE Is it over yet? Has the Bank of England reached a bottom with their rate cuts? After today's meeting BOE interest rates sit at 1.5% -- a 50 basis point haircut. Bloomberg.com tells us this is the lowest BOE rates have gone since the bank's introduction. Whoa. So far, the central bank and government in the United Kingdom have been throwing a lot of hope (read as: time and money) at the wall. But nothing seems to be sticking. The obvious indication is the availability, or flow, of credit among consumers. The situation remains really tight; lending and borrowing is minimal. Already there's talk of the BOE needing to adopt quantitative easing. That implies rates will first "flatline" ... approaching 0%. So you would think this is a big negative from a yield-differential perspective. No longer is the British pound a "high-yielding" currency as it was so often called on its meteoric rise beyond the $2 threshold. The big question now is whether, and when, central bank and government officials might finally be able to stop the economic pain and restore some faith in the UK consumer. I don't particularly think that will come anytime soon. Consumers across the globe are changing or have changed their spending habits. There is more pain still to go around and it seems like a recovery in consumption is well beyond the horizon. What about the British pound? Well today, in the first hour following the 50-basis point rate cut, the kneejerk reaction was to buy the heck out of it. Just since the announcement the British pound has run-off more than 200 PIPs – not exactly what you'd expect after the type of news we got this morning. Ok, so the rate cut was probably already priced in. But still, the long-term prospects for the pound remain sour. So what's going on this morning ... Daily view: The last couple days have been strong for the pound, but it did make a new low just before the first of the year. I would expect GBPUSD's climb falls short before the $1.57 mark. After that another new low is likely. Might this morning mark the turning point … Hourly view: On this morning's surge the pound has made a key test of yesterday's high. This is adverse price action (opposite what would be expected based on the news). And this move will prove critical in that the fundamental picture is decidedly negative. There's a chance the pound barreled through buy-stops, shaking out those shorts expecting a big rate cut. We saw some serious reversal moves yesterday. The pound's got upside momentum right now, but keep an eye on how the pound behaves after today's jump. Jack Crooks Black Swan Capital http://www.blackswantrading.com Black Swan Capital's Currency Snapshot is strictly an informational publication and does not provide individual, customized investment advice. The money you allocate to futures or forex should be strictly the money you can afford to risk. Detailed disclaimer can be found at http://www.blackswantrading.com/disclaimer.html

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FX Thoughts for the Day

Daily Forex Technicals | Written by Kshitij Consultancy Services | Jan 08 09 12:14 GMT |

USD-CHF @ 1.1024/26...Support at 1.0872 R: 1.1079-88 / 1.1179-99 / 1.1394 S: 1.0981 / 1.0948 / 1.0872 During the day, Swiss has dipped below the 21-day MA to find Support near the 50% fibonacci retracement of the rise from 0.9637 to 1.2300 at 1.0968 and has bounced up a bit from there. It is presently re-testing this Support and if broken could be targetting 0.0872 which is the 8-day MA. A rise above 1.11 has the potential to take it towards 1.14 over the next few days. On the monthly chart, the pair having caught up between the 8-, 13- and 21-MAs could continue to oscillate between 1.05-1.14 over the next few days/weeks. Cable GBP-USD @ 1.5055/58...Awaiting BoE decision R: 1.5134 / 1.5279 S: 1.4968-55 / 1.4895-66 / 1.4823 During the day, the pair had remained ranged between 1.4982-1.5111. Expected Rate cut of 50 bps seems to have factored into by the market. Markets could get volatile initially at the rate cut announcement. One should then excercise caution in entering into trade. If there is lesser volatility after the rate cut announcement, a rise from here on could potentially be limited to 1.5270 as can be seen from the daily candle chart. However, for that to happen it wil have to break the Resistance at 55-day MA at 1.5152 which it is currently facing Resistance from. A dip from hereon, could possibly be Supported near 1.4883. To see the chart of Cable, click on: http://www.kshitij.com/graphgallery/gbpcandle.shtml#candle Aussie AUD-USD @ 0.7030/35...Support at 0.7040-03 R: 0.7067 / 0.7107 / 0.7131-48 S: 0.6978-52 / 0.6917-13 / 0.6873 Aussie had risen towards 0.7099 during the day and then saw a sharp pullback to take Support on the 100-MA on the 4-hourly at 0.6956 (above the Support we had mentioned of 0.6925). It then has re-entered the Support region of 0.7040-03 as mentioned earlier which contains the 100-month MA, 200-month MA and the trendline Support on the daily chart. If it continues to take Support at the 100-MA on the 4-hourly or around 0.6925, it could be seen to rise towards the 21-week MA (at 0.7202) during the US session. Kshitij Consultancy Service http://www.fxthoughts.com Legal disclaimer and risk disclosure These views/ forecasts/ suggestions, though proferred with the best of intentions, are based on our reading of the market at the time of writing. They are subject to change without notice.Though the information sources are believed to be reliable, the information is not guaranteed for accuracy. Those acting in the market on the basis of these are themselves responsibly for any profits or losses that might occur, without recourse to us. World financial markets, and especially the Foreign Exchange markets, are inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved.

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Swap Spread Shows ‘Healing’ of Credit: Chart of Day

By Liz Capo McCormick

Jan. 8 (Bloomberg) -- Interest-rate derivatives are signaling credit markets are returning to levels not seen in over a year as the Federal Reserve keeps its target lending rate pinned near zero to unfreeze lending.

The CHART OF THE DAY shows the two-year interest rate swap spread narrowed to 61.25 basis points today, the least since October 2007. The spread, which is the difference between the rate to exchange floating for fixed interest payments for two years and comparable U.S. Treasury yields, is a gauge of investors’ perceptions of credit risk. Swap rates are based on expectations for the London interbank offered rate, or Libor.

“The move tighter in swap spreads is definitely a positive for the credit markets,” said Saumil Parikh, a portfolio manager at Pacific Investment Management Co. in Newport Beach, California, which oversees more than $790.3 billion in assets. “It is an important step in the sequential healing process of U.S. credit conditions and it signals immediately that there is decreasing risk in the inter-bank lending market.”

Lending conditions have improved because the Fed allowed excess reserves in the banking system to rise and set up several asset purchase and lending programs, according to Parikh.

Swap rates serve as benchmarks for investors in many types of debt often purchased by buyers using borrowed money, including mortgage-backed securities and auto-loan securities. That means wider swap spreads can push up borrowing costs even if Treasury yields are steady.

To contact the reporter on this story: Liz Capo McCormick in New York at Emccormick7@bloomberg.net

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Bank of England MPC Comments on Jan. Rate Change (Text)

By Mark Evans

Jan. 8 (Bloomberg) -- The following is the text of the Bank of England Monetary Policy Committee comments following the January rate decision:

The Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 0.5 percentage points to 1.5%.

The world economy appears to be undergoing an unusually sharp and synchronised downturn. Measures of business and consumer confidence have fallen markedly. World trade growth this year is likely to be the weakest for some considerable time.

In the United Kingdom, business surveys suggest that the pace of contraction in activity increased during the fourth quarter of 2008 and that output is likely to continue to fall sharply during the first part of this year. Surveys of retailers and reports from the Bank’s regional Agents imply that consumer spending has weakened. The outlook for business and residential investment has deteriorated. And the availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non-financial sector. But the substantial depreciation in sterling over recent months may help to moderate the impact on UK net exports of the slowdown in global growth.

CPI inflation fell to 4.1% in November. Inflation is expected to fall further, reflecting waning contributions from retail energy and food prices and the direct impact of the temporary reduction in Value Added Tax. Measures of inflation expectations have come down. And pay growth remains subdued. But the depreciation in sterling will boost the cost of imports.

At its January meeting, the Committee noted that the recent easing in monetary and fiscal policy, the substantial fall in sterling and the prospective decline in inflation would together provide a considerable stimulus to activity as the year progressed. Nevertheless, the Committee judged that, looking through the volatility in inflation associated with the movements in Value Added Tax, there remained a significant risk of undershooting the 2% CPI inflation target in the medium term at the existing level of Bank Rate. Accordingly, the Committee concluded that a further reduction in Bank Rate of 0.5 percentage points to 1.5% was necessary to meet the target in the medium term.

The minutes of the meeting will be published at 9.30am on Wednesday 21 January.

To contact the reporter on this story: Mark Evans in London at mevans8@bloomberg.net

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Bank of America, Citigroup May Face Restrictions After Crisis

By Scott Lanman

Jan. 8 (Bloomberg) -- The biggest U.S. banks may face the threat of lower profits or pressure to break up under greater regulation following the financial crisis.

Federal Reserve officials have made tackling the issue of firms that are too big to fail a priority. Options may include banning or restricting activities that could threaten the stability of the financial system, analysts said.

“Rates of return are going to be smaller,” said Vincent Reinhart, a former director of the Fed’s monetary-affairs division who is now resident scholar at the American Enterprise Institute in Washington. “That will be the quid-pro-quo for having the government safety net.”

The goal would be to avoid the type of government rescues mounted last year that have put taxpayers at risk of hundreds of billions of dollars of losses. The interventions have increased the risk of future crises because companies have come to rely on official lifelines, current and former policy makers said.

As the firms most exposed to the mortgage collapse failed during the 17-month crisis, some of the biggest players expanded. Bank of America Corp. acquired home-loan-financer Countrywide Financial Corp. and broker Merrill Lynch & Co., and JPMorgan Chase & Co. took on Bear Stearns Cos. and Washington Mutual Inc. Meanwhile, Citigroup Inc. was forced to absorb off-balance sheet units it had created to invest in complex securities.

‘More Vulnerable’

“We are certainly more vulnerable” because of the size and interconnectedness of today’s banking structure, said Harvey Goldschmid, a former commissioner at the Securities and Exchange Commission.

With the failure of investors “to discipline and hold companies accountable, we’d better figure out what kind of government oversight or other techniques will work,” said Goldschmid, who is now a Columbia Law School professor in New York.

Fed Chairman Ben S. Bernanke favors setting up a “macroprudential” financial supervisor to address systemic risks. While he hasn’t identified which agency should undertake the role, some -- including House Financial Services Committee Chairman Barney Frank and outgoing Treasury Secretary Henry Paulson -- have said the Fed is best-placed for the job.

“Reforming the system to enhance stability and to address the problem of ‘too big to fail’ should be a top priority,” Bernanke said in a Dec. 1 speech in Austin, Texas. “The right way to do this is through regulatory changes, improvements in the financial infrastructure, and other measures that will prevent a situation like this from recurring.”

Subprime Lending

A market-stability regulator might aim at making a small number of major decisions to contain threats. The supervisor could, for example, have targeted the subprime lending boom that triggered the mortgage crisis.

Another option is to levy fees on companies to create a bailout fund in a way that’s analogous to the Federal Deposit Insurance Corp.’s pool for guaranteeing bank deposits, which is funded by bank fees.

The biggest firms “have to be subjected to a higher degree of supervision,” said Edwin Truman, a former Treasury assistant secretary and director of the Fed’s international-finance division. “Not that supervision and regulation can solve all the problems, but it can mitigate them,” said Truman, now a senior fellow at the Peterson Institute for International Economics in Washington.

Pressure to Split

More-stringent supervision could create incentives for Citigroup and other large firms to break up, said Bruce Foerster, president of consultant South Beach Capital Markets Advisory Corp. in Miami and a former Lehman Brothers Holdings Inc. managing director. “I think Citi should have been broken up a while ago.”

Banks may be resigned to additional regulations, especially after receiving funds from the Treasury’s $700 billion financial- rescue program.

“It is entirely defensible” that the institutions whose disorderly failure would pose a threat to the system be “subject to oversight, the comprehensiveness and detail of which is commensurate with that” risk, said John Dearie, executive vice president of the Financial Services Forum. The forum is a group of 17 chief executive officers from financial companies including JPMorgan, Citigroup, Bank of America and Deutsche Bank AG.

JPMorgan spokesman Joe Evangelisti and Scott Silvestri of Bank of America declined to comment. Citigroup’s Stephen Cohen had no immediate comment.

Timing of Change

Officials have said that a regulatory overhaul will need to await the end of the financial crisis, seeking to avoid adding to banks’ burdens amid volatile markets. Lawmakers are also planning to consider legislation for new rules, which could lengthen the process.

Former FDIC Chairman William Isaac also said that “the very large banks are already the subject of a great deal of regulation” and “one might question how effective” it’s been.

“You can’t make the argument that they aren’t subject to an incredible amount of rules and oversight including thousands of examiners that live there on a daily basis,” said Isaac, who is now chairman of consultant Secura Group LLC.

The federal government has increasingly inserted itself in financial markets in the past 1 1/2 years to forestall a deeper credit crunch. By October, U.S. officials joined their Group of Seven counterparts in pledging to prevent the failure of “systematically important financial institutions.”

Federal Interventions

Federal officials took over American International Group Inc.,Fannie Mae and Freddie Mac, averted the collapse of Citigroup and Bear Stearns and encouraged mergers such as the takeover of Merrill by Bank of America.

Minneapolis Fed President Gary Stern said in a November speech that the “too-big-to-fail problem now rests at the very top of the ills elected officials, policy makers and bank supervisors must address.”

Richmond Fed President Jeffrey Lacker and Charles Plosser, his Philadelphia Fed counterpart, also warned last year that the central bank’s emergency lending programs raised the risk of future crises by worsening moral hazard -- where firms take on more risk in anticipation of a government backstop.

“If you’re going to get rid of ‘too big to fail’ then you have to be one of two things: either small enough to fail or too regulated to fail,” said James Ellman, who manages more than $100 million in financial stocks as president of Seacliff Capital in San Francisco and used to work for Merrill Lynch.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Robert Schmidt in Washington at rschmidt5@bloomberg.net

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Obama Warns of Irreversible Economic Decline Without Action

By Julianna Goldman

Jan. 8 (Bloomberg) -- President-elect Barack Obama warned that without immediate steps by the government to revive the economy, family incomes will drop, the unemployment rate could reach “double digits” and the U.S. risks losing a “generation of potential and promise.”

In excerpts of a speech he’s scheduled to give today at 11 a.m. New York time in the Washington suburb of Fairfax, Virginia, Obama says that while the cost of his economic recovery plan will add to a deficit already projected to exceed $1 trillion, he “won’t just throw money at our problems.”

“It is true that we cannot depend on government alone to create jobs or long-term growth,” Obama will say. “But at this particular moment, only government can provide the short-term boost necessary to lift us from a recession this deep and severe.”

Obama’s speech, which aides billed as a “major” economic address, is part of a broader pitch to Congress and the American public as he works on selling his $775 billion, two-year economic stimulus plan to pull the U.S. out of a recession. While the excerpts released by his transition office didn’t provide specifics of the plan, advisers said the full speech would expand on previously reported elements.

He also will again call for using the government’s “full arsenal of tools” to unlock credit markets and “a sweeping effort” to stem home foreclosures. Obama also is promising to overhaul financial-markets regulations and crack down on “reckless greed and risk-taking” on Wall Street to restore confidence in markets.

Quick Action Sought

Obama, who has made getting a stimulus package through Congress his top priority even before he takes office on Jan. 20, is pressing Congress to act quickly on his proposals, which include infrastructure spending aimed at creating or saving 3 million jobs and about $300 billion in tax cuts for individuals and businesses.

Yesterday, Obama said that spending in the stimulus plan would have to be geared toward programs that foster long-term economic growth -- in energy, health care and education.

As part of his effort to gain support from congressional Republicans, some of whom have questioned the price tag on the stimulus, Obama says his plan is “not just another public works program.”

Private Sector Jobs

“The overwhelming majority of the jobs created will be in the private sector, while our plan will save the public sector jobs of teachers, cops, firefighters and others who provide vital services,” he will say.

The cost of the economic recovery package is at the high end of the range the president-elect’s advisers had been promoting and lower than the $1 trillion stimulus that some economists have called for. In the speech, he warns that it will widen the federal budget deficit, which the Congressional Budget Office yesterday forecast would hit $1.18 trillion this year.

“It will certainly add to the budget deficit in the short- term,” Obama will say. “But equally certain are the consequences of doing too little or nothing at all, for that will lead to an even greater deficit of jobs, incomes, and confidence in our economy.”

Obama has spent the bulk of his first full week in Washington since the Nov. 4 election meeting with advisers and congressional leaders to help craft the package and shore up support. He is under pressure from lawmakers in both parties to ensure strong oversight given the price tag.

Oversight

Yesterday he named Nancy Killefer, a director at management consulting firm McKinsey & Co. and formerly an assistant secretary of the Treasury in the Clinton administration, to a new post of chief performance officer. She is charged with making the government more accountable for the money it spends.

In his speech, Obama will say the public will be able to use the Internet to view information about where the stimulus money is being spent and promises to create an economic recovery oversight board. He also will bar lawmakers from inserting pet spending projects, known as earmarks, into the legislation.

“Instead of politicians doling out money behind a veil of secrecy, decisions about where we invest will be made transparently, and informed by independent experts wherever possible,” Obama will say.

Obama’s speech comes as the Labor Department may report tomorrow that employers slashed jobs in December for a 12th consecutive month, putting total job cuts at 2.4 million for 2008, the most since 1945, according to the median forecast in a Bloomberg survey of economists.

U.S. stocks slid yesterday after ADP Employer Services said employers cut 693,000 jobs in December. The Standard & Poor’s 500 Index fell 3 percent to 906.65, cutting its 2009 gain to less than 0.4 percent. The index’s 38 percent decline in 2008 was its worst yearly drop since 1937.

Obama urged Congress to pass the measure, which has yet to be introduced, “as quickly as possible.”

“Every day we wait or point fingers or drag our feet, more Americans will lose their jobs, more families will lose their savings,” Obama will say. “More dreams will be deferred and denied. And our nation will sink deeper into a crisis that, at some point, we may not be able to reverse.”

To contact the reporter on this story: Julianna Goldman in Washington at jgoldman6@bloomberg.net;

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European Confidence Dropped to Record Low in December

By Emma Ross-Thomas

Jan. 8 (Bloomberg) -- European confidence in the economic outlook fell to the lowest on record and unemployment rose to a two-year high, adding to pressure on the European Central Bank for more interest-rate cuts.

An index of executive and consumer sentiment dropped to 67.1 in December from 74.9 in the prior month, the European Commission in Brussels said today. That is the lowest since the index started in 1985. Separate data showed euro-area unemployment rose to 7.8 percent in November from 7.7 percent a month earlier.

European companies are cutting jobs and reducing investment in order to weather the first recession in the euro region’s 10- year history. A combined rate cut of 1.75 percentage points since early October and billions of euros in stimulus measures have failed to reverse the slide in confidence and data today confirmed the economy contracted for two straight quarters last year.

“It’s a real shocker,” said Martin van Vliet, senior economist at ING Bank in Amsterdam. “Today’s worse-than-expected data make an even more compelling case for the ECB to cut rates significantly further from here.”

Investors indicate they expect the central bank to reduce rates at least 50 basis points, or hundredths of a percentage point, at its next meeting on Jan. 15, Eonia forward contracts show. That would take the benchmark rate to 2 percent, which would be a three-year low.

Job Cuts

Paris-based Alcatel-Lucent SA, the world’s largest maker of fixed-line networks, last month said it will cut 1,000 more managerial jobs and take other measures to reduce costs by 1 billion euros ($1.4 billion) in each of the next two years. Corus, the European unit of India’s Tata Steel, said on Dec. 31 that it may cut the workweek of 6,400 workers by an average of one day, equivalent to eliminating 1,100 full-time jobs.

A measure of manufacturers’ confidence fell to a record-low minus 33 in December from minus 25 in November, the commission report showed, while consumers’ expectations of unemployment rose to the highest since December 1993.

The economic situation is getting “significantly worse,” Amelia Torres, spokeswoman for European Union Monetary Affairs Commissioner Joaquin Almunia, told journalists in Brussels today. “I hope we will be able to avoid massive job losses because of the recovery plan that we are setting up.”

In December, EU leaders pledged economic-stimulus steps worth 200 billion euros, or about 1.5 percent of gross domestic product, to combat the fallout from the financial crisis. Torres said the government plans announced so far amount to about 0.9 percent of GDP, with Germany scheduled next week to approve a second package for that nation of up to 50 billion euros.

Struggling to Cope

Companies are struggling to cope with the economic downturn that began in last year’s second quarter and may extend through this year. Euro-area GDP shrank 0.2 percent in the third quarter from the prior three months, which saw a similar contraction, the EU’s statistics office said in a separate report today. In the fourth quarter it could contract 1 percent or more, said Ken Wattret, senior economist at BNP Paribas in London.

“Across the board, confidence is collapsing and the European Commission data are indicative of a massive contraction in output -- imminently,” Wattret said in a note to clients. “The euro-zone economic-sentiment data for December reinforce our view that the economy is in meltdown.”

Exports from Germany, Europe’s largest economy, plunged 10.6 percent in November, the biggest drop since records for a reunified Germany began in 1990, the Federal Statistics Office said today, and manufacturing orders fell for a third month. Volkswagen AG, Europe’s biggest carmaker, said on Jan. 5 that its U.S. sales fell 14 percent in December.

‘Gloomy’ Outlook

The economic outlook is “gloomy” for both the U.S. and Europe, Nobel laureate economist Joseph Stiglitz told reporters in Paris today. “Things at the end of the year are probably going to be worse than they are now.”

Amid global concerns about deflation after a 70 percent drop in the cost of crude oil from a July peak, price expectations fell further last month, today’s survey showed. Manufacturers’ selling-price expectations dropped for a fifth month to the lowest level since June 2003. Data yesterday showed that producer prices fell the most in 27 years in November, dropping 1.9 percent from the previous month, an indication inflation will slow further.

“It serves as a reminder to the ECB that it’s facing a serious risk of undershooting its inflation target in the medium- term,” Van Vliet said.

Today’s GDP report showed that investment fell 0.6 percent in the third quarter in the first back-to-back decline since 2002. Household spending stagnated after dropping 0.2 percent in the previous quarter.

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net

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U.S. Jobless Benefits Program Swells to 4.6 Million

By Bob Willis

Jan. 8 (Bloomberg) -- The number of Americans collecting unemployment benefits surged to a 26-year high as the labor market worsened in a yearlong recession.

Initial jobless claims unexpectedly fell by 24,000 to 467,000 in the week that ended Jan. 3, the lowest level in almost three months, the Labor Department said today in Washington. The total number of people getting benefits rose a week earlier to 4.6 million, the most since 1982.

While the government projects a surge in firings in late December and early January, job cuts may have come earlier last year as sinking sales and the worst credit conditions in seven decades forced companies such as General Motors Corp. and Chrysler LLC to pare costs. The claims report comes hours before President-elect Barack Obama delivers a speech on the economic outlook in a bid to build support for his stimulus plan.

“The labor market is just hemorrhaging here,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York, who correctly forecast claims would fall. “Just look at the continuing claims numbers, they give you a better idea of what is going on. Nobody can find work once they’re fired.”

Jobless claims were projected to rise to 545,000, according to the median projection of 35 economists in a Bloomberg News survey. Estimates ranged from 480,000 to 600,000. Claims in the prior week were revised to 491,000 from 492,000.

December Jobs

The government may report tomorrow the economy lost another 510,000 jobs in December, bringing the 2008 total to a six- decade high of 2.4 million, according to economists surveyed by Bloomberg. The unemployment rate probably jumped to 7 percent, the highest level since 1993.

Economists surveyed last month projected the rate will climb to 8.2 percent by the end of 2009, signaling job cuts are likely to keep rising. Martin Feldstein, a Harvard University professor and former adviser to President Ronald Reagan, yesterday predicted during an interview on Bloomberg Television that the jobless rate may eventually exceed 10 percent.

In excerpts of the speech due at 11 a.m. Washington time, Obama warned that without immediate steps by the government to revive the economy, family incomes will drop, the unemployment rate could reach “double digits” and the U.S. risks losing a “generation of potential and promise.”

Obama has pledged his plan will save or create 3 million jobs over the next two years.

Moving Average

The four-week moving average of claims, a less volatile measure, fell to 525,750 for the period ending Jan. 3, compared with 552,750 the prior week, today’s report showed.

Automakers were among companies shutting down operations last year earlier than the government anticipated, leading to a jump in claims when the figures are adjusted for seasonal variations. Those increases reverse in later weeks when the Labor Department’s computations project the firings will take place.

MFR’s Shapiro also said the numbers are being influenced by changing patterns in retail employment this year. Since merchants expected a drop in sales, they hired fewer workers and, as a result, now need to fire fewer seasonal employees than usual, he said.

The unemployment rate among people eligible for benefits, which tends to track the jobless rate, held at 3.4 percent. The unemployment rate, continuing claims and the state claims figures are reported with a one-week lag.

Thirty-two states and territories reported a decrease in new claims for the week ended Dec. 27, while 21 showed an increase.

Seasonal Changes

Jobless claims reflect weekly firings and tend to rise as job growth -- measured by the monthly payroll report -- slows.

The economy entered a recession in December 2007, the National Bureau of Economic Research announced Dec. 1. Economists surveyed by Bloomberg early last month projected gross domestic product would shrink in the fourth quarter by 4.3 percent, the biggest decline since 1982, and would continue contracting through the first half of 2009.

Federal Reserve policy makers saw “substantial” risks to the economy last month as they cut the benchmark interest rate to a record low and pledged o expand emergency loans if necessary.

“Conditions in the labor market deteriorated considerably in recent months as most major industry groups shed jobs,” the Fed said this week as it released minutes of the Dec. 15-16 monetary policy meeting.

GM, Chrysler

As General Motors and Chrysler last month sought billions of dollars in loans to keep operating, the major U.S. automakers also idled or slashed production to clear out inventories.

Chrysler idled all 30 of its assembly plants on Dec. 17 for at least a month, while Ford said 9 of 15 North American factories would shut for the first week in January. GM announced output cuts Dec. 12 that affected 20 plants.

Firings are rippling from manufacturers and construction companies to service industries as demand falters.

EMC Corp., the world’s biggest maker of storage computers, said yesterday it will cut about 2,400 positions, about seven percent of its workforce.

Retailers including Talbots Inc. and Sears Holdings Corp. may close 73,000 stores in the first half of the year, according to the International Council of Shopping Centers, as job losses and economic concerns keep consumers from the shops. Sales at stores open at least a year fell as much as 2 percent in November and December even as stores offered discounts of 65 percent or more.

To contact the reporter on this story: Bob Willis in Washington bwillis@bloomberg.net

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BOE Cuts Rate to Lowest Since Bank’s Creation in 1694

By Svenja O’Donnell

Jan. 8 (Bloomberg) -- The Bank of England cut the benchmark interest rate to the lowest since the central bank was founded in 1694 as policy makers tried to prevent the credit squeeze from deepening Britain’s recession.

The Monetary Policy Committee, led by Governor Mervyn King, trimmed the bank rate by a half point to 1.5 percent. The result matched the median forecast of 60 economists in a Bloomberg News survey. The pound rose against the euro and the dollar.

“The availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non- financial sector,” the Bank of England said in a statement. “Output is likely to continue to fall sharply during the first part of this year.”

The reduction limits the central bank’s scope to keep fighting the recession with its main policy tool. That may spur King to cooperate with Prime Minister Gordon Brown to inject money into the economy and the financial system through so- called quantitative easing.

“They’ll come down below 1 percent by the second quarter,” said Philip Shaw, chief economist at Investec Securities in London. “Things have deteriorated further and this highlights the need for further monetary stimulus. Quantitative easing or non-conventional monetary policy techniques are on the cards.”

Pound Rises

The pound rose as the Bank of England’s move dashed some investors’ expectations of a larger cut. The currency climbed as much as 1.3 percent against the euro after the decision and traded at 89.06 pence per euro as of 12:30 p.m. in London. Against the dollar, it increased 1.2 percent and traded at $1.5241.

The central bank reduced the interest rate by 1.5 percentage points in November and by 1 percentage point in December.

The Bank of England may soon have to join the U.S. Federal Reserve and the Bank of Japan in expanding its toolkit to fight the financial crisis.

U.S. officials, led by Fed Chairman Ben S. Bernanke, lowered their main interest rate close to zero in December and on Jan. 5 started buying mortgage-backed securities. Rates in Japan are also close to zero and the central bank has increased its emphasis on adding funds to the financial system.

The European Central Bank has cut its key interest rate by 1.75 percentage points to 2.5 percent since early October, and may reduce it again next week. President Jean-Claude Trichet may provide clues on his thinking when he gives a speech in Bratislava at 8 p.m. local time today.

Treasury Role

Chancellor of the Exchequer Alistair Darling told the Financial Times this week that the U.K. Treasury may need to play a bigger role in setting monetary policy if interest rates approach zero. That may prompt the government to authorize the central bank to buy assets including government securities and perhaps create money to pay for them.

Darling today tried to damp speculation the government is ready to create money as part of a quantitative easing policy.

“Nobody is talking about printing money,” he told broadcasters in Liverpool, northwest England, where Brown will hold his weekly Cabinet meeting later today.

Financial institutions are hoarding cash and a Bank of England survey last week showed they plan to constrict credit further even after the government unveiled a 50 billion-pound ($75 billion) rescue plan last year. Mortgage approvals dropped to the lowest level since at least 1999 in November.

Brown ‘Fighting’

“We are fighting to do the right things,” Brown said today in a speech in Liverpool, northwest England, where he is holding his weekly Cabinet meeting today. “The global banking system failed. We have got to rebuild it.”

House prices fell by the most since 1991 in December and consumer confidence dropped to the lowest in at least four years, reports by Nationwide Building Society showed this week. Services shrank at close to the fastest pace in at least a dozen years, the Chartered Institute of Purchasing and Supply said.

“It’s baked in the cake that we’ve got higher unemployment coming, and that economic growth is likely to remain weak for a long time,” said George Buckley, chief U.K. economist at Deutsche Bank AG in London. “They can still cut further.”

Rate History

The benchmark rate has never been this low since King William III founded the central bank to fund a war against Louis XIV’s France. The rate began at 6 percent and fell no lower than 4 percent throughout the 18th century.

It touched 2 percent several times in the second half of the 19th century. The central bank held it at that level throughout World War II until 1951.

The economy contracted 0.6 percent in the third quarter and may shrink further, prompting job losses to spiral. Unemployment rose at the fastest pace since 1991 in November and a survey released yesterday by the Recruitment and Employment Confederation and KPMG showed the number of workers placed in permanent jobs fell at the fastest pace since 1997 last month.

Barclays Plc, the U.K.’s third-biggest bank, said yesterday it will cut 408 information-technology jobs, primarily in London and Cheshire, England. Marks & Spencer Group Plc, Britain’s largest clothing retailer, said it will cut 1,230 of its staff.

Easing price pressures are giving the Bank of England scope to keep cutting interest rates. Inflation slowed to 4.1 percent in November from 4.5 percent the previous month. King predicted on Dec. 16 that the rate of annual price increases may drop below the 1 percent lower limit this year.

The central bank cut the benchmark interest rate by 1 percentage point in December, refraining from a bigger reduction because it may prompt an “excessive” drop in the pound.

“I’m not sure interest rates will necessarily get to zero,” said Matthew Sharratt, an economist at Bank of America Corp. in London. “We may see them at 0.5 percent by the end of the first quarter. But now it’s really about what they do about quantitative easing.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net.

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Brazil Has Lost Its Status as Net Oil Exporter, Estado Reports

By Jeb Blount

Jan. 8 (Bloomberg) -- Brazil has lost its status as a net exporter of oil two years after President Luiz Inacio Lula da Silva declared the country´s independence from imports, the Estado de S. Paulo newspaper said.

Brazil imported 243.5 million barrels of oil and oil derivatives through November, and exported 221.9 million barrels, the newspaper said, citing data from the ANP, Brazil’s petroleum regulator. That was an average daily deficit of 65,000 barrels a day, the newspaper reported.

In 2006 and 2007, Brazil exported 73,200 barrels a day of oil and oil products more than it imported, Estado said, citing the ANP. The deficit is caused by Brazil´s economic growth and greater demand for diesel, which the country´s refineries can’t produce in sufficient amounts, Estado said.

Petroleo Brasileiro SA, Brazil’s state-controlled oil company, exported an average of 54,000 barrels a day more of oil and oil products than in imported in the first 11 months of 2008, Estado said, citing Paulo Roberto Costa, the company’s head of refining.

To contact the reporter on this story: Jeb Blount in Rio de Janeiro at jblount@bloomberg.net

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Harvard’s ‘Hippo’ Jet Heads to Poles Sampling Greenhouse Gases

By Alex Morales

Jan. 8 (Bloomberg) -- Harvard University will fly a specially equipped jet from the North Pole to the South Pole testing the atmosphere for variations in global-warming gases to improve computer models used in predicting climate change.

The three-year mission that began yesterday dubbed Hippo will use a modified Gulfstream V traveling first from Colorado to the Arctic before turning south via New Zealand toward Antarctica, the National Science Foundation, a collaborator in the Harvard-led project, said on its Web site.

The plane will cruise over mountains, seas, forests and cities at various altitudes to test concentrations of carbon dioxide, methane and other heat-trapping greenhouse gases to find where they are being released and absorbed at exceptional rates. The findings will be produced in greater detail than any study to date, the scientists said.

“When we finish up, we’ll have a completely new picture about how greenhouse gases are entering the atmosphere and being removed from the atmosphere both by natural processes and by humans,” Steven Wofsy, professor of atmospheric and environmental science at Cambridge, Massachusetts-based Harvard said in a video posted on the NSF Web site.

The United Nations said in 2007 that warmer temperatures globally are caused largely by man-made CO2 and other gases that hold on to the sun’s energy in the atmosphere. Scientists are trying to better understand where the gases originate and how well oceans and forests absorb them.

Current computer models for predicting the earth’s future climate have been questioned by some climatologists for how they handle little-understood heat transfers such as those done by low- level clouds over oceans.

Whole-Globe Snapshot

“It’s the first time we’ve been able to look at the whole globe all at once,” Wofsy said. “Nobody has ever done that. Satellites see the whole globe, but they don’t see it in great detail.”

The mission’s acronym, Hippo, stands for Hiaper Pole-to-Pole Observations. Hiaper stands for High-performance Instrumented Airborne Platform for Environmental Research.

Four further series of flights will be carried out through 2011, the Arlington, Virginia-based National Science Foundation said. Each will take 21 days, according to the Boulder, Colorado- based National Center for Atmospheric Research, another project collaborator, on its Web site.

The planes are scheduled to fly first from Boulder to Anchorage, Alaska, and then to a latitude of about 85 degrees north. They’ll double back to Hawaii, American Samoa, and New Zealand, and cruise down to 67 degrees south and on to Easter Island, Costa Rica and back to Colorado.

To contact the reporter on this story: Alex Morales in London at amorales2@bloomberg.net.

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Russia, Ukraine Resume Talks to Resolve Gas Dispute

By Daryna Krasnolutska

Jan. 8 (Bloomberg) -- Russia and Ukraine resumed talks on a dispute over natural-gas prices that disrupted shipments to Europe for the second time in three years, spurring doubts over the former Soviet Union’s role as a reliable energy supplier.

Ukrainian Deputy Prime Minister Hryhoriy Nemyrya urged OAO Gazprom to resume gas shipments to Ukraine immediately. “There’s no agreement yet,” he said in an interview, adding that the heads of Gazprom and NAK Naftogaz Ukrainy met “face to face” earlier today in Brussels.

Since a previous dispute in 2006, European nations have diversified their sources of fuel and improved inventories. They are also using more gas, the source of 24 percent of the world’s energy in 2007, to reduce emissions linked to global warming. Gazprom suspended transit through Ukraine yesterday after saying Kiev wasn’t passing on fuel intended for European customers.

“Gas will start to flow again fairly soon,” said Fredrik Erixon, director of the Brussels-based European Centre for International Political Economy. “Both Russia and Ukraine want cash and they know that if no gas is flowing they won’t get paid.”

Russian President Dmitry Medvedev spoke with his Ukrainian counterpart Viktor Yushchenko by phone yesterday, the first high-level contact between the two sides since negotiations broke off on Dec. 31. Medvedev said Ukraine should pay the full market price for its gas and clear its debt with Russia. Each side blamed the other for the shutdown of the transit route.

Ruble, Hryvnia Climb

Russia’s ruble and Ukraine’s hryvnia rallied, rebounding from their lowest against the euro this year, following the resumption of talks.

French President Nicolas Sarkozy and German Chancellor Angela Merkel urged Russia to renew shipments of gas to Europe.

Russia must “respect” its contractual commitments, Sarkozy told a joint press conference in Paris today. “Russia has to hold to its obligations,” Merkel said.

Gazprom’s European customers receive 80 percent of supplies through pipelines that cross Ukraine. The Russian exporter, which provides a quarter of Europe’s gas, said its overall deliveries to Europe were cut by about 60 percent yesterday.

“Russia’s motivation isn’t exclusively financial,” David Hauner, a London-based economist at Bank of America Corp., said in a Bloomberg Television interview today. “In this tough time for the Russian government, with lower oil prices and a weaker ruble, they want to show strength. That always comes across well with the public.”

U.K. natural-gas prices climbed to the highest since March 2006 today following forecasts that inventories in the pipeline network may fall from a record.

Gas Prices

Within-day delivery gas increased as much as 8.25 pence, or 12 percent, to 76 pence a therm, according to broker ICAP Plc. That’s equal to $11.42 a million British thermal units. A therm is 100,000 Btus. Prices have surged 36 percent this week as the dispute between Ukraine and Russia intensified.

At least 20 countries have been affected by the supply halt. Ukraine, Romania, Bulgaria, Greece, Turkey, Macedonia, Serbia, Czech Republic, Slovakia, Bosnia-Herzegovina, Slovenia, Austria, Hungary, Italy, Croatia, Moldova, Turkey, Poland, Germany and France have registered shortfalls.

‘Near-term Solution’

The market is still “broadly pricing in a near-term solution to the crisis,” UniCredit SpA said today in an e- mailed note. Industrial stoppages “would spread relatively rapidly if gas supplies remain limited,” it added.

Bulgaria may be “at risk” with regard to gas reserves, with levels at less than 10 days of average consumption, UniCredit said.

RWE Transgas, the Czech Republic’s biggest natural-gas trading company, said domestic fuel supplies remain sufficient even as supplies from Russia remain stopped for a second day.

Hungary partially lifted gas use restrictions though it said it would reimpose them if needed, according to a statement from Mol Nyrt., the country’s biggest refiner.

OMV AG, Austria’s largest oil and gas producer, said today it’s still not receiving gas from Russia.

Italy has enough gas reserves for the next two months and the country relies less on imports from Gazprom than others in Europe, Edison SpA Chief Executive Officer Umberto Quadrino was cited as telling Il Giornale in an interview.

Ukraine’s gas transportation system is stable and no gas is arriving from Russia, Naftogaz Deputy Chief Executive Officer Volodymyr Trikolich said. Naftogaz is supplying gas only to customers in Ukraine, he told a press conference today in Kiev.

‘Real Problems’

European Commission President Jose Barroso said “real problems” may arise unless transit flows resume through Ukraine. Russian and Ukrainian officials have accepted a proposal to have international monitors verify gas transit, Barroso told a press conference in Prague yesterday.

Gazprom delivered about 170 million cubic meters of gas to Europe yesterday, compared with 420 million to 450 million cubic meters a day normally, Deputy Chief Executive Officer Alexander Medvedev said on a conference call yesterday. Gas is being supplied through Belarus and from underground storage.

In 2006, Russia turned off all Ukrainian gas exports for three days, causing volumes to fall in the European Union, and also cut shipments by 50 percent last March during a debt spat.

Russia cut shipments intended for Ukraine’s domestic market Jan. 1, and accused Ukraine of siphoning off gas destined for other buyers, a charge rejected by Kiev. Gazprom has warned that Ukraine risks amassing a debt of “billions of dollars” if the conflict continues.

Raised Demands

Gazprom raised its demands on Jan. 4 as CEO Alexei Miller cited a possible price of $450 per 1,000 cubic meters for deliveries to Ukraine, reflecting the average price in countries bordering Russia’s neighbor. Ukraine, which paid $179.50 for Russian gas last year, rejected a Gazprom offer last week of $250 for 2009 and says $201 would be fair.

Gazprom is still owed $615 million by Ukraine, Medvedev said earlier this week in London. Ukraine wants to charge Russia $2.05 for transporting 1,000 cubic meters of gas for 100 kilometres, compared with $1.70 in 2008.

Ukraine’s political leaders, Yushchenko and Prime Minister Yulia Timoshenko, are grappling with a financial crisis that has forced it to seek a $16.4 billion International Monetary Fund bailout.

The ruble gained 4.7 percent to 39.6468 per euro in limited holiday trading today, from 41.6079 yesterday, in Moscow. The hryvnia increased 2.7 percent per euro to 11.0893, from 11.4155 yesterday.

To contact the reporters on this story: Daryna Krasnolutska in Kiev on dkrasnolutsk@bloomberg.net

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Pound Gains as BOE Lowers Rate to Record Low to Revive Economy

By Matthew Brown

Jan. 8 (Bloomberg) -- The pound rose against the euro and the dollar after the Bank of England cut its benchmark interest rate to an all-time low of 1.5 percent to limit the fallout from Britain’s first recession in 17 years.

The Monetary Policy Committee, led by Governor Mervyn King, lowered the rate by 50 basis points, in line with economists’ predictions. It was the central bank’s fourth cut since the global coordinated emergency reductions on Oct. 8.

“Half a point is less than hoped for by traders, the market is disappointed,” said Neil Jones, head of European hedge fund sales in London for Mizuho Corporate Bank. “This may lead to a rise in sterling immediately on interest-rate differentials, but I think it will do damage to the pound in the longer term.”

The pound advanced as much as 1.6 percent to 88.94 pence per euro before trading at 89.29 pence as of 1:24 p.m. in London, from 90.35 pence yesterday. It was 1.1 percent higher at $1.5254 from $1.5095.

Any U.K. rate cut today would have brought borrowing costs to the lowest since the Bank of England’s foundation in 1694. The European Central Bank trimmed its key interest rate by 1.75 percentage points to 2.50 percent since early October and may reduce it again next week.

“The availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non- financial sector,” the Bank of England said in a statement accompanying today’s decision. “Output is likely to continue to fall sharply during the first part of this year.”

Record Low

The pound lost 23 percent against the euro last year as U.K. policy makers cut rates faster than their ECB counterparts. The Bank of England lowered the key rate by 4.25 percentage points since December 2007, while the ECB cut its rate by 1.5 percentage points in the same period.

Sterling weakened to a record 98.03 pence per euro Dec. 30 on expectations the central bank would continue to cut rates faster than the ECB.

“They’ll come down below 1 percent by the second quarter,” said Philip Shaw, chief economist at Investec Securities in London. “Things have deteriorated further and this highlights the need for further monetary stimulus. Quantitative easing or non-conventional monetary policy techniques are on the cards.”

Interest-Rate Bets

Traders raised bets today on further interest-rate cuts, with short sterling futures for March delivery falling to 1.65 percent, from 1.69 percent yesterday.

“The substantial depreciation in sterling over recent months may help to moderate the impact on U.K. net exports of the slowdown in global growth,” the Bank of England said.

The pound may extend gains against the dollar, Ashraf Laidi, chief currency strategist at CMC Markets in London, wrote in a research note after the decision. “Sterling has already knifed through our projected resistance of $1.52, making yesterday’s $1.5280 high a less challenging target, especially amid potentially negative U.S. jobs data ahead.”

Chancellor of the Exchequer Alistair Darling signaled in an interview with the Financial Times that the U.K. Treasury may need to play a bigger role in setting monetary policy if interest rates approach zero.

The government is “looking at what else we would need to do,” Darling said in the Financial Times interview published today. “The closer interest rates come down to zero, the more the normal transmission mechanism and the operation of monetary policy has to be looked at.”

No ‘Supportive Environment’

If the Treasury embarks on quantitative easing, the government may authorize the central bank to buy assets including government securities and even print money to pay for them, according to analysts.

“Attention will now turn steadily to the Bank’s appetite for a policy of quantitative easing,” said Neil Mellor, a currency strategist in London at Bank of New York Mellon Corp., the world’s largest custodian of financial assets. “It can hardly be said that this provides a supportive environment for pound.”

U.K. government bonds rose, pushing the yield on the 10- year gilt down seven basis points to 3.22 percent. The 5 percent security due March 2018 added 0.56, or 5.6 pounds per 1,000- pound face amount, to 114.06. The two-year gilt yield was at 1.67 percent.

To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net

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Hedging Gains Favor at Hertz After Oil Drop Hurts Delta, Vitro

By Edward Klump

Jan. 8 (Bloomberg) -- Hertz Global Holdings Inc., the second-largest U.S. rental-car company, may lock in some of its energy costs after a record drop in crude prices burned airlines that sought to hedge the risks of rising oil prices.

Hertz, based in Park Ridge, New Jersey, wants to level out costs after rising fuel prices contributed to an 89 percent drop in third-quarter profit, spokesman Richard Broome said this week in a telephone interview. Hedging would protect the company should energy prices rebound after crude tumbled 68 percent in the second half of 2008. Futures contracts in New York show investors expect oil to rise 38 percent by December.

Hedging backfired for Delta Air Lines Inc., Cathay Pacific Airways Ltd. and Vitro SAB, which locked in prices when oil was rallying, inflating their costs as 2008 turned out to be the worst year for commodities markets in five decades. Crude futures, currently $105 below their high-water mark, advanced for six straight years before jumping to a record high in July.

“Not only was there buying on fear, but there was hedging on fear,” said Bruce Bullock, director of the Maguire Energy Institute at Southern Methodist University in Dallas.

Wrong-way bets were understandable as petroleum prices jumped, Bullock said. “You’re trying to make a decision and manage your risk, and you’ve got to weigh the probability that it’s going to go up versus the probability that it would go down,” he said. “If you put yourself in their position last summer it was like, OK, once burned, twice cautious.”

Air France, Delta

The turnabout in petroleum markets left fuel users such as Air France-KLM Group and Shenzhen Nanshan Power Co. holding unprofitable hedging contracts.

Delta, the world’s biggest air carrier, said in December that it may have to post $1 billion in collateral, or 15 percent of its cash, on jet-fuel hedges. Executives at Vitro, Mexico’s largest glassmaker, stepped down in November after making losing bets on derivatives. Alfa SAB, the world’s top maker of aluminum engine heads and blocks, said Dec. 15 that it had a $158 million loss on contracts tied to natural-gas prices.

Cathay Pacific, Hong Kong’s largest air carrier, said yesterday its paper losses from fuel-hedging almost tripled to HK$7.6 billion ($980 million) in two months. All Nippon Airways Co., Japan’s second-largest airline, may also suffer after hedging 75 percent of its fuel needs for the fiscal year starting April 1 at an average of $111.73 a barrel, according to Bloomberg News calculations based on the airline’s reports.

Price Bet

Southwest Airlines Co. posted a third-quarter loss, breaking a 17-year streak of profits, on wrong-way hedges. The low-fare carrier, based in Dallas, said Dec. 23 that it had to post $230 million in collateral to back contracts committing to purchase prices higher than market rates. The airline unwound most of its hedging contracts, which reduced collateral requirements for the fourth quarter by $600 million.

Southwest is only about 10 percent hedged on fuel each year through 2013, down from about 85 percent in the fourth quarter of 2008 and from 75 percent for 2009 previously, according to a Dec. 23 regulatory filing. Hedging has saved Southwest $4.4 billion since 1999, spokeswoman Beth Harbin said.

“They’re definitely saying they’re sure oil’s going to stay down for a while,” said Michael Derchin, an analyst at FTN Midwest Research Securities in New York.

Oil futures will average $60 a barrel this year as OPEC cuts output, according to the average of 31 analyst estimates compiled by Bloomberg. Crude fell below $43 yesterday after U.S. supplies increased more than analysts estimated, spurring the biggest drop in prices in more than seven years.

Rout in Commodities

The Standard & Poor’s GSCI Index of 24 commodity futures lost 47 percent last year, the most since its introduction in 1971. The Reuters/Jefferies CRB Index of 19 raw materials dropped 40 percent, the steepest plunge since 1957.

Delta will be “working off” hedging contracts that locked in prices above current market levels through the first part of 2009, President Ed Bastian told investors in a Dec. 9 presentation. The Atlanta-based company has reduced use of hedging on new fuel purchases.

Air France-KLM, Europe’s biggest airline, said in November that second-quarter profit dropped 96 percent as lower oil prices reduced the value of fuel hedges.

The Paris-based carrier pays the going market rate for fuel when oil sells between $70 and $120. The company pays fuel prices reflecting $70 oil when crude goes lower, and its costs are capped at $120 a barrel when it goes above that level. Oil futures reached $147.27 a barrel on July 11.

‘Eat Dirt’

Hedging losses for airlines will give way this year to gains from reduced capacity and lower fuel costs, said Robbert Van Batenburg, head of research at Louis Capital Markets in New York.

“They’re going to eat dirt in the fourth quarter, but that’s now behind us,” he said. “Inadvertently, they have postponed the great benefits that they should have seen from the collapse in energy prices.”

Mexico’s Vitro said Dec. 15 that it had $342 million of losses related to derivatives and that it closed out positions except for $22 million related to gas. That statement followed the November resignations of Chief Executive Officer Federico Sada and CFO Enrique Osorio, after the company made bad bets tied to currencies, interest rates and fuel.

The glassmaker used hedges to lock in gas at about $10.20 per million British thermal units for parts of 2008 and 2009, Osorio said in a September interview. Osorio said in July he boosted Vitro’s hedging to cover 85 percent of its needs for the rest of 2008, up from 40 percent in the first half of the year. New York gas futures, which touched $13.69 on July 2, dropped as low as $5.21 last month.

Contracts Disputed

SMU’s Bullock said hedging 20 percent or 30 percent of a company’s fuel costs is prudent. “If they bet the farm, if you will, and hedged 70, 80, 90 percent of their fuel needs, then that probably was not well advised,” he said.

Alfa, the maker of aluminum engine parts, said last month that it had $494 million of losses on derivatives related to exchange rates, interest rates, equity swaps and fuel futures as of Nov. 30.

In China, Shenzhen Nanshan Power and Goldman Sachs Group Inc. are in talks to resolve a dispute over hedging contracts, according to a Dec. 18 statement by the Chinese electricity producer. Shenzhen Nanshan Power is refusing to pay for losses on contracts signed in March, when oil prices were surging.

Some companies profited from oil’s decline. China Southern Airlines Co., Asia’s biggest air carrier by number of passengers, made $6.3 million from fuel hedging last year after closing all of its positions in September, a spokesman said on Jan. 5.

For Hertz, the idea behind hedging is to bring more certainty to the company’s expenses.

“We’re trying to control costs in every way we can, and fuel has been a major variability in costs for us,” Broome said.

To contact the reporter on this story: Edward Klump in Houston at eklump@bloomberg.net.

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