FSRS Handbook - All Chapters PDF

Workshop 1 - Introduction to the Course and the Economic Environment 1.2 Introduction Any financial decision should be taken considering the wider economic environment. The economic environment, domestic and global, can have a significant impact on investments that are held or considered. Money and...

Workshop 1 - Introduction to the Course and the Economic Environment 1.2 Introduction Any financial decision should be taken considering the wider economic environment. The economic environment, domestic and global, can have a significant impact on investments that are held or considered. Money and finance are linked to most types of legal work that you may be interested in, and this course aims to increase your awareness of the factors which impact on the value of money or assets. Throughout the course you should consider how the content might be applied to your own life or when advising clients. It may be different to other law courses you have taken before, but the course will assist you in networking, interviews, personal finance and in dealing with clients by improving your financial awareness. 1.4 UK Economic Measures, Environment and Growth Prospects 1.4.1Economic Growth The main statistic used for measuring the state of the economy is Gross Domestic Product (GDP). The UK Office for National Statistics (ONS) produces GDP statistics by measuring: The value of goods and services produced by all sectors in the economy. The value of goods and services purchased by households and the government, and the value of investment in buildings and machinery. The value of all income generated in terms of profits and salaries. An increasing GDP means the economy is growing; a decreasing GDP means it is contracting. GDP is measured on a quarterly basis and if the economy is contracting on two consecutive quarters, it is defined as being in recession. GDP is often referred to as a marker of the economic health of the country. However, it is important to note that GDP does not measure quality of life outcomes, such as health, education, or the state of the environment. It consequently does not tell the whole story about the economy, or the wellbeing of a given country. The graph below shows UK GDP figures between Q1 of 2008 and Q2 of 2024 Figure 1 - GDP Growth 2008-2024 (Source: ONS) You can see from the graph that the UK’s last recession started in the spring 2008 and ended in autumn 2009. The economy then grew faster than expected but began to falter at the end of 2010. The heavy snow of December 2010 was largely blamed for the contraction. GDP growth for 2011 was 0.8% with one-off factors such as the Japanese tsunami and the Royal Wedding minimising potential growth. The Eurozone crisis rumbled on into 2012 and GDP fell. Growth remained static until 2020 then GDP fell by 2.0% in Quarter 1, signalling the first direct impact of Covid-19 on the economy. GDP continued to fall rapidly, experiencing a massive drop down 20% by Quarter 2 of 2020. After this point it finally began to rise again and gained huge momentum, climbing 36% in Quarter 3 of 2020 from its previous low. Most of this momentum declined by the end of 2020, nonetheless the economy had become more stable since the start of the pandemic. In 2021, trading in January and February was poor due to a lockdown and added costs of navigating new trading terms with the EU which limited many businesses' trading activities. This caused GDP to fall by about 4% from 2020. However, by the summer of 2021 GDP had increased to almost 5%, and it showed promising signs as the full aftermath of the pandemic unfolded. Over the full course of 2021, GDP increased by 7.5%, the fastest rate of growth since the 1940s. In February 2022, Russia invaded Ukraine. The invasion sent fuel prices skyrocketing due to Russia’s large share of the oil and gas market, concerns about supply, and sanctions against Russia introduced by many countries in response to the invasion. The price of fuel has knock-on effects throughout the economy because it creates higher transportation and energy costs for businesses. Food prices were hard hit because of the twin effects of increased fuel prices and the temporary threat to Ukraine’s usually large grain exports. The invasion led to a sharp increase in inflation and interest rates and came at a time when inflation was already high because of increased demand after the pandemic. The huge increase in inflation squeezed the economy, pushing up the cost of living in ways which were unaffordable for many British households. The UK economy slipped into a technical recession in the second half of 2023 but returned to growth in the first three months of 2024. Rising activity in the housing market and higher levels of consumer and business confidence were consistent with a continued economic recovery. The Bank of England has raised its forecast for UK exports this year from a contraction of 0.25% in February to an increase of 2.0% in its latest forecasts. The Bank’s new forecasts predict both faster growth and lower inflation than previously expected. The UK economy appears to be on the mend. Barring external shocks, growth is expected to continue through the rest of this year and next year at around trend, or normal, levels. Falling inflation, rising real incomes and growth in the US and Europe should help to maintain the recovery. 1.4.2Inflation Inflation is a general rise in prices across the economy and is expressed as a percentage. As the prices of goods and services increase, each pound will be able to purchase fewer of those goods and services. Deflation is the opposite and occurs when the inflation rate falls below 0% i.e. the prices are lower than a year earlier. To keep inflation low and stable, the Government set the Bank of England an inflation target of 2%. If the Bank of England misses the inflation target by more than 1% either side, the Governor of the Bank of England must write to the Chancellor to explain why that is, and how the Bank of England will get it back to 2%. If inflation is too high or it fluctuates a lot, it is difficult for businesses to set the right prices and for people to plan their spending. But if inflation is too low, or negative, then some people may put off spending because they expect prices to fall. Although lower prices sound like a good thing, if everybody reduced their spending then companies could fail and people may lose their jobs. Inflation will be covered in more detail in Chapter 2. 1.4.3Unemployment Unemployed people are defined by the Labour Force Survey as those without a job who have been actively seeking work in the past 4 weeks and are available to start work in the next 2 weeks. It also includes those who are out of work but have found a job and are waiting to start it in the next 2 weeks. Figure 2- Unemployment Rate Jan 1993 - June 2024 (Source: ONS) One of the hardest-hitting effects of the financial crisis was the rise in unemployment. UK unemployment rates peaked in November 2011 at 2.68 million, according to the ONS. There then followed a decade of strong employment growth. From 2012 to early 2020 the unemployment rate fell from over 8% to below 4%, while the employment rate rose from 70% to a record 76.6%. But in March 2020, the UK Covid-19 pandemic struck the UK. A huge contraction in the economy and continued social distancing marked the end of the period of plentiful work. By May 2020, about a third of the UK’s 33m workforce were being supported by the government, through the furlough scheme, self-employment income support or Universal Credit. A further third was working from home and a final third were at work. The lockdown imposed a nationwide experiment in working and consuming remotely, bringing about the organisational changes needed to exploit digital technologies. Before the crisis, homeworkers tended to be older, held more senior roles and were concentrated in sectors like IT, professional services, and real estate. The lockdown widened the age range and skills of those who worked from home. The UK labour market came through the pandemic in surprisingly good shape; predictions of mass job losses were not realised. The end of the furlough scheme, which was widely expected to result in major job losses, was instead followed by a surge in job vacancies and lower levels of unemployment. The UK unemployment rate was close to the lowest level in almost 60 years. Job vacancies had never been higher, and for the first time, there were more vacancies than unemployed people in the UK. The problem now was not a lack of jobs but a shortage of people to fill them. August 2024 ONS figures showed that the employment rate was up from the previous quarter to 75.4% between April and June 2024, and the unemployment rate falling slightly to 4.2%. The number of vacancies also fell for the 25th consecutive period in May to July 2024, as uncertainty about the economic outlook means that firms were holding back on recruitment. The shortage of workers occurred for several reasons. Firstly, the number of people not working in the UK due to long-term sickness has risen to a new record. The ONS figures released in June 2024 showed that over 2.8 million people were not working because of health problems. Until 2020, figures had remained consisted but, post-Covid, a consistent increase has been seen in conditions related to mental health, particularly in the young. There was also a rising number of people having neck and back problems, potentially due to home working environments. The pandemic also seems likely to have been a major factor in the decision by more than 50,000 people of working age to retire, a change that goes against the previous recent trend of later retirement. The pandemic also caused some people to reassess their priorities, student numbers surged, with uncertainty and dire predictions of job losses encouraging more young people to stay on in full-time education. Finally, Brexit affected the number of foreign nationals available to work in the UK by signaling the end of free movement from the EU to the UK and the introduction of new immigration rules for EU citizens. Meanwhile, the pandemic triggered many foreign nationals to leave the UK for both economic and personal reasons. Getting people back to work is a key part of the government's plan to get the economy to grow again and address the shortage of workers that has affected many sectors. The latest figures show limited progress being made on this front. The inactivity rate - the key measure of people not in work – is now at 22.2%, a year-on-year increase of 0.8% and around 1.5% higher than before the pandemic. 1.4.4Wages and Income Although you might expect decreasing unemployment and growth in GDP to lead to people becoming richer, one of the strange features of the economic recovery prior to the Covid-19 pandemic was the static nature of average wages. Figure 3 - UK Average Weekly Earnings January 2000 – June 2024 (Source: ONS) Since the economic downturn of 2008-2009, wage growth had been slower than it had been, with the annual increase averaging 1.6% per year between 2009 and 2017. Given that inflation was higher than that for much of that period, many people found they were poorer than they were before the financial crisis, despite the economy recovering. Through 2017 and 2018, when adjusted for inflation, regular pay for employees increased by 1.4%, yet earnings in real terms were still lower than before the 2008/9 recession. The Covid-19 pandemic threatened wage stability and equality. Wages fell in cash terms and lower earners lost out the most, amidst a climate of unemployment inevitably rising when the furlough scheme was withdrawn, and companies started making redundancies. Without an increase in public spending on universal credit and other benefits, inherited wealth mitigated the decrease in earnings for those who received it, which in turn exacerbated income inequality. In June 2020, the official earnings data looked strong but were boosted by the pandemic-driven fall in the proportion of lower-paid jobs. Adjusting for these effects, underlying real wages rose by almost 2.0% in the year to Q1 2021. This was still a good outcome with the economy operating way below pandemic levels. It also stood in contrast to the previous recession which triggered a long squeeze on real wages. However, by 2023, the story looked very different. In the period December 2022 to February 2023, total pay adjusted for inflation (including bonuses) grew 3% while regular pay (excluding bonuses) grew 2.3%, far behind the spiralling rate of inflation; making this one of the largest falls in growth since records began in 2001. The cost-of-living crisis and soaring inflation rates led to a sharp decline in real term pay. This started to ease in the middle of 2023 and as inflation has reduced over the last 6 months to July 2024, real growth rates have increased on the year. The most recent data on annual average earnings growth shows the public sector outperforming the private despite having figures impacted by the NHS paying one-off bonuses in June 2023 throwing off the annual comparison. The public sector is showing strong at around 6%, though it is down 0.4% on the quarter, and the private sector is only seeing growth at 5.2%, with figures last lower back in May 2022. National Living Wage/ National Minimum Wage All workers in the UK are entitled to be paid at least the National Living Wage (for those aged 21 and over) and the National Minimum Wage (for those of at least school leaving age). The rates change on 1 April every year. A 16–17 Rate was introduced in 2004 and is currently £6.40. In 2010, the Apprentice Rate was introduced, currently also £6.40. There is a separate rate for 21–22-year-olds, which is £8.60, while those 23 and older are entitled to the full National Minimum Wage of £11.44. 1.4.5Housing market Most UK households are owner-occupiers and approximately one-third of household wealth is tied up in property. The value of that wealth has risen by almost 50% in the last ten years. Taking account of rising house prices and rental costs, the average homeowner enjoyed a return of roughly 8% a year in the last ten years, slightly less than the return from equities but much faster than earnings, which have risen by around 2% per year over this period. The housing market was one of the first sectors of the UK to be affected by the financial crisis, due to banks reducing their lending which, in turn, made it more difficult for buyers to arrange a suitable mortgage. In 2007, the average price of a UK home peaked. This was followed by a rapid fall in 2008; however, the market recovered in 2009 and since then has grown relatively steadily. Strong growth in the population, an increasing number of single person households and a collapse in house building added to the upward pressure on house prices. Look at the graph: Figure 4 – Annual house price rates of change, January 2006 to December 2023 (Source: ONS) After years of steadily increasing, the housing market began to tail off during 2018-19. Prices fell harder in London due to higher rates of stamp duty on more expensive properties and weaker demand from foreign buyers, but this was offset by modest gains in most other parts of the country. Brexit uncertainties and consumer worries about the economy compounded the problem and increased rates of stamp duty on additional homes, reduced tax reliefs and new regulations dented the attractiveness of buy-to-let properties. During the pandemic, housing prices rose significantly. The average price increased throughout 2020 by August 2022. The increase was primarily due to temporary suspension of stamp duty on property sales up to £500,000 from June 2020 until July 2021, and because many families were relocating to bigger properties in the countryside with larger gardens and more space to work from home. The Bank of England increased interest rates 13 times starting in December 2021 in a bid to curb inflation and, as a result, housing market activity became subdued. July 2023 saw the first decline in house prices after over a decade of sustained growth. Whilst a drop in house prices would generally be welcomed by first-time buyers, the high interest rates meant that mortgage costs were higher than many people looking to get on the housing ladder might have planned for. The housing market began to pick up over 2023-2024, with the most recent Halifax data revealing that the average house price was £291,268 in July 2024, up from £285,044 the previous summer. The typical UK house price increased by almost 81% from July 2012 to July 2024. Halifax predicts a modest upwards trend in the market through the remainder of the year based on data showing that mortgage rates have already dropped noticeably following the Bank of England cutting the interest rate to 5% in August 2024 and further cuts are expected. 1.4.6Savings and Investments Savings and investments are covered in more detail in Chapter 3. The value of savings and investments will vary according to the interest rate set by the Bank of England. This Bank Rate, also known as the base rate, is the most important interest rate in the UK. It influences the interest rates offered by other banks and changes in the rate pass through to the rest of the financial services industry. For example, if it costs more for a bank to borrow money, it will cost more to borrow from the bank, so a change in the Bank Rate can have a significant impact on financial products with an investment return based on interest rates. 1.4.7Credit Rating Growth in the economy can also have an impact on the international standing of a country. In the same way that an individual might be rated for credit, a country will also be rated, and this will affect the perceived security of investing in the government debt of that country. If the country is rated highly, then the government can issue bonds to borrow money at a reasonable price, but as the rating goes down the investment is perceived as riskier, and the government will have to pay higher interest on such bond issues to attract investment. The UK had a top AAA credit rating initially but Moody’s, which was the first major credit ratings agency to strip Britain of its top-notch AAA rating in 2016, currently rates the UK at Aa3, though it has improved its outlook from ‘negative’ to ‘stable’ from 20 October 2023. S&P Global Ratings changed the UK's credit rating outlook to 'stable' from 'negative' and affirmed the debt grade at 'AA' on 21 April 2023, citing stronger economic performance and expectations of more contained budget deficits over the next two years. Fitch's credit rating for the UK was revised in March 2024 and is currently AA- with a stable outlook. You can read an explanation of sovereign credit ratings here: https://www.investopedia.com/terms/s/sovereign-credit-rating.asp 1.5 2007-2008 Global Financial Crisis & the European Debt crisis 1.5.1Global Financial Crisis The term “Financial Crisis” is ever present in the media, but have you ever considered what this really means? Read this article: Financial Crisis: Q&A (UK) - Practical Law The ramifications of the 2007-2008 financial crisis were felt globally and demonstrated how interconnected financial institutions are internationally. The big lesson from 2008 was that the authorities need to move swiftly and in scale to counter a banking crisis. The response from the authorities in the US and Switzerland in 2023 in response to the demise of three US banks was much more forceful. 1.5.2US Lending A long-term US policy to promote home ownership meant that, during the mid-1990s, banks were encouraged to extend lending to low- and moderate-income families. Many of these families had poor or no credit history and previously would not have met the bank’s lending criteria. These ‘sub-prime’ mortgages therefore carried high interest rates to compensate the banks for the increased risk of default. From the 1990s the number of sub-prime mortgages on the market increased dramatically – in 2005, sub-prime mortgages accounted for 10% of all US outstanding mortgages compared to 1% in the early 1990s. The global nature of the financial system allowed sub-prime lenders to package up their sub-prime debt with other debt into collateralised debt obligations (CDOs) and sell this on the global financial market. Investors were keen to invest in these vehicles, which were granted high credit ratings from the agencies and yielded high returns. In 2007, problems with the repayment of sub-prime mortgages in the US, combined with falling house prices, triggered a global wave of concern about lending practices. Sub-prime debt had become bad debt, and as such was worthless. Due to the lack of transparency of CDOs, it was impossible to identify which banks had exposure to this debt, so the banks stopped lending to each other. This became known as the ‘credit crunch’. The European Central Bank injected €95bn into the Eurozone banking market to calm fears over the credit crunch. This was its single largest intervention in the banking market since the immediate aftermath of the 9/11 attacks on the US in 2001. 1.5.3UK Lending Between 2002 and 2007 the UK bank balance sheets had nearly tripled in value without a correlating tripling in value of deposits. The UK financial system had more debt attached to each asset than any other system. This made the UK particularly vulnerable to loss of confidence in the sector and to the withdrawal of credit when banks became unwilling to lend to each other. When concern about defaults in the US subprime loans sector caused the market for using securitised assets to secure lending dried up, many banks started to rely on short term (1-3 month) lending. When this stopped, these banks could not fund their mortgages and lending provisions. Northern Rock had aggressively increased its share of the UK mortgage market by offering competitive interest rates and high loan-to-value loans. Its lending was mainly funded by short-term borrowing which froze as banks stopped lending to each other. Without this borrowing, Northern Rock was not able to fund its business, and it had to approach the Bank of England for emergency funding. When news spread that Northern Rock was receiving emergency support, the share price plummeted 30% and consumer confidence fell dramatically. Concerned savers queued to withdraw an estimated £2bn. The Government recognised that the situation could potentially destabilise the entire financial sector and stepped in to guarantee all deposits. Northern Rock was nationalised in February 2008 and ultimately sold to Virgin Money. Around the same time, the investment banks in the US also began to face difficulties. The large US investment bank Bear Stearns was rescued by one of its rivals, JP Morgan Chase. This created fear that the collapse of one of Wall Street’s big players would send shock waves throughout the entire financial system. In September 2008, these ripple-effect fears further materialised. The US government stepped in to rescue two mortgage lenders, Fannie Mae and Freddie Mac, taking them into temporary public ownership. These lenders, which accounted for nearly 50% of outstanding mortgages in the US, revealed huge losses on the US sub-prime mortgage market. As 2008 progressed, it became clear that the firm most exposed was Lehman Brothers. With no willing buyer and a refusal by the US government to bail it out, the bank collapsed. On the same day, Merrill Lynch was bought by the Bank of America after revealing huge losses. Three of the five US investment banks were now gone. In the UK, share prices of the banks fell sharply and attention focused on those banks most vulnerable to the weakening market - Halifax Bank of Scotland (HBOS) and Royal Bank of Scotland. Both had to receive emergency funding from the Bank of England. As the crisis deepened, rumours that HBOS was still in trouble began to circulate. Fearing a run on the bank, the UK Government, together with the FSA and the Bank of England, sought the takeover of HBOS by Lloyds TSB. With a combined 28% share of the UK mortgage market, the Competition Commission would normally have rejected the takeover. However, the UK Government deemed that, given the financial crisis, the takeover was in the public interest and allowed it to proceed. 1.5.4Cost of the Crisis in the UK The UK government and particularly the Treasury were forced to step in, and the following actions were taken:  The Financial Services Compensation Scheme (designed to pay a portion of losses for consumer deposits, investments, insurance and mortgages on the failure of financial institutions) was increased from £30,000 to £50,000 of bank deposits to allay public fears and prevent a run on Northern Rock – it didn’t work! The limit is now £85,000. Lloyds Banking Group was recapitalised for £17bn (following the merger of Lloyds TSB & HBOS) and Royal Bank of Scotland for £20bn. Last resort loan facilities were granted to Northern Rock. A new framework for bank insolvency was created with the introduction of the Banking Act 2009. Treasury liquidity schemes were introduced, providing guarantees on short- to medium-term debt issued by banks commercially for a fee. The Bank of England swapped high quality but temporarily illiquid assets on balance sheets for more tradable ones – providing liquidity. An asset purchase facility was provided and administered by Bank of England in March 2009. 1.6 Brexit and its Impact in the UK A UK referendum was held in 2016 to decide whether the UK should leave or remain in the European Union. More than 30 million people voted, and the ‘Leave Europe’ campaign won by 51.9% to 48.1%. Scotland voted to remain in the EU by 62% to 38%. The UK left the EU on 31 January 2020, but leaders had until the end of 2020 to work out a trade deal. The trade deal was reached on Christmas Eve 2020 after months of fraught talks. It avoided the disruption of a no-deal Brexit in the middle of the Covid-19 pandemic and marked a new era after more than 40 years of UK membership of the European Union. It meant that the UK and the EU could continue to trade without extra taxes being put on goods. The full complicated agreement was more than 1,246 pages long, but here are some of the key points: 1.6.1Trade There are no extra charges on goods (tariffs) or limits on the amount that can be traded (quotas) between the UK and the EU. However, there are additional checks at borders, such as safety checks and customs declarations. 1.6.2Immigration The UK introduced a new points-based system for foreign citizens (except Irish nationals) wanting to move to the UK. It treats EU and non-EU citizens equally and aims to attract people who can contribute to the UK economy. To qualify for a visa, migrant workers who want to move to the UK must qualify for 70 points. Having a job offer from an approved employer for a skilled job earns 40 points. Being able to speak English gives another 10 points. The applicant can achieve the remaining 20 points if they are due to be paid at least £25,600 a year. They can also gain extra points for having better qualifications (10 points for a relevant PhD, or 20 points for a PhD in science, technology, engineering, or maths) or an offer of a job in which the UK has a shortage (20 points), even if it doesn't pay as much money. 1.6.3Security The UK lost access to some very important EU databases but continues to have access to others, including the system which cross-checks fingerprints across the continent. But overall, security co-operation between the UK and the EU is no longer based on "real time" access. In some cases, such as access to data on which flights people take, data will only be made available under much stricter conditions. 1.6.4Fishing The UK has become an independent coastal state and can decide on access to its waters and fishing grounds. The value of the fish caught by the EU in UK waters will be cut by 25% (the UK had originally asked for 80%). The cut will be phased in over a period lasting 5.5 years, which is a lot shorter than the EU initially asked for. Once this transition is over, the UK will fully control its waters and could make much deeper cuts. 1.6.5'Level Playing Field' Level playing field measures were agreed which committed both the UK and the EU to maintain common standards on workers' rights post Brexit, as well as many social and environmental regulations. The measures do not have to be identical, so the UK does not have to follow EU law, but they do have to protect fair competition. 1.6.6Travel UK nationals now need a visa for stays of longer than 90 days in the EU in a 180-day period, and there are extra border checks for UK travellers. UK travellers will still be able to access emergency healthcare in the EU. The UK and EU agreed to co-operate on "fair and transparent rates for international mobile roaming" but there’s nothing to stop UK travellers being charged for using their phone in the EU, and vice versa. 1.6.7Northern Ireland The UK’s departure from the EU created a problem by introducing the need for checks on goods traded across the border between Northern Ireland and the Republic of Ireland. Boris Johnson, then Prime Minister, agreed the Northern Ireland Protocol which introduced checks at Northern Ireland’s ports, rather than at the Irish border. This therefore applied to goods travelling from Great Britain to Northern Ireland, even where the goods were destined to remain in Northern Ireland and not travel on to the Republic of Ireland. Furthermore, some EU laws still applied to Northern Ireland, although Northland Ireland’s Assembly had no way of influencing them. The Protocol also led to additional costs and delays for businesses. This agreement met contempt from Unionists who argued that they created, in effect, a border between Northern Ireland and the rest of the UK. As a result, the Democratic Unionist Party withdrew their first minster from the Northern Irish Assembly. The Windsor Framework was agreed in February 2023 and became operational from October 2023. There are two lanes for goods arriving into Northern Ireland from the rest of the UK: a red lane for goods which may be sent on to the EU, and a green lane for those destined to remain in Northern Ireland. Those goods travelling in the green lane do not require the same checks and paperwork as those travelling through the red lane. 1.7 Post-Brexit trade deals with other countries Before Brexit, the UK was automatically part of any trade deal that the EU had negotiated with another country. The EU had about 40 trade deals covering more than 70 countries at the time the UK left. Any existing EU agreement that was not rolled over ended on 31 December 2020, meaning that trade continued on World Trade Organization terms until a deal could be reached. This meant that importers faced tariffs and extra paperwork. Since leaving the EU, the UK has made deals to continue trading in the same way with the vast majority of countries. 1.8 Global Economic Environment It is important to have a grasp of the global financial environment as well as the UK environment as some of your clients and their businesses will interact internationally. You may want to look at the current economies of specific countries: https://www.focus-economics.com/countries Recent factors affecting economies worldwide include: 1.8.1Geo-political risk Tensions in the Middle East and the conflict in Gaza coincide with a full-scale war in Ukraine and the resurgence of superpower competition, with the West at loggerheads with Russia and, increasingly, China. The Economist Intelligence Unit estimates that 75% of countries are threatened economically by international tensions today, up from about half in 2010. Military spending is on the rise across the world. The US and China increasingly vote on different sides in the UN. A near tripling in the number of countries subject to western financial sanctions since 2010 testifies to growing international discord. UK chief financial officers responding to the Deloitte CFO Survey say that geopolitics poses the greatest risk to their businesses over the next 12 months, eclipsing worries about inflation and interest rates. Geopolitical shocks are not necessarily economic shocks, at least at a global level. The effects on the local economy, as in Ukraine or Gaza, can be devastating. Surrounding countries may also be affected, as has been the case with Egypt, where revenues from tourism and the Suez Canal have been hit by the conflict in Gaza. But the impact beyond the region may be limited. The 9/11 terrorist attack was one of the greatest geopolitical shocks of the post-war period. It triggered invasions of Afghanistan and Iraq, lengthy wars and major political changes in the Middle East. Yet it had little lasting economic impact on the West. Contrast this with the impact on Europe of Russia’s invasion of Ukraine. Here energy and other commodity prices and the curtailing of Russian gas exports were the mechanism that turned the invasion into an economic crisis for Europe. The result was high inflation and a weakening of activity, particularly in Germany. Geopolitical shocks that affect supply, prices or trade have the greatest capacity to wreak wider economic damage. Examples include Houthi attacks on shipping in the Red Sea, potential disruption to semi-conductor exports from Taiwan or the control of rare earth metal exports. Financial markets provide another channel through which geopolitical shocks can cause economic damage. Abrupt movements of mobile capital weaken currencies, cause de-stabilising fluctuations in equity and other financial markets and affect the supply of liquidity and credit. Emerging economies are more vulnerable to such effects than advanced economies, though the latter are not immune. In one key respect things have improved. The world is better placed to deal with disruption to energy supply than in the past. Energy markets are more efficient, integrated, and contestable than they were in the 1970s. Shale fracking has led to a huge increase in US energy production, weakening OPEC’s hold over supply. Consumer nations now have petroleum reserves that can be used to protect against shortages. Renewable energy production is rising. All these factors, along with huge levels of government subsidies, mean that the economic fallout from energy following Russia’s invasion of Ukraine was far less severe than had been feared (at the time a severe recession seemed quite likely.) Europe switched remarkably quickly from Russia to imported liquefied natural gas from the US, the Middle East and Australia. Systems and economies are adaptable and responsive. In many respects they have proved surprisingly resilient in the face of the multiple shocks of the last decade or so. Geopolitical risk is unlikely to abate. 1.8.2Hamas attacks on Israel The Gaza Strip is a 41km (25-mile) long and 10km-wide territory between Israel, Egypt and the Mediterranean Sea. Previously occupied by Egypt, Gaza was captured by Israel during the 1967 Six-Day War. Home to 2.2 million people, it is one of the world's most densely populated places. Just over three-quarters of Gaza's population are registered refugees, or descendants of refugees, the UN says. Israel and the Palestinian group Hamas have been at war since early October 2023. It began when Hamas gunmen launched an unprecedented attack on Israel from Gaza, the deadliest in Israel's history. An Israeli military campaign followed, which killed thousands in the Palestinian territory. Hamas is the sole ruler of Gaza; it has an armed wing and was thought to have about 30,000 fighters before the start of the war. The group, whose name stands for Islamic Resistance Movement, wants to create an Islamic state in place of Israel. Hamas rejects Israel's right to exist and is committed to its destruction. Hamas justified its attacks as a response to what it calls Israeli crimes against the Palestinian people. Hamas is considered a terrorist group by Israel, the US, the EU, and the UK, among others. Iran backs Hamas with funding, weapons and training. The UN and aid agencies say Gaza is suffering severe shortages of food and other essentials including fuel and medicine. This is particularly acute in northern Gaza, where it is especially difficult to deliver aid which enters the territory from the south. A UN-backed report says the situation across Gaza is turning into a man-made famine and a number of children have starved to death in northern Gaza. Humanitarian agencies and Israel have blamed each other. Agencies say Israeli security checks on aid going into Gaza are complex and arbitrary, causing major delays. Israel denies impeding aid and says agencies are failing to distribute the aid that is allowed in. Hamas wants an end to the war, for Israeli troops to withdraw from Gaza, for displaced people to return to their homes and an influx of aid. Israel says it cannot allow Hamas to remain in control of Gaza and wants hostages released in return for a temporary pause in fighting. There was a 6-day temporary truce in November 2023, but further ceasefire proposals from Egypt and Qatar May 2024, and the United States’ peace plan in June 2024, have been unsuccessful in bringing parties to the negotiating table. Hamas has viewed each of these proposals favourably, but Israel is firm on their stance that any plan that doesn’t involve eliminating Hamas’ capacity to govern is a non-starter. The future of the West Bank and East Jerusalem is one of the most difficult issues of the Israel-Palestinian conflict. An internationally backed plan for peace is known as the "two-state solution". It would mean an independent Palestinian state in the West Bank and Gaza, with East Jerusalem as its capital. This Palestinian state would exist alongside Israel. The idea of a two-state solution has never been officially advocated by Israel, and Prime Minister Bejamin Netanyahu has repeatedly stated his opposition to it. He says Israel must retain full security control over the West Bank and Gaza. The International Criminal Court's chief prosecutor has sought arrest warrants for Prime Minister Netanyahu in May 2024 alongside Hamas's leader, Yahya Sinwar, for alleged war crimes and crimes against humanity in Gaza. 1.8.3War in Ukraine In February 2022, Russia invaded Ukraine in a major escalation of the Russo-Ukrainian War that began in 2014. Economic damage from the conflict contributed to a significant slowdown in global growth in 2022, a severe double-digit drop in GDP for Ukraine and a large contraction in Russia, along with worldwide effects through commodity markets, trade, and financial channels. Even as the war reduced growth, it added to inflation. Fuel and food prices increased rapidly, with vulnerable populations, particularly in low-income countries, most affected. The number of individuals experiencing acute food insecurity shot up in 2022 to 345 million from 135 million in 2019. Elevated inflation complicated the trade-offs central banks faced between containing price pressures and safeguarding growth. Interest rates started to rise as central banks tightened policy, exerting pressure on emerging market and developing economies. The invasion contributed to economic fragmentation as a significant number of countries severed commercial ties with Russia and risked derailing the post-pandemic recovery. It also threatened the rules-based frameworks that had facilitated greater global economic integration and helped lift millions out of poverty. In addition, the conflict added to the economic strains wrought by the pandemic. Meanwhile, lockdowns in key manufacturing and trade hubs in China also compounded supply disruptions elsewhere. An international peace summit was held in June 2024, featuring representatives from 92 nations and 8 international organisations, with the aim to increase international pressure on Russia to force it to the negotiating table. Russia was not invited to participate and instead issued its own peace proposal; with conditions dubbed by the Ukranian president as ultimatums on par with what Hitler did to Czechoslovakia. As the war drags on, more Ukrainians are becoming open to peace talks, but Russia’s impossible demands are being seen as the biggest obstacle currently. 1.8.4Banking crisis Just as the global economic outlook started to improve in 2023, three mid-sized US banks failed in less than a fortnight, and Credit Suisse was fast tracked into a takeover by UBS. This represented the most challenging moment for the banking system since the early days of the financial crisis in 2008. A combination of rising interest rates and slowing growth were testing the financial system. The demise of Silicon Valley Bank (SVB), America’s 16th largest bank, on 9 March was the biggest bank failure since the 2008 financial crisis. The tech companies who were its main customers, facing a more difficult climate, had sought to draw down on their facilities. To meet demand for cash SVB was forced to liquidate holdings of US mortgage-backed securities at a loss, raising the possibility that the bank would be unable to fulfil its commitments. Investors took fright and rushed to withdraw their funds, forcing the regulator to take control. In the age of digital bank accounts, where rumours spread like wildfire across the internet, bank runs can happen very quickly. Faced with a crisis, and the risk that other regional banks could come under pressure, the US authorities reacted forcefully. The major US banks also stepped in and deposited $30bn with First Republic Bank, though this later entered administration and was bought by JPMorgan Chase. The banking sector is more tightly regulated than it was 15 years ago in 2008. Banks are better capitalised, run higher levels of liquidity and have been subject to rigorous stress tests to gauge their ability to cope with shocks. Financial markets initially interpreted the banking turmoil as a deflationary shock that would slow growth and reduce the need for central banks to raise interest rates. The standard response of central banks to financial shocks is to loosen, not tighten policy. This created a dilemma for central banks however as inflation remained far too high and therefore rate rises continued. 1.9 UK political landscape 1.9.1General Election The UK is divided into 650 areas, called constituencies. Each of these elects an MP to represent local residents in the House of Commons. On election day, registered voters in each constituency vote for their preferred candidate in their local polling station or some people vote by post in advance. Each person has one vote. Most candidates represent a political party, but some stand as independents and the United Kingdom uses the "first past the post" system, meaning that the candidate who gets the most votes becomes the MP for that area. The General Election that took place on 4 July 2024 saw Labour win 412 seats, 211 more than they had previously, and clearing the required 326 seats for a working majority. The results in Scotland were particularly surprising; Labour went from having 1 seat to 37 of the 57 available and the SNP dropped to 9 seats from their previous 48. 1.9.2Brexit As the UK pulled out of the single market and customs union in 2021, companies trading with the EU faced new rules, new paperwork and new checks on some goods. That prompted fears over what would happen to the £550bn of trade between the UK and its nearest trading partner. There was an initial dip in the amount the UK exported to the EU but, once the teething problems were dealt with, trade volumes, recovered to pre-pandemic levels, according to official figures. 1.9.3Decline of union power Fifty years ago, trade unions wielded greater influence and could collectively bargain for increased wages and improved benefits. Today, membership of trade unions has declined significantly, leaving workers to negotiate at an individual level or find new jobs with higher pay. With the decline of union powers comes the rise of company power, evident by the rising profits that far outmatch the rise in wages. However, in 2023, the UK experienced its greatest number of labour strikes in more than a decade with striking rail workers, teachers, NHS workers, barristers and postal workers. The NHS strike action is estimated to have cost the NHS upwards of £1.5 billion, proving the effectiveness of striking with staff receiving both a pay rise and a lump sum. 1.9.4Scottish independence In September 2014, Scotland held a referendum to determine the question: “Should Scotland be an independent country?”. The country voted against indepdenance, with 55% of the votes cast in favour of staying in the UK. At the time, the Scottish National Party claimed that the vote was a once in a generation event, and that a result against independence would not be questioned by continuous moves for a second referendum. However, with Scotland voting 62% in favour of remaining in the EU during Brexit, it was argued that a second referendum should take place, given the dramatic change in political circumstances now facing the Scottish population. In 2022, the Scottish Government drafted, but did not formally introduce, a Bill to hold a second referendum on independence. This was referred to the United Kingdom Supreme Court by Lord Advocate Dorothy Bain KC, the Scottish government's top law officer, to determine if Holyrood had the power to pass legislation for a referendum without the consent of the UK government. She said the issue was of "exceptional public importance" and asked the UK's top court to provide a definitive ruling. In a unanimous judgment, the Supreme Court ruled that the Scottish Parliament did not have the power to legislate for a referendum on independence without the agreement of Westminster. In advance of the 2024 General Election, the SNP released their manifesto which doubled down on their push for a second referendum. In response, now Prime Minister Starmer said he would refuse to participate in negotiations for another referendum with the SNP, even if they won a majority of the seats. Following Labour’s emphatic victory in Scotland in the General Election, the SNP party has declared it needs a period of soul searching and the results show that Scottish voters were no longer prioritising independence. 1.9.5Scottish National Party The Scottish National Party (‘SNP’) is a powerful political party. It is seen as the face of the Scottish independence cause and, as a result, large numbers of people donate to and become paid-up members of the party that they hope will deliver independence. The party raised £666,953 between 2017 and 2020 for independence referendums that never happened. Donors had been assured that the cash would be ring fenced to campaign in a future vote on leaving the UK. However, in subsequent years, the audited financial accounts issued via the Electoral Commission revealed much less money in the bank and in 2021, the SNP's national treasurer quit after only being in post for a few months, claiming he was not given enough information to do the job, 1.9.7.1 Operation Branchform Complaints about the missing money were received by Police Scotland who launched an investigation into the SNP finances, known as Operation Branchform, in June 2021. Peter Murrell, the former SNP chief executive and husband of Nicola Sturgeon, was arrested in April 2023. The party's treasurer, Colin Beattie, who had overseen the SNP's finances for almost two decades, was detained two weeks later before stepping down. Finally, in early June, Nicola Sturgeon was arrested and questioned. All three were released without charge pending further investigation. As part of the investigation detectives seized a £110,000 motorhome from the driveway of Mr Murrell's elderly mother which was confirmed to be owned by the party. Operation Branchform continued throughout the summer of 2023, with Police Scotland defending the timescale as necessary given the complexity of the investigation. Scotland’s chief constable also revealed in late July that the investigation had moved beyond the initial allegations into potential embezzlement and misuse of funds. In April 2024, Peter Murrell was charged with embezzlement after further questioning by officers investigating the funding and finances of the party and was subsequently released from police custody. In June 2024, it emerged that around £450 million in funds allocated to Scotland by the European Commission had not been claimed by the SNP. The funds were allocated to ensure devolved administrations had the funds necessary to achieve the Commission’s objectives, such as improved transport, regeneration of industrial areas, and training programmes to help poorer areas and reduce inequalities. The current unclaimed funds are approximately 28% of the total funds allocated to Scotland. If you want to read more, see: https://www.bbc.com/news/articles/ce55zm8z402o Leadership In February 2023, Nicola Sturgeon unexpectedly announced her intention to retire. Accordingly, the SNP held their first leadership contest in 20 years. which became mired in controversy when it emerged that the candidates were not given access to how many members were eligible to vote. The party had previously denied a newspaper report claiming it had lost 30,000 members in recent years but after a humiliating climbdown the SNP finally conceded the story was true. In March 2023, Humza Yousaf narrowly defeated Kate Forbes in the leadership contest and became First Minister. Ten days later he had to announce that the SNP had failed to disclose that it did not have any auditors; the accountants, Johnson Carmichael, that had worked for the SNP for a decade had resigned the previous year. The party appointed AMS Accountant Group as auditors in May 2023. In June 2023, AMS highlighted an issue with SNP accounts due to missing documents about membership fee donations, and issued a qualified audit opinion on the 2022 accounts. In April 2024, Hamza Yousaf ended the Bute House Agreement, a power-sharing deal with the Scottish Greens, following a backlash over the SNP scrapping 2030 climate targets and gender policies. Mr Yousaf was struggling to secure support to lead a minority government and opposition parties tabled two confidence votes - one in the first minister and another in the SNP government. Mr Yousaf resigned as leader having held the position for just over one year, saying that he had "underestimated" the level of hurt after ending the deal with the Greens. John Swinney was sworn in as the seventh first minister of Scotland in May 2024. He appointed Kate Forbes, who, after discussions with him, declined to challenge him for the SNP leadership. 1.10The US 1.10.1Economy The US economy is dominated by services-oriented companies; large US corporations also play a major role on the global stage, with more than a fifth of companies on the Fortune Global 500 coming from the United States. Even though the services sector is the main engine of the economy, the US is the second largest manufacturer in the world and a leader in higher-value industries such as aerospace, telecommunications and chemicals. Meanwhile, agriculture represents less than 2% of output but large amounts of arable land, advanced farming technology and generous government subsidies make the US a net exporter of food and the largest agricultural exporting country in the world. The US economy maintains its powerhouse status through a combination of characteristics - the country has access to abundant natural resources and a sophisticated physical infrastructure. It also has a large, well-educated and productive workforce. Moreover, the physical and human capital is fully leveraged in a free-market and business-oriented environment. The US is enjoying an economic boom. US President Joe Biden's economic policies are changing the country’s landscape. Since February 2021, just after his inauguration, monthly investment in factory construction has more than trebled, to almost $20bn (£16bn). Mr Biden is spending huge amounts of money to bring the manufacturing of green industries and microchips back to the US from China. In March 2024, it was announced that Intel would receive $24b in funding and up to $25b in tax credits, and that TSMC, Samsung, and Micron would also receive $6b in grants each. The most immediate challenge of the US economy is the stubbornness of inflation and the risk of high government debts becoming entrenched. 1.10.2Borrowing The US is borrowing hundreds of billions of dollars to pay for the investment in manufacturing. There are concerns that this could push US inflation higher again just as price rises are beginning to slow and there are fears that the country is building up too much debt. In 2023, the US annual deficit is around 6.3% of the size of the economy, well above the historical average of 3.7%. US national debt is now $35.27 trillion and as a proportion of GDP, it is expected to reach an all-time high at the end of the next presidential term. The costs of the pandemic, military aid, tax giveaways as well as the borrowing to fund green investments, have all contributed. Just paying the interest on this debt at current rates will cost the US more than it spends on defence, $875bn. In a decade, the combination of debt interest with mandatory government spending on Medicare, Medicaid and social security will eat up all US tax revenues, leaving nothing for anything else. 1.10.3Unemployment Following the end of the pandemic, unemployment in the US reached its lowest rate for 50 years with hundreds of thousands of new workers joining the workforce every month, defying all expectations. However, the unemployment rate has slowly been ticking up throughout 2024 and now sits at 4.3%, its highest since October 2021. 1.10.4Cost of living Prices remain high. Families are depending on their credit cards. This is an industrial boom, taking place in factories and not something people have noticed in their everyday lives. Prices are still rising by more than expected which means that interest rates are staying high. The cost of borrowing in the US is currently at its highest level for 22 years as the US central bank tries to slow inflation. 1.10.5Credit rating Last year, the US lost two of its three AAA credit ratings, and the Treasury, the Federal Reserve and the IMF all said that its fiscal trajectory is "unsustainable". 1.10.6The future The US is not going to go bankrupt. Its stability means the dollar is the world’s reserve currency, it is accepted around the world and seen as a safe investment in troubled times and so the US benefits from a seemingly endless flow of cheap money, supporting the economy. But the US is now really testing whether there are limits to the patience of some investors. 1.10.7 US Presidential election The 2024 United States presidential election is to take place on November 5, 2024. Voters will elect a president and vice president for a term of four years. Incumbent President Joe Biden, a member of the Democratic Party, has stepped down and has been replaced on the Democratic ticket by Kamala Harris. Former President Donald Trump, a member of the Republican Party, is running for re-election to a second term. Both candidates compete to win electoral college votes. Each state has a certain number of electoral college votes partly based on its population and there is a total of 538 up for grabs, so the winner is the candidate that wins 270 or more. This means voters decide state-level contests rather than the national one, which is why it is possible for a candidate to win the most votes nationally, like Hillary Clinton did in 2016, but still be defeated by the electoral college. All but two states have a winner-takes-all rule, so whichever candidate wins the highest number of votes is awarded all of the state's electoral college votes. Most states lean heavily towards one party or the other, so the focus is usually on a dozen or so states where either of them could win. These are known as the swing states. A NYT/Siena survey published in May 2024, showed that Donald Trump led Joe Biden in every swing state except for Michigan. Following Biden stepping down, August 2024 polls on these ‘battleground states’ now see Harris leading either leading or having closed the gap to within 1 or 2 points of Trump. 1.10.8Trump’s criminal charges In the entirety of US history, no president or former president has ever been indicted. That changed in 2023 when former President Trump was charged in four criminal cases for his conduct before, during, and after his term. The indictments were: The ‘Classified Documents’ case In June 2023, Trump was indicted for taking highly sensitive national security documents when he left the White House, obstructing government attempts to retrieve them, and showing them to individuals not authorised to see them. This was initially scheduled for trial on 20 May 2024 but, Trump appointed District Judge, Ailen Cannon, postponed it indefinitely then ordered the case dismissed after concluding that special counsel Jack Smith, who was leading the prosecutors, had been appointed unconstitutionally. The ruling is currently being appealed to the 11th Circuit Court of Appeals. The ‘Hush Money’ Case In August 2023, Trump was indicted with conspiracy to defraud the US, conspiracy to obstruct an official proceeding, obstruction of and attempt to obstruct an official proceeding, and conspiracy against rights for falsifying business records with the intent to conceal an underlying crime. The dramatic 6 weeks of trial began on 15 April 2024. A gag order was imposed on Trump, restricting him for publicly commenting on people involved in the case. He violated this order 10 times, was held in criminal contempt twice, fined $10,000, and eventually threatened with jail time. The trial concluded on 30 May 2024 with Trump being found guilty on all 34 charges, making him the first president to become a convicted felon. The case has been appealed. The ‘Federal Election Interference’ Case Also in August 2023, Trump was indicted on obstructing an official proceeding, conspiracy to defraud the United States and conspiracy against rights for his actions leading up the January 6th riots. This was initially set to go to trial on 4 March 2024 but, after attempts to dismiss the case on various grounds, the case was delayed, and trial called off, so that the Supreme Court could rule on his ‘novel argument’ that former presidents are immune from criminal charges in relation to their conduct as president. On 1 July 2024, the Supreme Court ruled that presidents have “absolute immunity” from charges stemming from their “core constitutional powers” and “presumptive immunity” for all other acts. An updated indictment was filed on 27 August 2024 complying with the Supreme Court’s ruling. The District Judge must now rule on whether any of the charges can move forward or if Trump is immune. The ‘Georgia Election Interference’ Case. Again, in August 2023, Trump was indicted on 10 counts in Georgia for attempting to unlawfully change the outcome of the 2020 election. This has faced a year’s worth of delays as well with the latest appeal expected to be heard in March 2025 and no further action can be taken in the Trump case until it is settled. Trump’s campaign has repeatedly claimed that the cases are all witch hunts and are part of an election interference conspiracy specifically targeted at him. He has employed as many stalling strategies as possible to delay each trial until after the upcoming elections, with the consensus being that, if he does become president, he will appoint Department of Justice officials who will have any unresolved cases dropped. Given the current state of play, this could see three of the four cases not proceed any further. 1.11China Since China began to open up and reform its economy in 1978, GDP growth has averaged over 9% per year, and more than 800 million people have lifted themselves out of poverty. There have also been significant improvements in access to health, education, and other services over the same period. For decades the Chinese economy expanded at a stellar rate, with official figures putting its gross domestic product (GDP) growing at an average of close to 10% a year. On the way it overtook Japan to become the world's second largest economy, with Beijing claiming that it had lifted hundreds of millions of people out of poverty. China is now an upper-middle-income country. Although it has eradicated extreme poverty, a significant number of people remain vulnerable, with incomes below a threshold more typically used to define poverty in upper-middle income countries. China’s high growth based on investment, low-cost manufacturing and exports has recently largely reached its limits and has led to economic, social, and environmental imbalances. Reducing these imbalances requires shifts in the structure of the economy and the challenge going forward is to find new drivers of growth while addressing the social and environmental legacies of China’s previous development path. Given its size, China is central to many regional and global development issues. Although not the main source of historical cumulative emissions, China today accounts for 27% of annual global carbon dioxide and a third of the world’s greenhouse gas emissions and its air and water pollution affects other countries. Global environmental problems cannot be solved without China’s engagement. China’s growing economy is also an important source of global demand. Its economic rebalancing will create new opportunities for manufacturing exporters, though it may reduce demand for commodities over the medium-term. China is a growing influence on other developing economies through trade, investment, and ideas. 1.11.1Recovery Beijing says that last year the economy grew by 5.2%, however some critics argue the real figure could be less than a third of that. Premier Li Qiang announced that China has set an ambitious growth target of around 5% for this year, as he outlined a series of measures aimed at boosting its flagging economy. A series of other measures to help tackle the country's slow recovery from the pandemic were also announced, including the development of new initiatives to tackle problems in the country's crisis-hit property sector. Beijing also aims to add 12 million jobs in urban areas. Research will be stepped up in new technologies, including artificial intelligence and life sciences. Along with measures to boost the economy, defence spending will be increased by 7.2% this year. Beijing's defence budget is closely watched by its neighbours and the US, due to concerns over its intentions as tensions remain high over Taiwan. While much of the rest of the world has struggled with soaring prices in the wake of the pandemic, China was one of the few major economies to avoid high inflation. Now it is having to deal with the opposite problem - persistently falling prices or deflation. Consumer prices in China fell in January at the fastest pace in almost 15 years, marking the fourth month in a row of declines. Deflation is bad for economies as people keep putting off buying big ticket items, like washing machines or cars, on the expectation that they will be cheaper in the future. It also has an impact on people and businesses with debts. Prices and incomes may fall, but debts do not. For a company with falling revenue, or a household with a declining income, debt payments become more of a burden. All of this means that China is lacking confidence. And authorities have been scrambling to reassure investors and consumers. Borrowing costs have been cut and direct support offered to developers along with other actions to tackle the property crisis. Earlier this month, the head of China's stock market regulator was replaced, in what was seen as a signal that the government was ready to take forceful measures to end the rout in its $8 trillion stock market. "The demographic dynamics are quite unfavourable, with the population aging fast due to the one-child policy," Qian Wang, chief Asia-Pacific economist at investment firm Vanguard said. "Unlike Japan that got rich before it got old, China is getting old before it gets rich," she added. There is also the ongoing trade dispute with the US, which started in 2018 under then-president Donald Trump and has shown no sign of easing during the Biden/Harris administration. 1.12India With 1.4 billion people, India is the world’s most populous country. From the near financial bankruptcy of the early 1990’s, India has transformed itself. It was forecast to be the fastest growing major economy in 2020 and one of the top three economic powers of the world over the next 10-15 years, backed by its strong democracy and partnerships. The Bharatiya Janata Party is the ruling political party and numerous foreign companies are setting up their facilities in India on account of the various government initiatives that have been introduced. The Prime Minister of India, Narendra Modhi launched the ‘Make in India’ initiative in 2014 to ‘turn India into the world’s factory’. It aimed to boost the manufacturing sector of Indian economy and to increase the purchasing power of an average Indian consumer, which would further boost demand and hence spur development, in addition to benefiting investors. In 2020, his government doled out $25bn in incentives to companies across sectors from semi-conductors to mobile electronics to enhance India's manufacturing capabilities. The likes of Foxconn, which makes iPhones for Apple, are moving their supply chains to India as part of the global "China plus one" diversification strategy. Other major global giants like Micron and Samsung have also been enthused to invest. But the numbers are not significant yet. 1.12.1Recovery India's growth is outpacing other major economies, its banks are strong, and the government's finances are stable despite a painful pandemic. India surpassed the UK as the fifth largest economy last year and according to analysts at Morgan Stanley, it's on track to overtake Japan and Germany and hit the third spot by 2027. Mr Modi's push for digital governance has begun to transform the lives of some of the country's poorest people. Today, Indians in the remotest corners of the country can buy many daily goods without cash, paying as little as 20p for a packet of bread using a QR code on their phone. Underpinning this digital revolution is a three-layer system of governance, which includes universal identity cards, a payments infrastructure that enables click-of-a-button money transfer, and a data pillar that gives people access to crucial personal documents like tax returns. Linking hundreds of millions of bank accounts to this "digital stack" has cut red tape and corruption, allowing the government to dole out a volley of social subsidies, cash handouts and also spend on infrastructure building, without running high deficits. But Mr Modi's policies haven't delivered for all. The brutal lockdowns imposed during the pandemic, the lingering after-effects of a cash ban in 2016, and faulty implementation of a new goods and services tax have had far-reaching structural consequences on India's economy. The country's vast unorganised sector, small enterprises that form the backbone of India, are still reeling under the impact of some of these decisions. And the private sector is not committing big investments. As a proportion of GDP, private investments slumped to barely 19.6% in 2020/21 from a peak of 27.5% in 2007/08. Manufacturing's share as a percentage of GDP has remained stagnant in the last decade despite these efforts. Growth in exports was also faster under Mr Modi's predecessors. Lack of a large-scale industry means half of India's population still depends on agriculture for their livelihoods, which is increasingly becoming unprofitable. At 3%, the growth in overall private consumption expenditure - the money people spend on buying things - is the slowest in 20 years. And household debt has touched an all-time high, even as financial savings plunged to their lowest levels, according to new research. Many economists argue that the nature of India's economic growth post pandemic has been uneven, or "K-shaped" - where the rich have thrived, while the poor continue to struggle. India may be the fifth largest global economy at an aggregate level, but on a per person basis, it still languishes at the 140th rank. And inequality has widened to a hundred-year high according to research from the World Inequality Database. 1.12.2Job market India's large young, low-paid, English-speaking population should have given it an economic advantage over other Asian economies and driven growth in exports of financial and technological services. But India's jobs crisis is real. The share of educated youths among all unemployed people increased from 54.2% in 2000 to 65.7% in 2022 according to latest figures by the International Labour Organization. There's also been no significant growth of real wages in India since 2014, according to numbers computed by noted developmental economist Jean Dreze. India "risks squandering its demographic dividend", the economic growth potential from a big working-age population, the World Bank's regional economist said in an interview to the Financial Times recently. 1.12.3India's decade? For all India’s problems, the country is on the runway for take-off, say experts. "India's next decade could resemble China's path (of hyper growth) from 2007 through 2012," analysts from Morgan Stanley wrote in a widely discussed paper. They add that the country has many advantages - a young demographic, the geopolitics of global de-risking from China and a clean-up of sectors like real estate. Other megatrends like digitalisation, a transition to clean energy and growth in global offshoring will propel future growth, say experts. The infra push is also something that will have long-term payoffs. By making improvements in roads, power supply and turnaround time at ports, India is finally "creating an environment in which manufacturing can flourish", says DK Joshi, CRISIL's India economist. 1.12.4 2024 Election 969 million citizens were eligible to cast their ballot in the marathon 2024 seven-week election, hailed as a "world record" by election authorities. To give you an idea of the scale of it, this is the equivalent of adding together the populations of the US, Russia, Japan, Britain, Brazil, France and Belgium. Nearly half of the voters were women. Prime Minister Modi won a third consecutive term in a much tighter general election than anticipated. The BJP won 240 seats in the election, several seats short of the 272 required to get a majority in India's 543 member parliament. However, two key BJP allies, the Telugu Desam Party (TDP) and the Janata Dal (United) (JD(U)), won 16 and 12 seats each in their respective states, pushing the NDA comfortably over the half-way mark. The results were a personal blow to Mr Modi, who had always secured majorities in elections as both chief minister of Gujarat state and India’s prime minister, and dominated the country's politics for a decade. 1.12.5 Risks Geopolitical tensions and weather-related shocks remain key risks to India’s economic outlook. 1.13The Environment The climate and biodiversity crises pose many threats to the economy. Climate change is caused by the emission of greenhouse gases, including carbon dioxide and methane, into the atmosphere. These gases trap heat from the sun leading to an overall increase in the earth’s temperature. The largest driver of climate change is the burning of fossil fuels – coal, oil and gas. The biodiversity crisis refers to a loss of variety in the species present on earth. It includes the extinction of species as well as the decline of species which are not extinct. It is driven by a vast range of human activities, such as construction, deforestation, hunting and overfishing, and pollution. Climate change also plays a huge role in the biodiversity crisis as species cannot evolve quickly enough to cope with new climatic conditions. The effects of these twin crises are all pervasive for society and the economy. Some of the most significant impacts include food insecurity, more frequent and more intense extreme weather, changes to weather patterns such as rainfall, and rising sea levels. The implications for the economy are complex. Some sectors are particularly hard hit by certain effects, for example the agriculture and tourism industries are particularly vulnerable to biodiversity loss. However, there are implications for all industries and all individuals. A failing agriculture industry poses a threat to food supply across the globe, with implications for the price and availability of food. Extreme weather and rising sea levels cause property damage which affects households and businesses alike. They also pose a direct risk to human, animal and plant life and place strain on public and emergency services, and infrastructure. To give just one example, extreme heat in the UK in July 2022 caused railways to close because tracks buckled in the heat. As climate change progresses in the coming years these and other impacts will become more pronounced. Governments and policy makers across the world are grappling with how to mitigate and adapt, both of which will require large investment of public and private money. In 2015, 196 countries adopted the Paris Agreement, which commits them to efforts to limit global warming to 1.5C. This goal is considered necessary to avoid the most extreme effects of climate change. The Intergovernmental Panel on Climate Change has said that, to achieve the goal, rapid and deep emissions cuts need to be made. The International Energy Agency has said that this means there must be no new investment in oil and gas and a rapid transition to renewable energy. Many countries have announced plans and commitments to meet ‘net zero’ emissions by a certain date. In the UK, the goal is to be net zero by 2050, while Scotland has announced a target date of 2045. However, the IPCC has said that policies and commitments made by governments so far are not adequate to meet Paris Agreement goals. Further policy developments can be expected in coming months and years. The proposed solutions to climate change will also impact the economy, changing the factors which influence income, prices, the way people work, and the factors which people consider when making financial and business decisions. The speed at which fossil fuels are phased out, for example, will bear on investors’ decisions. Investing in oil and gas now could mean holding ‘stranded assets’ in the near future and can impact the public image of institutional investors, such as pension funds. 1.14Artificial Intelligence Artificial Intelligence (‘AI’) describes the ability of computers to perform tasks so complex, they have previously required human intelligence to complete. There are numerous players in this sector, notably Google’s Bard and a new AI-powered version of Bing. Recently, the launch of ChatGPT, the artificial intelligence (‘AI’) chatbot, acquired over 100m subscribers in just two months following its launch in November 2022. This made it one of the fastest growing product launches in history. Meanwhile, image-generating AI programs have been around slightly longer, including DALL-E-2 and MidJourney. Experts have viewed the development of AI differently. Some have stressed its negative impact, even going so far as to warn that AI could lead to the extinction of humanity. Others have claimed that the apocalyptic disaster scenarios envisaged by their peers, and enjoyed by the media, are wholly unrealistic and obscure the more near-term opportunities and risks. The technology has numerous capabilities - creating pictures, analysing and summarising large tracts of text, writing and debugging programming code, translation and report writing, and answering complex questions. Consequently, new AI technologies have the potential to be used widely across the economy. Goldman Sachs have speculated that generative AI could raise global GDP by 7% and add to global productivity by 15% over the next decade. There are concerns from some sectors that AI may become so capable that it renders humans redundant. The Organisation for Economic Co-operation and Development has said that skilled positions in law and finance may be especially at risk. However, new technologies may also create jobs as they work well with, and complement, labour, and thus could increase capacity and productivity. The nature and structure of work has been transformed by technological progress in the last 200 years; work is less physically damaging and repetitive and better paid as a result. The capacity of today’s AIs, coupled with the pace of adoption and development, suggest that they are capable and immediately useful in speeding labour-intensive tasks. AI may reshape work, replace some jobs, create many more and raise productivity but this will take time. Other concerns have focused on the impact of AI’s adoption on state surveillance and authoritarianism. Saudia Arabia and The United Arab Emirates have recently raced to purchase Nvidia chips, crucial to building AI software, perpetuating a global AI arms race. Both nations have declared their desire to use AI as a means of supercharging their economies, but their ambitions have raised concerns from some outlets about the potential misuse of these technologies in relation to human rights. 1.15Chapter Reflection This section has described the economic indicators used to measure economic growth and set out the causes and consequences of the 2007-2008 global financial crisis. It has also explained some of the worldwide effects of the COVID-19 pandemic. The UK economic environment has been examined along with the impact of the financial crisis and the pandemic on individuals and society, in terms of employment prospects, housing affordability and returns of savings and investments. Workshop 2 - The UK Financial Services Industry and a Lawyer’s Role Within 2.2 Introduction This chapter will briefly summarise the structure of the financial services industry in the UK and the main organisations and institutions which operate within it. It will also examine inflation and interest rates and how these factors influence investment decisions. We will then consider regulation of the financial industry and of lawyers providing financial advice. 2.4 The Financial Industry in the UK The main functions of the financial services industry are: To bring together those who have surplus funds and wish to lend it for profit and those who wish to borrow those funds and are willing to pay to do so. To offer protection from risks that we do not want to take but which others are willing to assume in return for payment (insurance). To enable diversification of risk by facilitating investment in different financial products. 2.5 Key Institutions and Organisations 2.5.1Banks and Building Societies During the 1980s several pieces of legislation were introduced (the Financial Services Act 1986, Building Societies Act 1986 and Banking Act 1987) that liberalised the financial services industry and provided banks and building societies with greater freedom to diversify their product offerings and raise funds from the wholesale markets to support their lending. Many building societies began to provide services which had traditionally been the domain of the banks, and many banks actively moved into the mortgage, savings, and insurance markets. High street banks and building societies now offer a range of services including core services such as: Current Accounts Current accounts which provide security for customers’ money and easy access to it as well as other services such as direct debits, standing orders and foreign currency provision. These accounts pay a very low rate of interest on credit balances. Deposit Accounts Savings accounts which are less flexible than current accounts but can still offer easy access to money. Interest rates depend on the amount deposited and the notice term required for withdrawals. Loans and Mortgages The provision of personal, business and unsecured loans and loans secured over property. Other periphery services include: Portfolio Management An investment management service for clients’ portfolios, whereby the investment manager can take all trading decisions necessary to meet the client’s investment objectives, or simply carry out trading instructions from the client. These services are most suitable for high-net-worth individuals who want direct exposure to the stock market but do not have the time or the expertise to manage a portfolio of investments for themselves. Individual Savings Account (ISA) Cash and stocks and shares ISAs. These will be covered in Chapter 3. Unit Trusts/Open Ended Investment Company (OEIC) Most high street banks offer Unit Trust/OEIC investment to customers via a subsidiary. These will be covered in Chapter 4. Insurance and Pensions Most banks and building societies offer general insurance products such as motor, travel and home insurance and have established divisions or subsidiaries to transact in life assurance and pensions business. These will be covered in Chapters 5 and 6. 2.5.2Life Assurance Companies Life assurance companies now offer many of the core, traditional banking services including mortgages, loans, and deposit accounts. However, traditionally life assurance companies have offered the following services:  Life assurance; Income protection policies; Private medical insurance; Pensions; Annuities. 2.5.3Multi-Distribution Organisations The liberalisation of the financial services sector resulted in new providers entering the market as some of the previous barriers to entry were removed. Organisations such as Tesco, Marks and Spencer and Virgin have taken advantage of their established brand and loyal customer base by offering a limited range of financial products in partnership with banks. 2.5.4Stockbrokers and Investment Managers Stockbrokers buy and sell shares and stocks for clients, charging a fee for the service, which might include ongoing advice relating to individual shares and regular investment updates. Stockbrokers will either act on a client’s instruction or will advise a client on which investment to buy or sell. Stockbrokers are bound by the rule of “best execution” which requires them to effect a transaction on the best terms available at the time for each deal. Stockbrokers offer an investment management service, where the client gives the stockbroker cash, and the stockbroker, having ascertained the level of risk the client wishes to take, income and capital appreciation objectives and liquidity necessity, invests in the stock market on behalf of the client. Private investment managers manage a client’s cash by investing in stocks and shares without further reference to the client once the cash has changed hands. 2.6 Role of the Government The Government can impact the financial services industry in several different ways: 2.6.1Economic and Monetary Policy The Government has a significant impact on the financial services industry through economic and monetary policy. Economic and monetary policy determines the actions which a government takes on spending, borrowing and the level of interest rates. In the UK it is the Chancellor of the Exchequer who has overall responsibility for the role of the Treasury; the position is the equivalent of the finance minister in other countries. He/she has responsibility for defining levels of Government spending and borrowing, but the control of interest rates lies with the Monetary Policy Committee (MPC) of the Bank of England. The MPC sets an interest rate that it judges will enable the inflation target to be met. Government spending on domestic goods and services helps increase demand and stimulate the economy. Conversely, when the government borrows money, it reduces the amount of money in circulation which can dampen the economy. Look at the Bank of England’s monetary policy web page: https://www.bankofengland.co.uk/monetary-policy 2.6.2The Provision of Financial Products The Government plays a role in the investment market by issuing government loan stock and gilts. The Government also provides a range of savings and investment vehicles in the form of National Savings products. Deposit accounts, savings certificates and ISAs are all offered to investors. These will be covered in Chapter 4. 2.6.3State Welfare and Benefits The UK Government provides for different societal needs including the NHS, state pension, sickness/disability benefits, unemployment benefits and tax credits. While this provides a subsistence level safety net, it is likely that in the future this level of provision will decrease. As the Government deals with an ageing population and the aftermath of the economic crisis, in the future, state welfare cannot solely be relied upon to sustain a comfortable standard of living. 2.6.4Taxation Taxation affects the economy and financial services industry by impacting consumer and business spending power. For example, high taxation reduces disposable income and thus the ability of consumers to spend, and businesses to invest. This in turn slows down economic growth. Low taxation has the opposite effect and can stimulate the economy. The Government can also encourage savings and investments by providing tax concessions, for example on pension schemes and ISAs. Tax concessions, such as capital allowances, have been used by the Government as a tool to try to encourage businesses to invest in new equipment and consequently stimulate the economy. 2.7 Inflation 2.7.1Introduction to Inflation Inflation is a general rise in prices across the economy and is expressed as a percentage. As the prices of goods and services increase, each pound will be able to purchase less. For example, if inflation is 2.5% from January to May, then you must pay 2.5% more for the same products in May than you did in January. You might notice this at the supermarket checkout, petrol pump or online store. If not tackled effectively, the value of money will be eroded. It is generally accepted that a small amount of inflation is a good thing for an economy because if there is no inflation then the economy is not growing. We can compare the annual change recorded in one month to that of the previous month to get an idea of whether price rises are getting bigger or smaller - if the annual rate has risen from 3% to 4% from one month to the next, prices are rising at a faster rate. If the rate has instead fallen, say from 3% to 2%, the prices of the things we buy are still higher, but have not increased by as much as the previous month. If the percentage rate is negative, then prices are cheaper than a year ago. 2.7.1.1Calculating inflation Inflation is calculated by using a base year and comparing present prices to the prices in the base year. A base year is chosen and assigned the value of 100. Each year is given a value (which is published) and these values are used in a calculation to establish the rate of inflation between the two dates. Example If we take the figures for CPIH from July 2017 (103.5) and 2018 (105.9), the inflation rate would be calculated as ((105.9/103.5) x 100) – 100 = 2.31%. Therefore, for cash deposit savings account to show real growth between 2017 and 2018, the interest rate on the account would have needed to have exceeded 2.31% on average over the year. If the interest rate was below 2.31%, there would have been erosion in the spending power of the underlying capital. 2.7.2UK measures of Inflation The figures are compiled by the Office for National Statistics (ONS) with inflation calculated monthly by looking at the changes in prices of 700 goods and services in 150 different areas across the UK. This is known as the basket of goods and is regularly updated to reflect changes in the things we buy (hence the inclusion of vinyl records and air fryers and the removal of hand sanitisers in 2024). There are two main measures of inflation in the UK: The Consumer Prices Index (CPI) This was used as the headline inflation measure of the Office of National Statistics (ONS) from 2003 until March 2017. The UK government set the Bank of England a target of keeping CPI below 2%. The Consumer Price Inflation Including Owner-Occupiers Housing Costs (CPIH) This has been the official inflation measure for the UK since March 2017 and measures how much prices are rising in the same way as CPI but extends this to include a measure of costs associated with owning, maintaining, and living in an owned home (‘owner-occupier housing costs’), and Council Tax. It is important to note that the CPI and CPIH are not cost of living indices but are based on the increase in price of an ‘average’ basket of goods. Because the basket of goods used for the calculation includes luxury or non-essential items, it does not reflect the increase in the cost of living, especially for low-income households. For example, poverty campaigner Jack Monroe highlighted in January 2022 that the cost of pasta in a mainstream supermarket had gone up by 141%, despite overall inflation being at 5.4%. 2.7.3Movements in inflation The graph below shows how inflation has fluctuated over the last ten years: Figure 7 - UK CPI over a 10-year period (Source: ons.gov.uk) You can see a period of deflation in January 2015. This was largely due to lower energy prices. Many experts believed that the 2015 deflation was "good" because people benefited from the lower prices (while most suffered asset deflation in 2009). After the Brexit vote in 2016, partly because of the fall in the pound which raised the prices of imported goods, inflation accelerated, reaching a new high of 2.8% by the end of 2017. It then slowly declined and reached the 2% target in December 2018. This was primarily due to ongoing concern over the consequences of Brexit negotiations, discouraging businesses from raising their prices for services and consumer goods. Alongside this economic downturn was a fall in crude oil prices in 2019, causing gas, electricity, and petrol to become particularly cheap. At the beginning of the Coronavirus pandemic the inflation rate fell to just 0.7% by May 2020 but then inflation rates increased continuously in 2021, reaching 2.1% by May 2021. This was the highest rate in nearly two years and reflected large increases in global energy prices and other tradable goods prices. The pattern of recovery pushed up on consumer prices globally with a rotation of consumer spending towards goods and away from services. This was expected to be temporary as the pattern of demand around the world was projected to revert to its previous balance between goods and services as the economic outlook improved. The recovery was interrupted, however, by Russia’s invasion of Ukraine, which greatly exacerbated the rise in energy prices as well as wholesale prices of many agricultural commodities. These external factors contributed to a peak in CPI inflation at 11.1% and CPIH inflation at 9.6%, both in October 2022. Higher clothing and footwear prices have tended to be volatile, and the annual food and non-alcoholic beverage price inflation reached a 45 year high in March 2023. The rise in food prices is a global phenomenon, exacerbated by adverse climate conditions and supply constraints caused by the war in Ukraine. These contributed to the rising cost of agricultural commodities, energy and fertiliser used in food production. Core goods inflation also tends to be volatile. Subsequently, as these factors have waned, both measures of inflation have fallen. In June 2023, CPI inflation sat at 7.9% while CPIH sat at 7.3%. While this decrease is positive, inflation was still higher in the UK than in other advanced economies such as the US and Eurozone. In the following year to June 2024, inflation rates continued to sharply decrease, with CPI inflation sitting at 2% and CPIH inflation at 2.8%. The UK inflation rates are now lower than those found in the US and Eurozone. In comparison to the CPI rate, the EU June 2024 inflation rate was at 2.6% and the US June 2024 inflation rate was at 3%. UK inflation has now fallen to its lowest level in three years. Energy prices are at the heart of the falling inflation rate, with the prices for electricity and gas in the year to April 2024 decreasing by 16% and 29% respectively. Other contributing factors include the falling inflation rates on food and non-alcoholic beverages which had previously peaked at 19.2% in March 2023. By March 2024, these rates had decreased drastically to 4% and have continued to decline to 1.5% as at June 2024. CPI inflation has increasingly been driven by factors that are more domestic. In particular, the labour market has been tight in the UK because of low unemployment rates and high vacancies. As firms have passed on rising labour and other costs to consumers, inflationary pressures have broadened to sectors in which price setting is driven more by domestic costs than traded goods prices. However, recently, the rate of unemployed people per vacancy has been increasing, with it rising to 1.7 in May 2024, up from 1.3 in May 2023. This is suggestive that the labour market is ‘loosening’ which in turn lessens the pressure on driving inflation. 2.7.4Effects of Inflation The effect of inflation on different groups of people can vary widely: Pensioners The state pension was changed to be increased in line with CPI from 2011. The legislation deals with State pensions, but some private schemes may also have switched to this method of indexation where the scheme rules permitted this. Those with income from private pensions will be hit by inflation unless their pensions are fully index-linked. For pensioners, inflation will therefore mean a reduction in the real value of their pension and a reduction in their standard of living. Wage Earners Over the past decade, until 2021 earnings in the UK increased on average 2% faster than price inflation year on year, wage earners therefore had little to fear from inflation. However, since the recent increase in the cost of living, average pay increases are not keeping pace with inflation and therefore the pay that workers receive does not pay for as much as it did previously. Unemployed and Low-Income Families People on lower incomes tend to be hit hardest by high inflation. As discussed above, methods of calculating inflation may not accurately reflect the real increase in the costs of essentials. Moreover, those on low incomes have far less control over whether they spend money on certain items. While an increase in the price of luxury goods can be mitigated by a consumer’s choice not to purchase that item, low-income households cannot decide not to purchase food, electricity, gas and water. Those receiving government support will also be hit. Benefits including universal credit, jobseekers’ allowance and disability support only rise every April, and are tied to the inflation rate the previous September. This means there is a significant delay in state benefits catching up to the cost of living. Borrowers Borrowers tend to benefit from rising inflation because the value of the outstanding amount is eroded in real terms. However, during times of increasing inflation, interest rates also tend to rise. It may be therefore that only those who have borrowed with a fixed rate of interest will benefit from an increase in inflation, as those with a variable rate of interest may find their payments are increased to maintain the real value of the capital. Lenders These people will feel the opposite effect from borrowers. In general, they will lose out in inflationary times because by the time the capital is paid back by the borrower, its real value will have been eroded by the increase in inflation. Again however, if they have lent the money on a variable rate of interest, they may find the repayments have increased and this can help to alleviate the erosion of the real value. Savers People with money held in a savings deposit account tend to lose out because of rising inflation when the rate of interest on the account does not exceed the rate of inflation. Where this happens, the spending power of the underlying capital is eroded in real terms. Money placed in a deposit account can have its value eroded very quickly if the interest rate does not exceed the rate of inflation. This particularly hits those who have not moved their savings around to get a better rate of interest. Investors with savings which yield a fixed income, such as gilts, annuities, bonds and other fixed interest stock suffer if inflation rises because the amount of their income will not change, and the spending power of that money will be reduced. Savers can protect against inflation by investing in products such as index-linked gilts, annuities, and National Savings Certificates. Taxpayers As inflation rises, so often does income. If the personal allowances for the various individual taxes do not rise in line with inflation, taxpayers may find themselves paying more tax. 2.7.5UK inflation in a global context It is also important to consider how a high rate of inflation affects the UK in a global context. If the UK has higher inflation than the rest of the world, it will lose price competitiveness in international markets. The level of exports will fall which will reduce domestic economic growth. High inflation will also be a disincentive for international investors as they will not gain “real growth” on the capital they invest into the UK economy. 2.8 Causes of Inflation There are many causes of inflation. If the economy is operating at full capacity, there will be no room for increased production to cope with increasing demand. This will lead to higher prices for products and services, which in turn will lead to an increase in inflation. Possible causes include (but are not limited to): Rising wages  Decreasing value of sterling Increase in money supply Increase in wealth Increase in government spending 2.9 Interest Rates 2.9.1Introduction Interest is the cost of borrowing money – the amount that you pay to the bank, or the bank pays to you, for the use of the other party’s money. Of course, the interest rate the bank pays to you will never be higher than the rate you pay to the bank! Interest rates vary across the market depending on the level of risk involved to the initial capital and the length of time the money will be tied up. Risk Levels of risk influence the rate of interest. The riskier the project, the more the lender is going to want to be paid for the use of its capital. If there is a risk that the capital will be eroded or even lost completely, the interest rate will be set higher than if there is little or no risk to the underlying capital. For example, government bonds are backed by the government and there is little risk that the capital will be lost. For t