City given boost from mortgage bailout

Bear versus bull

The US government’s bailout of two mortgage lenders has prompted a global market rally that could signal a turning point to the current turmoil.

On Sunday, US Treasury Secretary Henry Paulson confirmed a $200 billion investment in mortgage giants, Freddie Mac and Fannie Mae, which together finance nearly 50% of all mortgages in the US. The deal will see the capital used to help keep the two firms solvent.

President George Bush has admitted that, without government intervention, the two lenders posed an unacceptable risk to the American economy. This is the third time the government has pumped money into the struggling US economy this year. In March it acted following the collapse of Bear Sterns and in July made initial efforts to help Freddie Mac and Fannie Mae.

The investment, which is over 25 times the size of the Northern Rock rescue package, means the US government now effectively owns around half of US mortgage debt.

The rescue package has prompted a rally on the European and Asian stockmarkets, with banking stocks feeling the benefit.

In the UK, the FTSE 100 jumped nearly 4%, with shares in Royal Bank of Scotland and HBOS up 13%.

Jeremy Tigue, head of global equities at F&C Investments, says the US government’s actions are extremely significant and could “signal a real turning point”.

“The scale of the rescue means it removes a huge amount of systemic risk from the global financial system,” he explains. “It also provides support to the ailing US housing market by ensuring mortgages will still be available, albeit at more expensive levels than in the past.”

However, Tigue adds that the US economy looks set to remain fragile for the foreseeable future

In another piece of good news, official UK data revealed that the cost of products leaving factories fell in August – suggesting that inflation at factory-level could have peaked. The fall is the result of cheaper crude oil.

Nur Ata, an economist at the Centre for Economic Business Research, says if inflationary pressures at the factory gate have reached their peak, then this should start to feed through to retail prices in the coming months.

“We expect that the slowing global and UK economy will alleviate the inflationary pressures in the medium term,” Ata adds. “This will allow the Bank of England to make rate cuts possibly before the end of the year to support the slowing UK economy."

Gordon Brown also indicated his optimism in the forward to the 2008 Labour Party conference.

He writes: “I am confident that we can come through this difficult economic time and meet these challenges a stronger, more secure, and fairer country than ever before.”