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Markets rally on fiscal deal

Jan 02 2013 15:11 Sapa-AP

The US Capitol in Washington. (File, AP)

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London - Markets breathed a huge sigh of relief on Wednesday when US lawmakers finally agreed on a budget deal that will stop hundreds of billions of dollars in automatic tax increases and spending cuts that risked plunging the world's biggest economy into recession.

Stocks around the world started 2013 with hefty gains as investors welcomed the vote in the House of Representatives that made sure that the US does not go over the so-called fiscal cliff. Though longer-term fiscal problems remain and President Barack Obama will likely face more battles with the Republican-dominated House, investors were relieved that the biggest near-term stumbling block to the world economy has been cleared.

"Investors are trading with a sense of relief after lawmakers in Washington agreed on a compromise to avoid the fiscal cliff that has been the dominant theme in equity markets since the Presidential elections back in November," said Mike McCudden, head of derivatives at stockbroker Interactive Investor.

In Europe, the FTSE 100 index of leading British shares jumped 2.2% to 6 026, its first foray above the 6 000 mark since July 2011. The CAC-40 in France rose 2.4% to 3 728 while Germany's DAX was up 2.3% at 7 781.

Earlier, in Asia, Hong Kong's Hang Seng index shot up 2.9% to close at 23 311.89, its highest finish since June 1 2011. Australia's S&P/ASX 200 surged 1.2% to close at 4 705.90, its best finish in 19 months while South Korea's Kospi jumped 1.7% to 2 031.10.

Wall Street was likewise set to rally on the open - Dow futures were up 1.4% at 13 215 while the broader S&P 500 futures jumped 1.9% to 1 447.

The fiscal cliff deal is likely to remain the focus of attention in financial markets over the rest of the day.

The bill that Congress approved calls for higher taxes on incomes over $400 000 for individuals and $450 000 for couples, a victory for Obama.

Earnings above those amounts would be taxed at a rate of 39.6%, up from the current 35%. It also delays for two months $109bn worth of across-the-board spending cuts that had been set to start affecting the Pentagon and domestic agencies this week.

If lawmakers had not agreed by the January 1 2013 deadline on the new budget measures, more than $500bn in tax increases would have hit the economy in 2013 alone. Government spending worth $109bn would have been cut from the military and domestic spending programs.

Though fears over an imminent fall off the fiscal cliff have eased, investors still have a host of issues to worry about - not least the prospect of more debates over unresolved longer-term US budget issues.

"Cynics will point out that another argument has been booked in for two months' time, when the debt ceiling comes up for debate, and Republicans will be looking to make progress on the spending cuts that haven't featured in the New Year deal," said Chris Beauchamp, market analyst at IG.

Investors will also keep a close watch on any response from the credit rating agencies. After a fight in Congress to raise the debt limit in 2011, Standard & Poor's lowered the US government's AAA bond rating, citing the lack of a credible plan to reduce the federal government's debt. It also voiced its concerns about the "effectiveness, stability and predictability of American policymaking."

Meanwhile, investors will be monitoring the state of the global economic recovery and Europe's ongoing battle to contain its 3-year debt crisis. A string of indicators were released on Wednesday and more are due later, including the closely-monitored monthly U.S. manufacturing survey from the Institute for Supply Management.

Figures released earlier Wednesday highlighted the scale of the downturn in the economy of the 17 European Union countries that use the euro.

The manufacturing purchasing managers' index - a key gauge of business activity published by data information company Markit - showed the industrial sector was mired in recession in December. The index for the eurozone fell to 46.1 from 46.3 the previous month. Anything below 50 indicates a contraction in activity.

How the European economy fares over the coming months will likely hinge on developments in the debt crisis. In the last few months of 2012, tensions eased largely in the wake of the announcement of a new bond-buying plan from the European Central Bank.

"If the second half of 2012 is anything to go by it seems that on the back of central bank action investors are presently inclined to turn a blind eye to poor news and more likely to look on the bright side of events," said Jane Foley, senior currency strategist at Rabobank International.

That has shored up the euro over the past few months and Europe's single currency eked out further gains Wednesday as investor sentiment was buoyant in the wake of the fiscal cliff deal. When investors have a propensity to take on riskier assets, the dollar often loses ground. The euro was up 0.3% at $1 3240.

Oil prices also pushed higher, with the benchmark New York contract up a dollar at $92.81 a barrel.

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