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James Hughes, senior market analyst, Alpari

Comment: Proposed Europe-wide financial transactions tax willl have negative impact on the City

James Hughes, Senior Market Analyst at Alpari UK, says the proposed Europe-wide financial transactions tax, announced this week and backed by Angela Merkel and Nicolas Sarkozy, will have a negative inpact on the City of London…

The proposed financial transactions tax isn’t a new concept and has been mentioned before – but only now has it been put forward as a plausible policy idea which explains the market reaction.
On the surface, the effect on the City of London is likely to be net negative because it will become more expensive to conduct transactions, which in turn means lower volumes in many financial instruments. This can be backed up by the initial price action seen soon after the proposed tax was announced: shares of NYSE Euronext (a large trading exchange) fell over 8% making the worst performer in the S&P 500 on Tuesday.
Investors are right to be concerned but most at risk are speculators who are comparatively more active market participants. Speculative volumes are likely to fall sharply as a result of the new transaction tax which will probably hurt share prices of large banks, financial institutions and intermediaries. Firms specialising in high-frequency trading services and algorithmic/black box trading services will suffer most.
The UK economy is hugely responsibly for, and dependent on financial services so such a tax is likely to weigh on UK GDP (as well GDP in all countries where transaction tax is active) but on the flip side, less speculative activity should reduce intra-day volatility and improve market stability at times of heightened uncertainty.
Another issue worth considering is the actual application of the new tax – if it is not implemented equally and multilaterally, non-participating countries will attract higher capital flows over time at the expense of participating countries – this could potentially lead to a seismic shift in how various financial centres around the world line up in the global pecking order – the City of London would be most at risk as it accounts for the highest share of global financial transactions on a daily basis.

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