Recession Fears Recede. For Now.
Sterling bounced back to a 7 week high this week against the US Dollar and the Euro. This came on the back of a delightfully perfect storm of good news for the currency. GDP data surprised on the upside; amidst sentiment that a Hard Brexit could be averted; and reports of a ceasefire in the trade war between the US and China which improved overall risk appetite in the market and benefited the pound. The latest GDP numbers has created a rush of economic updates from market analysts. Estimates from the NIESR (National Institute of Economic and Social Research) indicate that that the UK is likely to grow by 0.3% in the third quarter of 2019. This return to growth after posting a loss in Quarter 2. Furthermore, since GDP data releases are now monthly, July’s growth figures also came in ahead of forecast at +0.3%.
However a cautionary statement from the NIESR said, "...it is not clear how long growth will continue. Only the services sector is expanding, primarily to meet higher demand from consumers driven by increased household incomes fuelled by rising real wages. But there is a limit to how much further real wages can grow without a pick-up in investment and productivity, and this seems unlikely in the near term.” This underlines the longer term structural weaknesses in the UK economy which will still need to be addressed - whether the UK remains in the EU or leaves via one flavour of Brexit or another.
The ‘risk on’ mood has prevailed in markets this week and was reflected in rises in global equities and a backup in government bond yields as signs of progress in US-China trade talks as bopth sides made some concessions. This reduced some of the downside concerns about global economic growth. Against this more positive background it will be hoped that further face to face talks between US and Chinese trade negotiators scheduled for next month will yield some progress, with some talk of an interim deal.
Despite the more positive mood markets are still looking to central banks to provide more stimulus as insurance against downside growth risks. Following this week’s moves from the ECB five more central banks will give policy updates next week. The US Federal Reserve will be the main focus and Wednesday’s policy meeting is expected to result in a second successive cut in interest rates. Markets are expecting a reduction of 25 basis points, to take the range for the Fed Funds rate down to 1.75%-2.00%. There has been speculation that the FOMC may opt for a larger decrease of 50bp. However, while the Fed is under political pressure to make deeper cuts it is unlikely that there will be a majority for more aggressive action. The rate setting Committee will probably leave the door open for further rate reductions by maintaining an easing bias in its policy statement. However, that doesn’t necessarily mean that it will follow through with further action. Fed policymakers will also have to update their economic forecasts, including their interest rate projections. In June these showed the Committee almost evenly split between those expecting rates to stay unchanged this year and those who foresaw some cuts. This month’s forecasts will reflect the rate moves that have been seen since June and may incorporate an expectation of additional easing.
The Bank of England is unlikely to make a policy change this week. Given ongoing uncertainties the Monetary Policy Committee is likely to want to continue to sit on the sideline so we expect a unanimous vote for unchanged policy.
However, the minutes of the policy meeting may provide some new insights into policymakers’ thinking. BoE Governor Carney recently noted that the downside risks for UK economic growth had gone up, a possible reference to international uncertainties as well as Brexit developments. His concerns may well be shared by other MPC members but the Committee is also likely to continue to be mindful of evidence that a tight labour market is putting upward pressure on wages, which may eventually boost inflation. Therefore the MPC is likely to maintain a policy bias toward gradual and limited rises in interest rates.
Ahead of the BoE’s announcement Wednesday’s inflation data is expected to show that annual headline CPI inflation slipped slightly below the Bank’s target in August. Due in part to lower oil prices analysts expect it to have fallen to 1.9% from 2.1% in July. ‘Core’ CPI inflation is also expected to be lower (1.8% from 1.9% in July). That is due in the part to the competitive pressures on retailers that are helping to suppress goods price inflation.
The level of August retail sales (Wed) is forecast to be flat. This series is volatile and so after an outsized rise in July a weaker outturn would not be unusual. Nevertheless it should be noted that the fundamentals for consumer spending remain largely positive and so it continues to be a key area of support for UK growth.
This week was another busy one for Brexit developments. On Monday, the Benn Bill aimed at avoiding a no deal Brexit was passed and the House Commons, for the second time in a week, rejected PM Johnson’s call for an early general election. Parliament was then prorogued until 14th October, although a Scottish court subsequently ruled that this was illegal. The Government intends to appeal to the Supreme Court, who will hear the matter on Tuesday. If it loses, parliament may need to be recalled early. Meanwhile, Brexit talks continue and PM Johnson is reported to be meeting with outgoing EU President Juncker on Monday. Some media sources are suggesting that UK negotiators are now strongly considering a backstop deal that just covers Northern Ireland. However, political commentators say it is unclear whether this has a serious chance of obtaining adequate HoC support.
And just to add to the mix, there was a rumour late this afternoon that the EU had already agreed an extension, should the British government ask for it.
So looking into next week, positive fortunes are likely to depend on: a combination of reports of progress between Boris and Juncker; and a court result on the legality of the Prorogation of Parliament.
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See you next week!