The Rogue State Cometh

BRITANNIA WAIVES THE RULES The latest round of negotiations between the UK and the EU ended in London with both sides indicating that significant differences remain. Moreover, the UK government’s publication of the Internal Market Bill, aimed at safeguarding unfettered market access for Northern Ireland firms to mainland Britain in the event of no deal, led the EU to threaten legal action and to give the UK until the end of the month to amend it. The UK government said the proposed legislation would breach international law (the Withdrawal Agreement) in a “specific and limited way”. With the risk of a no deal perceived to be rising, the pound was under pressure through the week, falling towards $1.28 and €1.08. Six-month volatility for sterling crosses rose, while risk reversals were more negative. UK government bond yields also fell relative to their US and German counterparts. The 2-year gilt yield, for example, declined below -0.10% and the 10-year yield fell to around 0.20%. According to reports, the UK’s chief Brexit negotiator David Frost will travel to Brussels next week for further talks. ECB MORE UPBEAT The ECB, meanwhile, left policy settings unchanged as widely expected, including the deposit rate at -0.5% and the stock of asset purchases at €1.35trn. What was slightly surprising was the more upbeat tone from President Lagarde regarding the Eurozone economic outlook. The ECB’s economic growth projection for 2020 was revised up to -8.0% from -8.7% in June, while next year’s growth was revised down only slightly to 5.0% from 5.2%. Importantly, underlying core CPI inflation for 2022was revised up to 1.1% (although still below target) from 0.9%. That probably explained Ms Lagarde’s relatively lukewarm warning about the euro’s recent rise. The euro strengthened, although its foray above $1.19 was temporary.

BOE, FED AND BOJ TO STAND PAT It will be the turn of the US Federal Reserve (Wed), the Bank of England (Thu) and the Bank of Japan (Thu) to announce their policy decisions next week. No changes are expected. In the UK, this week’s July GDP figures showed a rise of 6.6%m/m, a strong start to Q3, suggesting that the economic recovery is proceeding broadly in line with the BoE’s expectations. With policy on a pre-set course for the remainder of the year, i.e. the current stock of asset purchases announced will likely not be completed until December, the MPC is expected to keep policy settings unchanged, including Bank Rate forecast to be unchanged at 0.1%. Nevertheless, there are a number of potential headwinds ahead, including the impact of the end of the furlough scheme on unemployment, the risk of further lockdowns and Brexit uncertainties. As such, downside risks to the economic outlook remain and the minutes may even indicate that they have increased. Hence, the BoE is likely to reiterate it is ready to provide more stimulus before the end of the year, which could come at the November MPC meeting. That would most likely entail a further increase in QE, while a shift to negative interest rates has not been ruled out, but the hurdle for doing so is high in our view. In the US, the Fed is expected to keep interest rates at the 0.00-0.25% range next week and maintain its current pace of asset purchases. It recently announced a change to its policy framework, which now aims for an average 2% inflation target over time, allowing for inflation to overshoot to make up for past undershoots. Markets will be on the lookout for more details on the new inflation-targeting regime, but it suggests the start of policy tightening will occur later than under the previous regime. Markets already anticipate no rate rise for a considerable period of time; additional policy stimulus is not expected to be announced next week.

UK AND US DATA DELUGE

There are a lot of data releases next week, particularly in the UK and US. So far, the official UK unemployment data have shown little sign of the malaise seen in other metrics as a result of the furlough scheme and a fall in participation (people not actively seeking work due to lockdown). We expect the unemployment rate (Tue) to edge up to 4.0% in the three months to July from 3.9% in June. As noted above, policymakers will be watching closely the impact of the end of the furlough scheme. Survey evidence still points to weak hiring intentions. In other UK data, we predict a sharp drop in August annual CPI inflation (Wed) to 0% from 1.0%, with a risk of a negative outturn. The decline is due to the temporary VAT cut for the hospitality sector and the Eat Out to Help Out scheme. Official retail sales figures (Fri) are also predicted to have risen again in August – we forecast a rise of 1.5%m/m on the headline measure after the 3.6% gain in July. Key Eurozone data releases include July industrial production (Mon) and the German ZEW survey (Tue). In the US, we expect further signs of slowdown in the recovery. Industrial production (Tue) is forecast to have risen by 0.8% in August, down from 3.0% in July, while headline retail sales (Wed) is predicted to have increased by 0.5% compared with 1.2%. Weekly jobless claims (Thu) will continue to be closely watched – this week showed initial claims staying at 884k against expectations for a decline. Housing starts and permit data (Thu) are also due, as are latest September business survey updates from the NY Fed (Tue) and Philadelphia Fed (Thu). Particularly interesting will be the preliminary results of the September University of Michigan consumer sentiment survey which we see falling to 72.5 from 74.1.

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None of the information in this article is, nor should be construed as, financial advice. All foreign exchange transactions involve risk and you should always seek your own independent financial advice before entering into any foreign exchange transaction.