Message From Fed and BoE: Keep Calm & Carry On


FED AND BOE PROVIDE REASSURANCE

Concerns about the impact of the coronavirus delta variant on global economic activity, and reports of China’s regulatory clampdown, maintained a cautious tone in the financial markets. However, indications from officials at the US Federal Reserve and the Bank of England (BoE) that policy tightening is likely to proceed, albeit gradually, in the years ahead may have provided some reassurance that current high levels of inflation are likely to be transitory and that the economic recovery remains on track. The US economy added 943k jobs in July, more than markets were expecting, while the unemployment rate dropped to 5.4% from 5.9%. The BoE left policy interest rates at 0.1% and the target size of asset purchases at £895bn to be completed this year, although one MPC member (Michael Saunders) dissented in favour of an early end to QE. There was an eye-catching revision to its inflation forecasts, with headline CPI now expected to peak at 4% in Q4 before falling back to the 2% target in two years’ time, based on the expectation that current supply bottlenecks will subside over time. The BoE noted, though, that “some modest tightening of monetary policy over the forecast period is likely to be necessary”. Currently, interest rate markets are pricing a 15bps hike to 0.25% around the middle of 2022 and an increase to 0.5% in 2023 at the earliest.



UK GDP TO CONFIRM REOPENING BOOST

Official GDP data (Thu) will confirm that the UK economy rebounded strongly in Q2, following the third national lockdown at the start of the year. Monthly GDP figures for April and May have already been released, and we look for a further increase of 1.3% in June, which would result in Q2 growth of 4.9%. The retail and hospitality sectors have driven the recent recovery, with the rolling back of Covid restrictions. Going forward, economic growth is expected to continue, but the pace of expansion is likely to slow to more normal rates. The July services PMI survey this week was revised up to 59.6 (although still lower than in June) as full pandemic restrictions were lifted, signalling a solid start to Q3, while business confidence in the Lloyds Business Barometer was slightly lower but remained at a strong level. The Bank of England expects UK GDP to reach its pre-pandemic level in Q4 of this year, but noted downside risks relating to concerns about new Covid variants.



US INFLATION TO REMAIN ELEVATED

US CPI inflation has surprised on the upside in the past four months. The headline annual rate rose to 5.4% in June, the highest since 2008. Most of the increase, however, was led by energy, used-car prices and the reopening of the economy, which is expected to be ‘transitory’. So the upward impetus on inflation is expected to fade over time. There is, however, considerable uncertainty over how quickly it will do so. For the July report (Wed), we expect seasonally adjusted month-onmonth inflation to rise by 0.5%, a bit less than in recent months, and for the annual rate to edge down to 5.3%. For the underlying ‘core’ measure, which excludes food and energy, we forecast the annual rate to fall to 4.3% from 4.5%. These would still be elevated levels and inflation is expected to stay high for a while longer. Rising prices, eroding real spending power, is cited as a key factor in last month’s fall in the University of Michigan’s US consumer sentiment index. The final reading for July was 81.2, a significant fall from 85.5 in June. For the preliminary August report (Fri), we expect a partial reversal of July’s decline to 82.0.


GERMAN ZEW EXPECTATIONS MAY EDGE LOWER

The German ZEW survey’s economic expectations component has fallen in the past two months, albeit from very high levels, led by concerns about Covid variants. The current situation component, however, increased for a fifth consecutive month, reflecting the economic recovery. For the August report (Tue), we expect these trends to continue, and look for a fall in expectations to 57.0 and a rise in the current situation component to 27.0. The ZEW report is a survey of financial market participants rather than businesses. We expect Eurozone industrial production (Thu) to have fallen slightly in June by 0.4%, based on the latest national figures available, including a second monthly decline in Germany. That would round off a disappointing quarter for industrial output despite strong order books, with production affected by supply constraints such as the semiconductor shortage in the auto sector. That has been more than offset by stronger services activity as economies reopen. Timelier survey evidence suggests that manufacturing input and output price pressures and backlogs of work remain high.


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