The Moment of Truth


TENREYRO AND MANN PUSH BACK Prospects of slower global economic growth momentum and more persistent high inflation remain at the forefront of investors’ minds, but the risk tone in financial markets improved this week. US Treasury yields fell despite further gains in the oil price, an upside surprise to US CPI inflation, and Fed minutes reaffirming the likely start of tapering of asset purchases this year. Sterling markets, meanwhile, have fully priced a 15bps rise in Bank Rate to 0.25% by the end of the year, with a further increase to 0.5% in February 2022. The pound, however, remains below June’s highs above $1.40. The interesting question is whether it will still find support if market interest rate expectations fall back. Two BoE MPC members, Tenreyro and Mann, this week pushed back on expectations for near-term UK interest rate rises.


UK GDP RISES AFTER FULL LIFTING OF RESTRICTIONS

The latest evidence suggests that the UK economy is set to grow more slowly in Q3 than previously expected. GDP increased by 0.4%m/m in August, up from a marginal fall of 0.1% in July (revised down from +0.1%), led by sizeable gains in consumer-facing service sectors which reflected the first full month without Covid restrictions in England. Nevertheless, Q3 growth is now more likely to be close to 1.5%q/q, below the BoE’s recent forecast of 2.1%q/q. The UK labour market remains strong. The unemployment rate fell to 4.5%, while HMRC payrolled employee data is above pre-pandemic levels. The level of unfilled vacancies also recorded a new record high of nearly 1.2 million in September, pointing to an increasing shortage of workers. The key uncertainty ahead is to what extent the workers still on furlough at the end of September, estimated to be over a million, will re-enter the labour market and help to alleviate supply and wage pressures. That may not become clear in the official data until the end of the year.


FURTHER HINTS OF SOFTENING MOMENTUM The global economic outlook remains uncertain, with risks predominantly related to the pandemic impact on demand/supply mismatches in goods and labour markets, and policy responses from governments and central banks. Global ‘flash’ PMIs (Fri) will provide an early indication of activity and price pressures at the start of Q4. We look for a slight decline in the UK manufacturing PMI to 56.5 in October from 57.1, although the backlog of work is expected to support activity even if new order flows are slowing. We predict a bigger fall in the UK services PMI to 54.5 from 55.4. Overall the surveys are expected to indicate continued expansion, but with supply constraints contributing to a further softening in momentum. Similarly for the Eurozone, we forecast the manufacturing PMI to move down to 57.0 from 58.6 and for the services PMI to fall to 55.0 from 56.2. These levels would remain well above the 50 level separating expansion and contraction, but supply issues are having an impact on the pace of growth. The German manufacturing PMI may receive particular attention after latest official industrial production figures revealed a slump in output due to shortages of intermediate goods, including semiconductors, hitting areas such as car production.


PAUSE IN UK INFLATION’S UPWARD MARCH

There are several other important UK data releases next week. Top among these is September CPI inflation (Wed). We expect inflation to edge down to 3.0%y/y from 3.2%y/y, partly as a result of the base effects from the end of the Eat Out to Help Out Scheme on prices a year ago. But it will be a temporary respite from inflation’s march up to and probably beyond 4% in the coming months. The increase in the energy price cap will pull inflation higher in October, with a further significant rise likely next April as a result of soaring wholesale gas prices. That means that inflation seems set to remain above 4% into the second quarter of next year. It will present the MPC with a difficult policy trade-off between supporting the economy and tackling inflation. Other UK data include public sector finances (Wed), the CBI industrial trends survey including quarterly questions (Thu), GfK consumer confidence (Fri) and retail sales (Fri). The stockpiling of fuel due to the panic over shortages may have boosted overall retail sales in September. We predict an increase in headline retail sales of 1.8%m/m, with underlying sales (excluding automotive fuel) at 0.9%. But broader concerns about energy supplies and prices are expected to have weakened consumer confidence further to -16 in October from -13.


FED SPEAKERS, CHINA GDP

The US data calendar is relatively quiet next week. Highlights include industrial production (Mon), housing starts (Tue), the Philadelphia Fed survey (Thu) and the Markit flash PMIs (Fri). The Fed Beige Book survey (Wed) may warrant attention as it provides a summary of economic conditions based on anecdotal information. In particular, what report says about labour market and broader supply conditions will be particularly interesting. There will also be focus on a number of Fed speakers next week ahead of the quiet period before the 2/3 November FOMC meeting. China’s Q3 GDP (Mon) is expected to show a sharp deceleration in growth to 5.0%y/y from 7.9%y/y in Q2. The slowdown reflects a number of factors including the impact of the Covid delta variant, power shortages and concerns about the health of the property sector following high-profile reports of debt defaults. The impact of the delta variant may have eased towards the end of the quarter, but the energy crisis probably continued to affect industrial activity.


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