To Taper Or Not To Taper That is The Question

US FED CONSIDERING WHEN TO START TAPERING ASSET PURCHASES Risk sentiment was under pressure over the past week. Global equity markets and government bond yields mostly fell and oil prices declined for a third consecutive week. A long shadow was cast over financial markets by last Friday’s slump in a measure of US consumer sentiment to a decade low, reinforced by weak July retail sales data this week, which raised concerns that US consumer spending may be slowing by more than expected. More positively, industrial production was stronger than expected and weekly initial jobless claims continued to fall. An added concern for markets were the minutes of the US Federal Reserve’s July policy meeting, which noted that some officials saw an earlier start to the tapering of the central bank’s asset purchases than previously anticipated, i.e. later this year rather than in 2022. The minutes and comments from Fed officials this week suggest that an announcement may be made at the next policy update in September, although some policymakers would clearly like to wait for longer. Next week’s speaker calendar is light, not surprisingly given the time of year, but there is considerable speculation that next Friday’s remarks on the economic outlook by Fed Chair Powell at the Kansas City Fed’s Jackson Hole symposium (an annual gathering of central bankers and others) may provide some new detail.

POUND FALLS AMID MIXED UK DATA The pound’s near 2% fall this week towards 1.36 against the US dollar was probably less to do with a string of mixed UK data and more about safe-haven demand for the greenback. The surprisingly strong drop in UK CPI inflation back to the 2% target will be short-lived, with the uptrend set to resume in August. Meanwhile, UK retail sales dropped by 2.5% in July, as the aftermath of the Euros affected sales of food and drink, while wet weather did not help either.

There were indications, however, that some of the weakness reflected a switch to ‘social’ spending, including restaurants and takeaways, so overall consumer spending probably held up better. Furthermore, signs are that the UK labour market remains strong, as the unemployment rate fell to 4.7% and unfilled vacancies reached a record high of nearly a million in the May-July period.

EUROPEAN ATTENTON ON FLASH PMI REPORTS

Next week’s European focus is the release of August ‘flash’ PMI surveys (Mon). In the UK, both the manufacturing and services PMIs fell back in July to 60.4 and 59.6, respectively, affected by supply issues such as raw materials and labour, although they remain firmly in expansion territory. The decline in services had been limited by the full easing of Covid restrictions. For August, we expect the manufacturing PMI to rise to 61.3 and the services index to 60.3. Overall, the PMIs are expected to be broadly consistent with some moderation in economic growth in Q3 after the strong rebound in the second quarter. In the Eurozone, the manufacturing PMI was very strong in July at 62.8 reflecting solid output and orders, although as elsewhere supply chain delays were driving up costs. The services PMI at 59.8 in July was the strongest since 2006, with buoyant activity related to tourism, travel and hospitality, although there were concerns about the delta variant. For August, we have pencilled in a moderation in the Manufacturing PMI to 62.0 and a slight rise in the services index to 60.0. The German IFO business survey (Wed) is also closely watched. We expect the headline business climate index to ease slightly for a second month to 100.5 in August from 100.8 in July, due to a decline in the expectations component related to supply constraints and concerns about new variants. The current assessment index, however, is forecast to improve for a seventh consecutive month as economic recovery is sustained.

US SPENDING DATA IN FOCUS In the US, next week’s focus – aside from Fed Chair Powell’s remarks at Jackson Hole – will be on the July personal spending figures (Fri). As in the UK, US retail sales data fell in July, but the question is whether it represents a broader weakening of consumer spending or a shift in spending from goods to services as the economy reopens. In contrast to the retail sales outturn, we expect personal spending to have risen by 0.4% in July, although that would be lower than the 1.0% gain in June. The PCE deflator is the Fed’s preferred inflation measure and we expect the annual rate of the core measure (excluding food and energy) to move up to 4.2% from 4.0%, reflecting a firm month-on-month increase of 0.4%. Other US data releases include the second estimate of Q2 GDP (Thu), which we expect to be unrevised at 6.5% (annualised rate). Home sales data (Mon/Tue), durable goods orders (Wed) and the advance goods trade data (Fri) are also due. The IHS Markit PMIs (Mon) typically receive less attention in the US than in Europe. Nevertheless, we predict the services PMI in particular to rise to 61.5 from 59.9, which would be the first increase in three months.

ECB MINUTES WATCHED FOR POLICY CLUES The ECB will publish the ‘account’ of its July policy meeting (Thu). Although there were no policy changes, the meeting was the first under the new 2% symmetric inflation target which also allows for some tolerance above that target. The main change in the July meeting was that the forward guidance for interest rates now sees no increase until inflation reaches 2% “well ahead” of the projection horizon and durably for the rest of the projection horizon. That seems to have raised the hurdle for the start of interest rate normalisation. The minutes may shed some light on whether the new guidance will also necessitate more policy stimulus, including more asset purchases.

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