Chief Economist’s Weekly Brief – Summer soft patch

It’s looking a lot like October all over again. Just as a flurry of US policymakers were talking up the chances of a Fed rate rise later this month, the labour market produces a bad headline and throws it all into doubt. Exactly the same thing happened towards the end of last year when October’s move was postponed till December.

Weak signal. The soft patch for UK business continues, according to the latest Purchasing Manager’s Index, with activity remaining subdued in each of the UK’s three main sectors in May. Manufacturing output, at 50.1, just about scraped above the 50-mark that separates expansion from contraction. But orders are weak and come mainly from domestic demand. Meanwhile output in construction is the weakest in three years, although true to form construction firms remain optimistic. Lastly, activity in the dominant service sector, at 53.5, remains below its long run average of 55.2.

Credit where it’s due. The number of mortgage approvals for house purchase fell -5.8%m/m in May, the third monthly fall in a row. Throw in the rebound from the March buy-to-let rush and you get a -29%m/m fall in new mortgage lending in April. It will be a while yet before we can tell exactly how much of an impact the new stamp duty changes has had on the market. For now, there is some sense of stability. Nationwide reported that prices rose 4.7%y/y in April.

Re-writing history. Once a year the Office for National Statistics makes new estimates for GDP growth over the past few decades. These revisions are normally small but sometimes they are meaningful. Take the first two years of this recovery. The original data showed that 2010 was a year of fairly slow growth (1.5%) before the recovery speeded up to a sprightlier 2% in 2011. But the revised statistics have now reversed that, with 2010 being the year of 2% growth before a slowdown in 2011. What hasn’t changed is the fact that this is one of the slowest recoveries the UK has ever experienced.

Comeback kids. Ireland and Spain were amongst the economies hit hardest by the Euro crisis, but their growth is now the envy of the rest. Business confidence, as measured by the PMI, is highest in Ireland (59.1) with Spain in second place on 54.8. But current concerns are concentrated on two big economies that aren’t doing very well. France and Italy are hovering close to the stagnation point of 50. That’s unfortunate for France, but at least the GDP of the Euro 2016 hosts is 3% above its pre-crisis peak. But it is disastrous for Italy whose economy is still 7% smaller than it was in 2008.

Let’s see. There was no new stimulus from European Central Bank President Draghi last week. He’s still assessing the impact of his last batch of easing announcements in March. As part of that the ECB will next week begin buying corporate bonds and from this month banks can access a program that potentially pays them to receive central-bank cash. But the ECB doesn’t seem to have huge faith in the measures. Its own inflation forecast is just 0.2% this year, 1.3% next year and 1.6% in 2018 – still short of the ECB’s target of “below but close to 2%”. Its growth forecasts are hardly great either, around 1.6% through to 2018. It won’t take much for the ECB to be forced to get even more inventive on the policy front.

Crunch. That was the sound of the American jobs machine stalling its engine last month. Employment rose by just 38,000, the slowest May increase in five years. What’s more, the initial estimates for March and April were revised downwards by 59,000. There were mitigating factors; a strike at the telecoms company Verizon knocked 35,000 off the total. But add them back and this would still have been a disappointing report. Even the apparently good news of a fall in the unemployment rate was mixed at best. That drop was caused most by people giving up looking for work.

More of the same? Surveys suggest the US growth slowdown might be more than a passing phase. The Institute for Supply Management’s service sector index slipped from 55.7 in April to 52.9. That was the lowest level since February 2014. Especially notable was the fall from 59.9 to 54.2 in the new orders gauge. The manufacturing report was more encouraging. It rose by 0.5 points but a reading of 51.3 hardly signalled runaway growth.

Hold, surely? The price index for “personal consumption expenditures” is the inflation measure to which the Fed pays most attention. In the year to April it grew by 1.1%. Even excluding volatile items like food and energy the underlying rate was just 1.6%. Both are a fair distance from the Fed’s desired rate of 2.0%. Along with a disappointing jobs report and weak business survey data, the absence of meaningful inflationary pressure surely means the Fed will keep rates on hold at its meeting next week. And perhaps for longer still.

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