Chief Economist’s Weekly Brief – Limited ammunition

There’s a renewed sense of caution amongst central bankers. Both the Fed and the ECB are moving towards renewed policy support while the Bank of England has softened its stance on rate hikes. Pessimism over the global outlook and below-target inflation are to blame. The problem is their armouries are looking rather bare. 


Powell throws in the towel. The Federal Reserve stood pat in June but a downgrade to inflation/interest rate forecasts and a dovish press conference from Fed Chair Jay Powell suggest an easing has merely been delayed. The “dot” plot revealed that eight members were projecting a rate cut in 2019 – seven called for 0.5% and one 0.25% – a marked reversal from May when the consensus was for higher rates. The Fed dropped its “patience” wording with respect to its policy stance, it acknowledged “increasing uncertainty” about the economic outlook and stated it will “act as appropriate” to support US growth. Barring a strong June employment report and/or a US/China trade resolution, a rate cut is likely in July.

Draghi surprises (again). Dovish comments from ECB president Draghi at the annual conference in Sintra have bolstered hopes of further easing in coming months – even a resumption of QE. Mr Draghi was more downbeat about the Euro area economy than June’s ECB press conference, noting that recent indicators point to “lingering softness”. He stated that additional stimulus “will be needed” unless there is an improvement in growth amid persistent disinflation pressures. The ECB president stressed the need for fiscal policy to take up the mantle from monetary policy but political hurdles are acting as a constraint.

Who’d a thought it? Just as ECB President Mario Draghi dangled the carrot of further monetary stimulus, a spot of sunshine emerged over the Eurozone’s private sector. The PMI ‘flash’ reading rose a touch to 52.1 in June, up from 51.8 in May. It’s not much, but still a seven-month high. Services shouldered the lift, as manufacturing output regrettably slipped again, to 48.8, down a whisker from 48.9, so still suggesting recession. Yet overall Q2’s PMI seems to have outperformed Q1’s, suggesting GDP growth in the current quarter could edge ahead of Q1’s 0.4%. Let’s see. But not bad if true.

Up or down? Making decisions is tough at the best of times, even more difficult amid heightened uncertainty – as was the case for the Monetary Policy Committee (MPC) last week. Rates were left unchanged at 0.75% but June’s MPC minutes were more dovish than expected, noting underlying growth was “slightly weaker” during H1 2019. The MPC highlighted rising risks, citing rising global trade tensions, fuelled by US trade policy, and falling forward interest rates in major economies. But these are overshadowed by the increased likelihood of a no-deal Brexit. The outlook for interest rates will be heavily influenced by the nature and timing of Brexit: the MPC stated the policy response could be in either direction.

Transitioning to a new economy. Two main themes dominated the latest Mansion House speech delivered by BoE Governor Mark Carney: (1) the transition to a digital economy and (2) the shift to a carbon-neutral economy. Mr Carney welcomed recent innovations in UK payment systems but stressed the need for improved access to finance from households and companies. He acknowledged the new technologies, such as Cloud and AI, would speed up the collection, storage and analysis of data, necessitating more regulation. On climate change, Mr Carney reiterated the need for a sizeable reduction in carbon emissions over the next decade, requiring a huge increase in capital spending and rising disclosure by firms. The Prudential Regulation Authority (PRA) has published a Supervisory Statement and a new Climate Financial Risk Forum has been established. An inaugural stress test on climate change will run in 2021.

Bullseye. UK annual consumer price inflation eased from 2.1% in April to 2% last month, hitting the BoE’s 2% target for the first time since December 2013, and was below market expectations. Lower airfares, a volatile component, and falling car prices were key factors exerting downward pressure on inflation. Core CPI inflation – which strips out volatile items such as food, energy, tobacco & alcohol – eased to a twenty-eight month low of 1.7% y/y in May, led by softer underlying service inflation.

Pause. UK consumers had a quieter month at the shops in May, with spending dropping by a fraction (-0.5% in volume terms). Still, with continued wage growth, job growth still solid and inflation close to its 2% target, households are providing plenty of growth to the economy. Retail sales are up 4.8% in real terms, comparing the last three months with the same period in 2018. But that growth is less even than it used to be. Online sales are up 8.2% and account for a whisker under a fifth of retail spending. On the other hand department stores are struggling.  Sales have shrunk since Q3 2018 and are now down 2.4% on a year ago. Britain’s high streets will have some big holes to fill.

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