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Reflation enthusiasm is tempered
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We have made important changes to the baseline forecast for Brazil this month. The GDP growth forecast for 2017 has been cut to just 0.1% on the back of a very weak Q4, but we have upgraded the estimate for 2018 to 2.9%. We now expect the central bank (BCB) to be more aggressive and deliver two rate cuts of 100bp each in April and May, taking the Selic rate to 9.25% by year-end. In addition, we have lowered our end-2017 forecast for inflation to 4.2% and now think the Brazilian real (BRL) will trade around the 3.05-3.15/$ range this year.
The recent uptrend in Eurozone consumer price inflation has come to an end in March after a decline in energy and core inflation, data is likely to show on Friday. Core inflation may even plunge to an 11-month low of 0.7% because of Easter timing effects, which will then cause a spike in April. Core inflation will only settle back to a more normal level in May.
The upshot of this is that it would be unwise to read too much into the spring gyrations in core inflation. While these trends could cause some volatility in financial markets, we expect the ECB to look through the undulations in core inflation and maintain its current dovish stance.
The triggering of Article 50 by the UK is dominating the headlines across Europe. Although little is currently known about the procedures that will follow Theresa May’s formal request to leave the EU, this should change shortly. The European Council will, according to media reports, release a set of guidelines for the EU’s chief negotiator, Michel Barnier, by Friday.
On the data front, two releases this morning – from France and Italy – confirm that sentiment in Europe remains upbeat. The French consumer sentiment indicator remained at a 9-year high in March, defying political risks, while Italy’s business climate index rose in the same month. Overall, Eurozone GDP growth still looks set to come in at a robust 0.5% q/q in Q1.
February’s household borrowing numbers yielded little in the way of new developments. Mortgage lending, mortgage approvals and consumer credit saw only modest changes on January’s levels.
Continued rapid growth in consumer credit may pique the Bank’s concern. But with households’spending power facing a squeeze from rising inflation, policymakers may, for now, accept rising household debt as a necessary evil.
Monthly data remain relatively subdued, with household spending failing to show a convincing pick-up as inflationary pressures edge higher. Meanwhile, cement consumption data, a proxy for capex investments, point to lacklustre expenditure on infrastructure in January and February. Moreover, government expenditure continued to contract in early 2017, extending its decline from Q4 (that weighed on headline growth at the end of 2016). Overall, the economic outlook for Indonesia in 2017 remains similar to that in 2016, with GDP growth forecast to average 5.1%, only marginally higher than the 5% achieved in 2016.
Consumer confidence climbs to highest since December 2000. Current conditions reflect solid labor market and business conditions while six-month expectations reflect a robust outlook for business, the labor market, and incomes.
The UK serving its divorce papers on the EU tomorrow will not herald another plunge in sterling. We think the pound is significantly undervalued. It hasn’t broken below the October lows despite the hawkish policy shift by the Fed, a less dovish ECB and Brexit-specific shocks materialising. Sterling will likely rebound to 1.32 against the dollar by end 2017. We see risks of an overshoot to our forecast in the intervening period.
As the euro continues to climb against the US$, further gains can be expected if the Fed and Trump continue to disappoint. But given we do not expect an early end to the ECB’s asset purchases, the upside will be limited with the euro seen ending 2017 at $1.10.
Peter Praet (the ECB’s chief economist) maintains the view that the Eurozone is still missing sustainable underlying inflation, in addition to reiterating the bank’s commitment to its forward guidance. This corroborates our view that rate hikes will not begin until after QE purchases have been tapered.
Italian industry had a disappointing start to the year, with both sales and orders down on the month, consistent with production data released earlier. The survey data (such as PMIs) is consistent with trends elsewhere in the Eurozone, and thus our GDP forecast of 0.9% this year still stands.
Exports surged across most of the region in February. And while the timing of the Chinese New Year distorts figures in the first two months of the year, smoothing for the volatility indicates that growth momentum was still solid, particularly among South East Asian economies. The region is expected to continue to benefit from improving global trade. However, we remain somewhat cautious on how rapidly global trade will gather momentum amidst increased US protectionism and the prospect of slower Chinese import demand.
The central bank's board of directors reduced the overnight rate by 25bp to 7.0% as expected. Going forward, we expect the board to continue cutting rates by 25bp each month until reaching a level of 6.0% in July.
Economic activity expanded by just 1.2% y/y in January, down from the 1.3% growth seen in December, and shrinking on a month-on-month basis (-0.3%) for the second month in a row. We agree with BanRep's board of directors that there is a risk of economic activity being disappointingly weak this year.
Lending figures for the Eurozone showed a marked slowdown in credit flows to corporates in February. But the detail presents a slightly more positive picture, as gains were exclusively centred around long-term loans. Nevertheless, there seems to be signs of exhaustion in the upward trend in lending that started in 2013, casting doubt on the possibility of a strong pick-up in investment in the Eurozone.
The Prime Minister will finally trigger Article 50 of the Lisbon Treaty on Wednesday to begin the Brexit process. This will start the clock on the two-year period of exit negotiations, though effectively the timeframe is quite a bit shorter so the Government will need to work quickly.
Since the global financial crisis, export growth across Asia has varied significantly. A group of “winners”—the Philippines, India, South Korea, China—has seen robust gains in productivity and/or moved up the value chain, gaining global market share in the process. The “losers,” including Japan, Taiwan, Thailand, and Singapore, are mainly developed economies that have lost manufacturing dynamism because costs have risen faster than innovation or product development.
February durable orders rose 1.7%, driven by an increase in civilian aircraft orders. Core capital goods shipments excluding aircraft, our preferred proxy for business investment, rose 1.0%. Altogether, the latest data point to a moderate rise for business investment in Q1 GDP.
The Central Bank of Russia (CBR) has re-started its easing cycle sooner than markets expected, cutting its main one-week policy rate by 25bp to 9.75%.
Political developments remain a key factor in the economic outlook. A referendum to amend the constitution in favour of expanding the powers of the presidency will be held on April 16. Polls suggest that the vote is still too close to call. Until then, the economy will remain in a 'wait-and-see' mode, with private investment and consumption depressed amid a significant tightening of financial conditions in the wake of a weaker currency and higher interest rates.
An overload of expectations and rich valuations amid global reflation mean the dollar won’t benefit much from positive US surprises. Steady growth in other blocs is beginning to challenge the US-centric view of global reflation. Cheap European currencies, especially the euro, will be key beneficiaries of a market reassessment of relative policy outlooks. Oversold currencies such as sterling will take a breather from heightened perceptions of idiosyncratic risk. Finally, much of EM FX looks like it’s in a good place against the greenback.
The further rise in the Eurozone composite PMI to 56.7 in March, its highest in almost six years, suggests that the region may be in the midst of a mini-boom. The available hard data suggest that Q1 GDP growth is likely to be to be lower than the 0.7% rise implied by the PMI – we continue to pencil in a 0.5% quarterly increase – but the March rise in the PMI does suggest that growth prospects for Q2 are firming and that the risks to our 2017 GDP growth forecast of 1.6% now lie to the upside.
The strong PMIs will increase speculation that the ECB may bring forward the start date for policy normalisation. But comments this morning from Executive Board member Peter Praet suggest that the Bank remains in cautious mode and that the unwinding of non-standard measures will be a slow process.
National accounts for Q4 2016 confirmed that the Argentine economy is now finally growing after a deep recession in the first half of last year. However, the economy remains very fragile. Indeed, growth in Q4 was solely driven by strong exports as all the components of domestic demand fell. But, notwithstanding the economy's fragility, we do expect the recovery to broaden out this year as the benefits of 2016's policy changes start to feed through. We expect GDP to grow by 2.5% this year, but there is some concern that the disinflationary process is taking longer than expected, forcing the central bank (BCRA) to adopt a more hawkish approach towards its easing of monetary policy.
Export growth has remained fairly slow over the past two years despite a much weaker Canadian dollar. We believe that a mix of cyclical and structural drags have been and will continue to weigh on export growth and offsett some of the competitiveness gains from a weaker currency.
Stronger economic activity and higher inflation have prompted comments in the markets that the ECB may start unwinding its crisis measures as soon as this year by raising the deposit rate. We disagree. We think the ECB will tread more cautiously and start policy normalisation by tapering QE in January 2018, while rates will not rise until the second half of next year. After that though, unconventional policy will be rolled back faster than markets currently expect.
New home sales were stronger than expected in February, increasing 6.1% to a SAAR of 592,000. Unlike existing homes, the market for new homes is benefiting from steady increases in inventory.
Demand for the ECB’s TLTRO funding today significantly outstripped expectations, as banks stocked up on cheap long-term ECB loans at what is likely to have been its last ultra-cheap auction.
Meanwhile, French business and German consumer confidence surveys are showing signs of turning down after a period of strength, and therefore converging with the more subdued hard data. In Germany, the ongoing rebound in inflation is eating into consumer confidence. French business confidence has also softened, due to much weaker manufacturing sentiment.
Following three successive monthly falls, February’s 1.4% increase in retail sales volumes offered some reassurance that shoppers haven’t quite lost their appetite to spend more.
But February’s growth is unlikely to be enough to prevent Q1 2017 from recording the first quarterly decline in sales volumes since the end of 2013. And with shop price inflation heading up, this year remains on course to be a difficult one for the retail sector.
The situation in Ukraine has taken a sudden turn for the worse. The blockade of transport links with the separatist regions, initiated by a group of nationalist activists, has led to the nationalisation of Ukrainian enterprises in the breakaway regions and now an official severance of trade links. This risks derailing Ukraine’s fragile recovery, and is likely to trigger another bout of UAH devaluation as the IMF continues to postpone the release of the fourth tranche of funding under the Extended Fund Facility programme.
We also note that Ukraine remains one of the riskiest emerging markets despite a sharp correction in current account and fiscal imbalances since 2014. While the IMF is unlikely to walk away from the programme, Ukraine’s sluggish growth means that the debt burden remains unsustainable and its ability to start repaying its debts from 2019 remains limited.
Treasuries are higher on a risk-off bid as markets worry about passage of the American Health Care Act. However, if Republicans can push the bill through it would raise hopes for quicker passage of fiscal stimulus this year.
At first sight, the composition of Italian and French banks’ balance sheets suggests that their financial position would not severely deteriorate because of ‘currency mismatch’, in the event of either economy leaving the Eurozone.
But this observation is flawed. As Greece’s experience has shown, concerns about a future Eurozone exit can dramatically alter the composition of banks’ balance sheets and quickly result in large direct costs associated with currency redenomination and devaluation.
The only way to avoid this kind of deposit flight would be a sudden exit or capital controls in the build-up to a final decision on whether to exit the currency bloc. The former is unlikely to be politically feasible, while the disruption created by the latter would provide voters with an indication of the potentially huge costs of exit, undermining support for the leave option.
China's economic growth picked up in the first two months of the year, reflecting stronger investment and exports as well as restocking in industry. Following this solid data and the signalling of a slightly more accommodative macro policy stance during the NPC compared to what we had expected, we now expect GDP growth to slow to 6.5% this year, up from 6.3% previously.
Political developments continue to be in the news. With just a month until the first round of the French elections, the Fillon scandal continues to run. We still see Macron as the most likely candidate to move into the Elysee Palace in May.
US trade rhetoric towards Mexico has substantially moderated in the last few weeks, increasing our conviction that trade tariffs will not be imposed on Mexican exports to the US, as we have assumed since President Trump's election. Thus, our GDP growth forecast remains unchanged at 1.9% and 2.0% respectively for 2017 and 2018.
The latest vulnerability scorecard shows Turkey, South Africa and Malaysia as the most fragile economies, with Turkey's situation deteriorating further over the last month because of a worsening inflation outlook and a re-acceleration of credit growth over the last four or five months. In South Africa, low real interest rates and large external imbalances remain key vulnerabilities. At the other end of the spectrum, Korea, Thailand and India (replacing the Philippines this month) score as the least vulnerable.
Since April 2016 the relative rankings of Brazil and Russia have improved the most. In April last year, the scorecard suggested that Brazil was the most risky large EM, but the subsequent impeachment of President Rousseff facilitated a huge change in economic policy and a resurgence of market confidence, paving the way for dramatically lower inflation, easing monetary policy, planned fiscal consolidation (which now must be credibly delivered) and an eventual economic recovery. In addition, the country's banking sector is much less stretched than it was a year or so ago.
Russia's improvement in the rankings has, in part been driven by the stronger oil price outlook than seemed likely eleven months ago, helping both the government's fiscal position and the escape from recession. But the inflation outlook is also noticeably better, helped in part by a stronger rouble. However, the exchange rate may now be overvalued, but central bank intervention in the FX market will likely limit further strength over and above what would be implied by oil prices.
Emerging market (EM) currencies may have entered a long cycle of strength, unless significant risks materialise. We see positive momentum; and EM currencies have historically tended to follow long cycles associated with flows of capital into emerging economies. However, we find that average EM currency performance is quite closely correlated with developments in global financial markets, which limits diversification benefits.
The first debate of the French presidential election saw Emmanuel Macron outperform Marine Le Pen, according to two snap polls. Against Le Pen’s attacks, Macron repeated that he sees a “strong France in Europe”. We still see Macron as the most likely winner of the presidential election. However, he will find it difficult to assemble a majority in the parliament needed to implement his reformist programme.
Elsewhere, talks between the Greek government and the Eurogroup continue, with both sides hoping an agreement can be reached in order to approve the long-stalled second review of the country’s bailout.
Economic growth across the Gulf Cooperation Council (GCC) region will fall to its weakest since the financial crisis this year at just 1.1%, depressed by OPEC-led cuts in oil production. But in underlying terms, the outlook is improving as budget deficits are reined in and large sovereign bond issues ease pressures on the financial system. Growth is forecast to rebound to 3.3% in 2018.
There was a modest upside surprise in February’s inflation data, with both the CPI and CPIH measures coming in at 2.3%. We continue to expect inflation to peak at around 3% in late-2017, as the weaker pound continues to feed through. Another set of strong borrowing figures has left the Government well-placed to undershoot the OBR’s full-year forecast of £51.7bn.
The government’s economic plans for 2017, presented at the National People’s Congress, indicate that, despite more emphasis on containing financial risks, solid economic growth is still a key objective. The planned macro stance is somewhat less generous than last year. But, although cutting excess capacity is set to continue, overall the approach to reform seems timid.
In our global macro chartbook, we summarise our take on current global themes as well as our key macro and asset views. This month, in particular, we discuss reflation as well as forces that are still holding back long-term global growth. Furthermore, we discuss and quantify key global risks including populism in Europe and uncertainty about US policy.
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