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GDP contracted by 3.4% y/y in Q2. This was a sharper fall than our forecast of a 2.8% drop and the market’s 2.5%.
The recent softening in consumer price inflation and manufacturing data has re-ignited the debate over further policy easing in India. Our baseline forecast is for no more interest rate cuts in this fiscal year as CPI inflation is still likely to be above the central bank’s 5% target for early 2017. However, our Global Economic Model indicates that a window for further rate cuts may open up if consumer food price inflation averages below 6% in the coming two quarters.
A normal south-west monsoon should lead to moderating food inflation over the next couple of quarters relative to that seen mid-year (indeed it slowed from 8% in July to 5.8% in August). However, policy changes, base effects and the rise in global food prices this year are likely to limit the downtrend.
Meanwhile, the partial recovery in global crude prices is expected to push fuel and transport inflation higher. And, domestically, the upcoming increases to government salaries will, at the margin, place upward pressure on core prices.
Thus, while headline inflation is likely to trend lower in the second half of the current fiscal year relative to mid-2016, we think it is unlikely to maintain August’s rate of 5%. If it looks that inflation will be above the RBI’s glide path of 5% in early 2017, then the central bank will stay on “pause”, until the risks to inflation are skewed more favourably.
A simulation of alternative inflation scenarios, using the Oxford Economics’ Global Economic Model (GEM), indicates that food inflation would have to average below 6% in the next couple of quarters for the RBI to ease further, assuming that fuel and core inflation rise in line with our baseline forecast.
We outline our views on a linked set of questions about the outlook for global growth, world trade and interest rates. We expect global growth to remain modest and core government bond yields to rise only slowly in the coming years. Structural factors – changes in world trade patterns, demographics, corporate cash hoarding and a shortage of ‘safe’ assets underpin this view. There is a strong case for governments to shift toward using fiscal policy to support growth, and monetary frameworks may also need to adapt.
We expect world growth over the next decade to run at 2.7% per year, well below pre-crisis trends. This reflects slower trend growth in the US, China and the Eurozone and the end of the commodity-driven boom in emerging markets.
The pace of growth in world goods trade has undergone a long-term decline. We expect a ratio of growth in trade to growth in GDP of 1.3 during 2016-25, down from 2.3 in the 1990s-2000s. But trends in services trade are much more positive.
Low investment partly reflects cuts in government investment, but also defensive cash hoarding by firms, structural shifts in China and the impact of low commodity prices in emerging markets.
Low interest rates have resulted from lower trend growth, central bank bond buying and a global shortage of ‘safe assets’. We expect only a slow rise in global bond yields in the coming years with US yields peaking at 3.5% in 2026 and German at 3.25%. Risks are to the downside; yields could easily be 0.5-1% lower than this.
We favour a shift to the use of fiscal policy to support growth, especially given the low risk of ‘crowding out’ effects – but we recognise this may be resisted. Changes to monetary frameworks may also be needed if ‘Japanification’ takes hold or when the next downturn comes.
The Bank of England’s Agents’ summary of business conditions suggested that activity growth had slowed over Q3, albeit remaining positive.
While consumer spending growth had remained resilient, companies’ investment and employment intentions had fallen to a level consistent with stagnation in these metrics over the next year.
The total orders balance of September’s CBI Industrial Trends Survey was unchanged from the previous month’s -5. But the balance of firms expecting higher output over the next three months rose from +11 to +22.
The US Fed’s decision to keep interest rates on hold bolstered the value of UK equities. The FTSE All-Share Index rose by 2.4% during the week and the FTSE Local was up by almost 3%.
But the US decision did not prevent sterling from slipping, down by 1.3% against both the dollar and the euro.
We judge that the risk of recession to be unchanged from last week at 25%.
The slightly weaker than anticipated Eurozone composite PMI reading was driven by a puzzling further sharp fall in German service sector sentiment. But the PMI still points to Eurozone GDP growth of about 0.3% in Q3, in line with the Q2 outturn.
Meanwhile, comments from senior ECB staff suggest that the Bank is currently in no mood to signal that a dramatic further policy easing will be forthcoming later in the year.
China's housing market is recovering, with sales, prices and starts all up again. But the recovery is uneven, with signs of a price bubble emerging in some, mostly large, cities, while inventories remain high in others.
It would make sense to rein in credit growth and tame excessive financial flows into property, but we do not expect significant nation-wide tightening. We look for implementation of more city-specific measures; although local governments' desire for higher land prices will limit such steps as well.
Mr. Trump's assertion that his policies would generate 25 million jobs over the next decade is unrealistic and inconsistent with his anti-immigration stance.
Existing home sales slipped 0.9% in August. Despite improving incomes and still-low mortgage rates, limited supplies of home for sale continue to constrain sales.
The central bank of Turkey (CBRT) has lowered its overnight lending rate for the seventh consecutive month this year, cutting it by 25bps today to 8.25%.
At its September meeting the BoJ announced that it will abandon its monetary base target and will now target the yield curve. It also announced a commitment to overshoot the 2% inflation target to boost inflation expectations. However, at least in the short term, the announcement held little in the way of new stimulus. But in the future we expect the BoJ will increase its average JGB holdings from around 65% of GDP currently to above 80% next year amid slow growth and inflation still way below target.
Following the ‘no change’ decision from the US Fed at its September meeting, Bank Indonesia unloaded its fifth rate cut of the year, lowering its new policy tool – the 7 day reverse repo rate – to 5%.
Below-target inflation and risks to growth from decreased fiscal policy support may have triggered today’s move. But, going forward, the Fed is likely to hike interest rates and this will constrain BI’s room for manoeuvre on policy.
The French business climate indicator rose to 102 in September, recovering from the August dip to 101. Confidence improved in manufacturing and services, but edged down in the retail sector. On the whole, this morning’s figures corroborate our view that the economy has returned to growth in Q3 after stagnating in Q2.
Following the Bank of Japan’s decision to tweak its quantitative easing programme, the Fed stayed on hold last night. This has lifted the euro slightly and dampened bond yields across the common currency area.
Although Brexit could affect the Spanish economy through several channels, we think the short-term impact will be limited. Following the UK's decision in June to leave the EU, we lowered our GDP growth forecasts for Spain in 2017-18 by around 0.2 percentage points to allow for the likely effects.
The most immediate risk following the decision was a large confidence shock and a volatility spike in financial markets. However, after an initial negative reaction in equities, markets overall seem relatively unscathed by Brexit.
The biggest risk for Spain comes from tourism, a key sector for the Spanish economy, as British nationals are the largest group of foreign visitors to the country. Lower GDP growth in the UK combined with the depreciation of sterling could cause a decline in both the number of visitors and their overall spending. But we do not find enough historical evidence to confirm that a weaker pound will have a major impact on tourism.
Trade is the other main channel of transmission. The UK is Spain's fourth largest export market, so the potential introduction of tariffs could have a substantial impact. In the short term, however, we do not expect any significant shift in trading volumes between the two countries.
There is an obvious caveat to our forecasts. Little is known about the form and timing of the UK's exit path from the EU. While there is as yet no reason to incorporate a stronger effect from Brexit to our baseline, the final shape of post-Brexit relations between the EU and the UK will greatly determine what this impact will finally be in the long run.
The FOMC held the range for the fed funds rate steady at 0.25% – 0.5%, but three policy makers dissented in favor of hiking rates. The large number of dissents, along with several key changes in the policy statement and indications from Chair Yellen, suggest the Fed is strongly poised to raise rates in December. We see odds of around 80% that the Fed will lift rates by year-end, while the fed funds futures market now sees a near-60% probability.
Monthly economic data in August were reassuring. Trade rebounded, with both exports and imports showing a significant improvement. In addition, retail sales growth also bounced back, while inflationary pressures were subdued.
In light of the latest data, the risks to our GDP growth forecast of 5.1% for 2016 seem to be balanced. Moreover, the economic data do not warrant further easing from Bank Indonesia, at least in the near term. However, given the persistent global uncertainties and the low level of domestic inflation, further easing cannot be completely ruled out.
The ECB continues to step up its pressure on governments to do more to improve economic growth. The Bank’s chief economist, Peter Praet, said yesterday that German growth is too externally driven and that its fiscal position allows the government space to boost domestic demand.
Following the Bank of Japan’s decision to tweak its quantitative easing programme, European bank equities are seeing their biggest bounce in two months this morning. Meanwhile, the OECD released its new economic forecasts, in which it warns that weak trade and financial distortions are damaging global economic prospects.
Against a backdrop of large fiscal deficits, the next few months could see an unprecedented amount of new international sovereign debt issued by the oil-rich Gulf region, including a potential $15bn bond from the region’s largest economy, Saudi Arabia. By drawing on foreign funds, GCC governments can ease the pressure on the domestic banking sector, avoid additional austerity and diversify their own sources of funding.
However, a rush of new issuance could test markets’ appetite for Gulf debt at a time of tight liquidity, ratings downgrades and pessimism over the outlook for oil prices – so will need to be priced attractively to succeed. Moreover, it could leave local corporates competing for capital against their own governments, making private investment more expensive just as it is most needed to boost economic diversification.
At September’s highly anticipated monetary policy meeting the BoJ announced that it will abandon its base monetary target replacing it with a yield target set for around 0% for 10-yr yields. It also announced a commitment to overshoot the 2% inflation target to boost inflation expectations. While this de facto amounts to a higher inflation target, its fulfilment depends on credible tools and actions.
Today’s announcement held little in the way of new stimulus. It maintained its negative interest rate of -0.1% while stating that it will conduct purchases more in line with current pace of ¥80 trillion per year. We had been looking for an additional ¥10 trillion to be announced today.
The BoJ’s policy shift also raises a question mark over the entire concept of negative interest rates, an issue with ramifications well beyond Japan’s shores.
Although public sector borrowing of £10.5bnin August was £0.9bn down on the same month a year earlier, the deficit was slightly above expectations.
Moreover, August’s number makes an achievement of the OBR’s borrowing forecast even more challenging. But a “reset” of fiscal policy in November’s Autumn Statement should prompt a more relaxed attitude to the deficit.
Real GDP contracted 1.6% annualized in Q2, the sharpest contraction since 2009, largely due to the impact of the Alberta wildfires. Looking beyond the transitory impact of the wildfires, we think that the underlying economic fundamentals remain fairly dim. Non-energy export growth is still on a fairly weak track, household debt burdens continue to rise, and housing prices in some at-risk locales (notably Vancouver) have begun to fall.
Concerns over the strength of the economy were highlighted by the Bank of Canada's September policy statement. The central bank is now calling into question the potential strength of the economic recovery from the oil shock. The central bank's main concern is with non-energy export growth, which has disappointed in the wake of the plunge in oil prices and the resulting much more competitive Canadian dollar. We remain cautious on the outlook for Canada's economy and forecast real GDP growth of 1.2% this year and 2.0% in 2017.
Given current labor market and inflation conditions, we believe there is a 40% chance the Fed hikes rates in September versus markets' pricing of about a 24% chance. Admittedly, weak data in recent weeks will make this a close call and the Fed could very well wait until December to lift rates.
Activity was soft in H1 but growth is set to rebound 3% in Q3. Given the slow start to the year, we forecast real GDP growth will average only 1.6% in 2016.
Persistent global headwinds, low oil prices and election-related uncertainty are weighing on business investment and exports. However, consumer spending and housing activity will keep the economy on a moderate expansion path.
Inflation is expected to slowly rise over the course of the year on moderate activity, base effects and rebounding energy prices. We see headline and core PCE inflation ending the year around 1.6% and 2.0%, respectively.
Equity markets have shrugged off recent bouts of volatility but financial conditions have tightened in recent weeks (in particular on the LIBOR front with new SEC rules for money market funds coming into effect mid-October).
We believe the Fed will take a cautious approach to tightening and hike rates only once this year and twice in 2017.
PDVSA's swap offering is unattractive; it is difficult to think that many investors will be willing to accept a 1:1 exchange ratio for adding collateral of highly uncertain value. However, we still see the swap as a positive since it highlights the country's willingness to pay, and even if the overall participation is low it will still somewhat improve PDVSA's and the sovereign's ability to pay.
We remain of the view that the Venezuelan government will do whatever it takes to avoid an outright default by PDVSA, as the costs outweigh the benefits. Thus we cannot rule out the possibility of a second, more attractive, swap offering next year. Without extensive management of its liabilities, the country will be unable to increase imports and the political situation will remain highly unstable.
After the results of the German regional elections that weakened Chancellor Angela Merkel’s position, political attention will shift to the Italian referendum on the Senate and developments in Spain.
Italy’s Constitutional Court decided yesterday that it will not rule on the legitimacy of the new electoral system before the referendum on the Senate, which will probably take place at end-November.
Meanwhile, the situation in Spain has not progressed in the last couple of weeks. We see a third election in December as increasingly likely.
Sterling has taken the brunt of the post-EU referendum economic fallout. But a look at the factors which have pushed the pound lower suggests that the current consensus around the UK currency’s prospects may be too gloomy.
The pound’s drop since 23 June can be put down to three influences: (i) the view that Brexit will make the UK permanently less wealthy, (ii) the expectation of a response by the Bank of England to alleviate the economic shock from the ‘Leave’vote and (iii) ‘herd’ behaviour among currency traders.
But having driven the pound down, the same three factors now offer upsides. Even a worst-case projection of the permanent structural damage inflicted by Brexit does not justify the fall in sterling inherent in the current exchange rate. A long-run value against the US dollar of $1.45-$1.50 looks reasonable.
Growing evidence that the economy has escaped the degree of immediate damage than the consensus had expected should aid the pound’s recovery to that value. And if a less gloomy economic outlook, aided by a loosening of fiscal policy in November’s Autumn Statement, causes the MPC to reconsider the need for further monetary action, upward pressure on sterling will build.
In terms of the more ‘casino’drivers of the pound’s drop, the scope for an unwinding of the present very high level of sterling short positions, which have already begun to ease back from a record high, may trigger a surprisingly strong rebound.
Admittedly, it is still early days to judge even the short-term economic consequences of the referendum. And extricating the UK from the EU may prove to be the long and painful process that many have warned of. But panicky predictions following past sharp drops in the pound have proved misguided. Overall, a rise to the mid- to high- $1.30s over the next year isn’t beyond the bounds of possibility.
The informal meeting due in Algiers between 26-28 September has raised expectations that agreement will be reached within OPEC and with Russia to freeze and even possibly cut oil production. We expect this to be another ‘false dawn’, with no change from the Saudi policy of maintaining market share.
There remains a lack of trust and discipline within OPEC as well as weak barriers to entry, while Saudi aims conflict with any meaningful deal. More specifically, there is little trust between arch rivals Saudi Arabia and Iran. Saudi Arabia does not want to see Iran benefiting from any cuts in production which it committed to. In addition, many other desperate participants are likely to flout any agreed OPEC quota if they can.
Furthermore, rapid improvements in technology have seen many US shale producers able to survive in a US$40 to US$50pb price range (and able to switch on and off production relatively quickly) so that any deal negotiated would unlikely be effective in pushing prices up rapidly anyway.
Q2 GDP growth was stronger than expected, at 0.5% q/q. The government provided an unexpected boost, with current spending and investment boosting growth by 0.3pp and 0.7pp respectively. In contrast private sector domestic demand underperformed, with consumer spending growing just 0.4% q/q and private business investment falling 5.7%, with the unwinding of the mining sector boom continuing to weigh on demand.
We expect GDP to grow by 2.9% this year and 2.7% in 2017. Although the Q2 GDP data were better than expected we continue to forecast that the RBA will cut interest rates to 1.25% at its November meeting, with concerns over the low level of inflation still uppermost in policymakers' minds.
The impact of Mr. Trump’s policy proposals would range from a modest slowdown in economic activity to a recession within the first 18 months of his presidency – significantly weaker than his recent statement of reaching 3.5% growth over the next decade. Under Mrs. Clinton, the economic impact would range from neutral to a modest positive boost.
Income polarization is an important factor behind the increasingly populist stance of the US electorate, and populist movements need not win elections to see their ideas triumph.
Every presidential election tends to generate a certain amount of uncertainty. However, the 2016 race is characterized by a particularly high degree of uncertainty – with both elevated ex-ante uncertainty (the “who”) and tremendous ex-post uncertainty (the “what”).
In terms of ex-post uncertainty, a “trial and error” presidency whereby Mr. Trump would implement policies regardless of advice from his Cabinet and subsequently reverse course would be an important risk.
Four key factors would explain diverging economic trajectories under a Trump and Clinton presidency: fiscal, trade and immigration policy and confidence.
On the fiscal front, the fiscal multiplier from increased government spending under Mrs. Clinton would be greater than that of the tax cuts for high income earners under Mr. Trump.
On trade, Mr. Trump’s aggressive protectionist stance would hurt the economy much more than under a “neutral” Clinton stance.
The anti-immigration stance under Mr. Trump as well as increased ex-post uncertainty would further weigh on the economy.
July’s narrowing in the current account surplus and sharp rise in construction output suggest Eurozone growth will rely on domestic support in Q3.
German regional elections continue to weaken Chancellor Angela Merkel’s position, suggesting continued disapproval of government policies.
S&P upgraded Hungary’s credit rating on Friday, pushing bond yields down.
Net financial flows remained broadly unchanged at US$38bn in August, while the stock of FX reserves shrank a bit more than in July as beneficial valuation changes declined.
Given a globally strong US$ amid rate-rise speculation, we expect capital outflow pressures to remain, but not to escalate, with a slightly better economic outlook after the August data likely to dampen outflows.
All eyes will be focused on the FOMC policy meeting on September 21 to see if policy makers raise rates or defer once again. We now see equal odds of 40% each for a September versus December tightening. We agree with the hawks that the economic data overall justify a tightening at next week’s meeting. However, the recent slowing in economic momentum raises the odds they wait. If the FOMC does not tighten, then the question is whether they indicate a rate hike is in the offing by December. Investors also get to digest policy makers’ updated interest rate and economic projections, including key forecasts for inflation and the neutral fed funds rate.
The hawks argue that the slack in the labor market has essentially been removed and that inflation is accelerating, albeit gradually. Moreover, inflation looks to be on a path to reach the 2% target over the next few years.
The doves led by Fed Gov. Brainard will counter that inflation still remains well below its 2% target and with continued headwinds facing the US and global economy, there is no urgency to raise rates at this upcoming meeting.
Fed officials will provide their updated Summary of Economic Projections (SEP). Within the SEP, we believe the most critical forecasts to examine will be the medium-term inflation figures since they will guide the pace of future interest rate changes.
At the June meeting, Fed officials materially reduced their interest rate forecasts for the medium to long-term. Foremost they reduced their long-term neutral fed funds rate to 3% from 3.25%. It will be of great interest to see if they further pare this projection.
We recently reduced our projection for the long-term neutral fed funds rate to 2.75% from 3.25%. This lowered our expected rate trajectory for the next several years. We see room for Fed officials to further reduce their rate expectations (see table below).
As expected, the central bank (BCCh) kept interest rates unchanged at 3.5% after its September meeting.
August CPI up 0.2% and core CPI up 0.3%, both higher than expectations. CPI up 1.1% y/y. Core up 2.3% y/y, a 9th consecutive month of above 2.0% readings. For the FOMC, these readings combined with the strength in the labor market should be of comfort to the hawks, but the doves likely need to see further improvement. We continue to expect a rate hike next week, though concede that a cautious FOMC may defer till December.
The Central Bank of Russia cut its key policy rate by 50bp for the second time this year to 10%, citing falling inflation and a decline in inflation expectations.
The retail sales release for August reported a surprisingly small monthly drop of 0.2%, after July’s upwardly-revised increase of 1.9%. Even if sales volumes are flat in September, they will grow by 1.5% over Q3 as a whole.
Retail demand has been supported by low inflation, with the CPI measure flat at just 0.6% in August. But there are inflationary pressures building in the supply chain, with annual producer input cost inflation rising to a four-year high of 7.6% and factory gate prices also accelerating. CPI inflation is likely to rise above 1% in September and move close to 2% by end-year, squeezing household spending power.
The labour market data was mixed, with vacancies rising in August but the single-month LFS data reporting back-to-back falls in employment .
Bond yields have been relatively stable, after last week’s sharp rise.
The MPC signaled that it still intended to cut interest rates, in spite of the recent resilience of the economic data. Monetary conditions remain very stimulative.
We judge the risk of recession to be unchanged from last week at 25%.
The peso has been the worst performing EM currency this year as a number of external and domestic factors have kept it under pressure. In our baseline forecast, the peso ends the year at MXN18.9 per US$ (a slight appreciation from the current level) as we expect the recent bout of weakness to be relatively short-lived. Furthermore, although the peso's fundamentals remain fragile, there is a non-negligible probability (16% to 28%) that the peso might rally by more than in our baseline forecast.
A Trump victory in the US election would undoubtedly result in a dramatic depreciation of the peso. However, as we asserted last week, a Trump victory would be bad but not catastrophic for Mexico. Indeed, the peso would likely partially reverse some of its initial plunge once it became apparent that Mr. Trump would be forced to water down his policy proposals to get them approved by Congress.
Although some recent polls have pointed to Hillary Clinton losing support, 8 out of 10 polls released so far this month still showed Clinton leading over Trump, with an average of 46.1% versus 42.5% of voting intentions. In our latest GSS report, we assigned a 20% probability to a Trump victory, while bookmakers' odds have it at 33%.
A surprise (to the markets) move by the Fed this month would almost certainly be followed by a symmetric rate hike south of the border, as indicated by Banxico's latest monetary policy minutes. Thus, it would not be a major event for the peso.
And if the Fed postpones its rate hike until December and Clinton wins the election as expected (a joint probability of 48%), two factors driving peso weakness would have gone, providing the MXN with some room to rally.
Although the peso is still being squeezed between worries about a Trump presidency and tighter Fed policy, this situation is unlikely to last for much longer. Even when using bookmakers' rather higher probability (33%) of a win for Trump, the balance of risks points to an appreciating peso from current levels.
Labour cost growth in the Eurozone fell to 1% on the year in Q2, the weakest pace since 2014. The slowdown was largely due to a drop in the wages and salaries component, with wage growth down to a six-year low of 0.9%. National breakdown reveals surprising weakness in the German data. However, as the labour market in Eurozone’s largest economy remains in good health, we forecast wage growth will pick up again in Q3.
Several ECB officials spoke this morning on the possible changes to the QE programme. The ECB is in a wait-and-see mode: monetary policy is working for now, but any deterioration in data means likely policy action in December. Our baseline remains that the asset purchases will end in March 2017.
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