Bank of England – Trick rather than treat

The Bank of England (BoE) hiked rates 25bp yesterday for the first time in a decade, as expected, with recent domestic and global macro data seemingly helping the Monetary Policy Council inch over the rate-hiking start line.

But that was not real story, with financial markets always likely to look beyond the headline decision and focus instead on the underlying message.

Markets’ dovish reaction in the past 24 hours suggests that they zeroed in on BoE Governor Carney’s view that future rate hikes would be gradual and limited.

The Sterling Nominal Effective Exchange Rate is down 1.4% to the bottom of a 5-week range and markets are now pricing only a 34% probability of a 25bp hike in February.

Carney’s cautious outlook for the policy rate’s path is in line with my expectations that macro data and the cloak of uncertainty which surrounds Brexit will limit the need and room for the BoE to tighten monetary policy.

Fundamentally, the UK economy remains fragile, with lacklustre GDP growth of only 1% in Q1-Q3 2017 lagging growth in other G7 economies, and the medium-term outlook remains uncertain at best, in my view.

Weak retail sales and household consumption growth of only 0.5% in H1 is clearly acting as a drag on overall economic growth.

A key reason is that growth in economy-wide real earnings has slowed sharply in the past two years, in turn the by-product of slowing growth in employment and real earnings.

Moreover, the household savings rate is an already very low 6% while commercial banks are looking to tighten lending standards and pass on yesterday’s rate hike to borrowers.

With this backdrop and likely slowdown in imported inflation, core and headline CPI-inflation may be close to peaking, in my view, although there is of course the no small-matter of Brexit, a known unknown of considerable magnitude.

Governor Carney’s clear message that the BoE may not need to hike much to get inflation back down to 2% in coming years is somewhat reminiscent of the US Federal Reserve’s policy stance in 2015 and 2016.

It is possible, in my view, that the BoE’s rate hiking cycle could mirror the Fed’s with the BoE only delivering one (or perhaps two) hikes in 2018, in which case markets may need to further reduce their expectations of a February 2018 rate hike.

Read the full article on my website.

My Top Currency Charts

My macro & FX analysis is premised on both a detailed qualitative assessment of Emerging and G20 fixed income markets and economies and a rigorous quantitative analysis of data, trends, policy decisions and global events too often taken at face-value.

A picture can say a thousand words and a well-constructed and timely chart can shed light on often complex economic and market developments and challenge engrained assumptions.

Ideally, a chart will be forward-looking and a valuable tool in helping forecast economic and market developments and ascertain whether possible market mis-pricing may trigger turning-points or corrections.

There are of course limits to what even the best chart can do, with in particular the line between correlation and causation sometimes blurred. One should also be weary of reading too much into sometimes limited or patchy data sets and underlying data sources can add to or detract from the chart’s credibility.

Moreover, a chart can lose its potency over time, so while on average my research notes include about a dozen charts and tables I am constantly adding new ones.

I have re-published and updated below a small cross-section of the currency-specific charts which continue to play a central part in my narrative and forecasts, including:

1. Global Nominal Effective Exchange Rates (NEERs)
2. Euro and government bond yield spreads
3. Sterling NEER
4. Sterling NEER and annual pace of appreciation/depreciation
5. The Renminbi NEER
6. Renminbi NEER and monthly pace of appreciation/depreciation

I will in coming weeks expand on other notable charts and for a more detailed analysis I would refer you to my previously published (hyperlinked) research notes.

Read the full article on my website.

Appetite for destruction… and procrastination

Financial markets continue to take into their stride a number of man-made and natural crises and the procrastination of policy-makers in the US, UK and Eurozone.

Global risk appetite remains seemingly well bid despite the still very opaque end-game for rising geopolitical tensions stemming from North Korea and the impact from Hurricanes Harvey and Irma.

In the world of FX, the emerging market carry trade is seemingly enjoying a mini-revival thanks to low yields in developed economies, signs that global GDP growth continues to inch higher and a surge in commodity prices, particularly industrial metals.

Event risk is clearly more acute in September than it was in August but it is not obvious to me that major central banks will deliver the kind of surprises which cause major dislocations in financial markets, including EM currencies.

However, these high-yielding EM currencies’ volatility versus the Dollar remains quite elevated, with perhaps the exception of the Turkish Lira and Indian Rupee.

Chinese policy-makers are seemingly intent, at least for now, on using Renminbi appreciation as a show of strength and I expect further currency gains near-term.

In the UK, the mammoth challenge facing Prime Minister Theresa May is coming into greater focus. Moreover, the Bank of England is unlikely to seriously consider a rate hike before next year, in my view. With this in mind, I see the risk biased toward bouts of Sterling weakness.

The Euro, which eked out small gains versus the Dollar and Sterling following ECB President Draghi’s Q&A session, is ultimately behaving like a safe-haven currency.

I expect the common currency to benefit, not suffer, from lower interest rates for longer and the associated improvement in economic activity even if future Euro appreciation could be modest rather than spectacular.

Read Appetite for destruction… and procrastination in full on my website.

Broken Records

The past year has been remarkable with political precedents set in the US, UK and France, still record-low central bank policy rates in most developed economies and financial markets and macro data at all-time or multi-year highs (and lows).

The US presidency is fraught with problems but markets turning are a blind eye…for now. The UK is still on course to be first ever member state to leave the European Union come 29th March 2019, at least on paper. French elections have repainted the political landscape and present many opportunities but old (fiscal) hurdles still need to be cleared.

Central bank policy rates remain at record lows in the majority of developed economies, including the Eurozone, UK, Japan, Australia and New Zealand and I expect this to remain the case for the remainder of the year. Loose global monetary policy is likely to continue providing a floor to risky assets, including equities and emerging market currencies.

A number of central banks have hiked 25bp in recent months, including the Fed, BoC and CNB, in line with my year-old view that rate hikes would gradually replace rate cuts. But in aggregate the turnaround in developed central bank monetary policy is proceeding at a glacial pace and I see few reasons why this should change.

The Bank of England has not hiked its policy rate for 526 weeks – a domestic record – and I continue to believe that this stretch will extend into 2018.

In contrast to the Dollar and Sterling, the Euro – by far the most stable major currency in the past seven years – has appreciated over 7% since early April.

While the ECB may want to slow the current rapid pace of Euro appreciation, it is unlikely to stop, let alone reverse, the Euro’s upward path at this stage. For starters, Eurozone growth and labour markets continue to strengthen. The German IFO business climate index hit three consecutive record highs in June-August.

Perhaps the most obvious record which financial markets have broken is the continued climb in US equities to new highs and volatility’s fall to near-record lows.

Emerging market rates continue to edge lower in the face of receding inflationary risks and I see room for further rate cuts, particularly in Brazil given the pace of Real appreciation.

Non-Japan Asian (NJA) currencies continue to broadly tread water, in line with my core view that NJA central banks have little incentive to materially alter their currencies’ paths.

Year-to-date emerging market equities have rallied 24%, twice as fast as the Dow Jones (12%) which has rallied twice as fast as EM currencies versus the Dollar (6%).

Read 'Broken Records' in full on my website.

No UK rate hikes this year and room for further Euro upside

The odds of a 25bp Bank of England rate hike at next week’s policy meeting are all but dead in my view following tepid GDP growth of 0.3% qoq in Q2 2017.

Moreover, UK GDP growth and inflation dynamics, allied to forthcoming changes in the composition of the Monetary Policy Council, point to the record-low policy rate of 0.25% remaining on hold for the remainder of the year.

Forecasting European Central Bank (ECB) monetary policy, including the timing and modalities of changes to its Quantitative Easing program, is arguably a far trickier proposition.

While the ECB may be incentivised to slow the current rapid pace of Euro appreciation, at this stage I do not expect the ECB to try and to stop, let alone reverse, the Euro’s upward path.

Read the full article on my website.

Bank of England and Inflation – Sense of Déjà-vu?

UK retail sales in Q1 likely contracted from Q4 2016, despite their rebound in February.

Falling real wages and slowing household borrowing are likely to further dampen retail sales and consumption growth going forward.

The still large pool of available workers is seemingly limiting their wage-bargaining power, with nominal wage growth falling behind rising inflation.

Moreover, investment growth is still only making a negligible contribution to GDP growth ahead of the British government’s decision to trigger Article 50 on 29th March.

Much of the rise in inflation in recent months is attributable to imported inflation driven by Sterling’s depreciation since November 2015 with little evidence of demand-led inflation.

This situation is reminiscent of 2007-2008 when Sterling’s collapse fuelled imported and in turn headline inflation.

Should Sterling remain broadly unchanged going forward, its year-on-year pace of depreciation, currently around 9%, would slow from June onwards and hit zero towards end-year according to my estimates, in turn dampening imported inflation.

I would expect retailers to stabilise prices to maintain market share in the face of tepid demand and for wage-inflation expectations to remain modest. This was certainly the case in the 12 months to September 2009 with CPI-inflation falling from 5.2% yoy to 1.1% yoy.

The question is whether the BoE is willing to look beyond a potentially temporary rise in UK inflation – as Governor Mark Carney suggested – or whether it tries to short-circuit any self-reinforcing rise in prices.

My base-line scenario is that the BoE will look beyond the current rise in UK inflation, unless at least one of three conditions materialise:

(1) Nominal wage growth accelerates, comfortably outstripping headline inflation and driving consumption growth;

(2) Commercial bank lending picks up significantly; and

(3) Sterling depreciates materially from current levels, exacerbating imported and in turn headline inflation.

I expect that neither (1) or (2) will materialise any time soon and that while risks to Sterling are probably to the downside, Sterling is unlikely to weaken sufficiently to push the BoE into hiking. I would however expect it to keep a possible rate hike firmly on the table.

Read the full article here.