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Big miss: Real GDP grew only 1.2% in Q2. A sharp inventory contraction was the main factor behind the weak headline figure, but weakness in business investment is an important and lingering growth constraint. Reassuringly, consumers are still spending and outlays are well supported by income growth. We foresee growth rebounding to 3% in Q3, but average 2016 growth will fall to just north of 1.5% (from 2.0% previously).
Alberta wildfires burned a hole through May GDP. Real GDP likely contracted in Q2 due to the wildfires, but economic activity should rebound in the latter half of the year as the wildfires' impact fades and non-energy activity slowly gains momentum.
Consumer Sentiment Index down to 90.0 on both current conditions and six-month expectations. Current conditions still strong; supported by low energy prices, healthy labor market, improved household balance sheets.
The Central Bank of Russia held off from further easing in July amid rising risks to inflation from higher wage growth and a weaker rouble.
Employment costs continued to increase about on trend with up 0.6% quarter-over-quarter, but year-over-year picking up the pace at up 2.3%. Gains in wages and salaries showed signs of building some upward momentum year-over-year; benefits costs rising slightly faster, but about on trend.
The Bank of Japan merely tweaked monetary policy at its meeting today, prompting a jump in the yen against the dollar. There is the prospect of more substantive easing in September after a “comprehensive assessment” but the need for monetary easing is urgent as the June inflation data shows.
Since the UK voted to leave the EU many commentators have suggested that the UK is likely to fall into recession. We think that an outright technical recession is unlikely, but still expect a sharp slowdown compared with H1 2016. Given the uncertainty surrounding the outlook, we are launching a new report, UK Recession Watch, which will be published at the end of each week. This report will look at the week’s economic and financial data and use it to assess the probability that the UK will enter recession over the coming year.
The short duration of the failed military coup-attempt on July 15 allowed the authorities to regain control of the situation, albeit in a reconfigured political landscape as the government purges many of the country’s institutions. Turkish assets have recovered some of the ground lost in the initial market reaction to the coup as the government has been quick to limit the economic fallout, announcing a series of measures and support to the economy.
We have maintained our baseline growth forecast, which sees the economy slowing to 3.3% in 2016 from 4% in 2015, as it already assumed a high level of political uncertainty. But the downside risks have intensified, not only related to the potential for a credit rating downgrade but also this year’s sharp fall in tourism.
GDP in the Eurozone rose 0.3% in Q2, the slowest rate in two years. GDP in France was flat over the quarter, while Spanish GDP rose by a solid 0.7%. But momentum looks set to improve in Q3 and 2016 Eurozone GDP is on track to grow 1.6% or perhaps a touch stronger.
Eurozone inflation in July was 0.2% year-on-year, up slightly from June. Core inflation was stable, while energy inflation was slightly weaker. Looking ahead, base effects will see inflation gradually rising in the coming months to reach 1% by the end of the year.
A fall in mortgage approvals in June to a 13-month low suggests that the EU vote may have injected nervousness into the housing market. But gross mortgage lending rose, while consumers’appetite for credit accelerated further.
Evidence of a sharp weakening in consumer confidence post-Brexit points to subdued lending growth going ahead. But the latest Lloyds Business Barometer offers hope that sentiment could snap back surprisingly quickly.
Our short-term forecasts for GDP growth are unchanged at 1.8% for 2016 and 1.1% for 2017. Post-referendum we expect heightened uncertainty to dampen business investment, while the weaker pound will push up inflation and hamper consumer spending. But in our view, the UK is likely to endure a slowdown in growth, rather than a technical recession. The MPC has given notice that it plans to loosen monetary policy at the August meeting.
The Chinese economy expanded by 6.7% in both Q1 and Q2, only slightly down from 6.9% in 2015. GDP growth was supported by somewhat better export momentum, steady infrastructure investment and relatively robust consumption growth. The stabilisation in GDP growth is corroborated by our ‘bottom-up’ GDP indicator, which grew by 6.3-6.4% year-on-year in H1, the same pace as in Q4 2015.
But the continued weakening of corporate investment momentum, with FAI in manufacturing contracting year-on-year in June, remains a challenge for the growth outlook. In addition, the real estate sector is losing momentum again, having been a key factor behind the recent stabilisation in GDP growth, amid still high inventories of unsold housing. These factors will challenge overall GDP growth in H2, making the achievement of the overly ambitious growth targets reliant on continued stimulus, in particular expansionary fiscal policy. We continue to expect that GDP growth will average 6.5% in 2016, which is the low end of the growth target range for this year.
We think that the MPC will announce a loosening of monetary policy on 4 August. But the absence of financial market stress suggests that the Committee will hold back from a dramatic package of measures. A 25bps cut in Bank Rate combined with an expansion of the Funding for Lending Scheme and a shift in communications strategy is our best guess. QE, whether via purchasing gilts or private sector assets, is less likely, at least for now.
A reduction in Bank Rate seems almost certain. However, continued concerns over the effect of ultra-low rates on the banking sector and a desire to avoid a further decline in sterling will caution the MPC to tread carefully.
The MPC could announce a new round of gilt purchases as a complement to lower rates. But record-low gilt yields mean that this policy will deliver less bang-for-the-buck than past rounds of QE. Alternatively, purchases could be focused on corporate bonds. However, the small size of the market and the time needed to deal with operational issues suggest this will be left as a potential future step.
Reassuringly, it is not clear that the need for a sizeable unconventional monetary response is pressing, at least at present. The financial market stress that was predicted by some as a consequence of Brexit has so far not materialised. For example, investment-grade corporate bond spreads and inter-bank lending rates have fallen since 23 June, although this may partly reflect anticipation of monetary easing.
Consequently, the MPC is unlikely to pursue Andrew Haldane’s “sledgehammer” approach, involving, for example, negative interest rates and/or major purchases of private sector assets. But the emphasis will be that more can be done if necessary.
If the Government does follow through with its talk of a “reset” of fiscal policy, pressure on the MPC to support the economy should ease. Fiscal activism would also boost the potential for monetary and fiscal policy to work in a coordinated fashion, with additional QE effectively soaking up extra gilt issuance.
Advanced economy corporate sectoral financial balances were negative from about 1981 to 2001. Since then, they have become positive, but in two distinct phases, with somewhat different drivers.
In the first phase, 2001-2007, the main driver was rising corporate savings. In the second, post-2008, phase, while rising savings remained a key factor, the weakness of corporate cap-ex was more marked.
In the first phase, the improved corporate sector balance was primarily off-set by deteriorating household sector balances. In the second phase, it was mainly the public sector that bore the brunt of the adjustment.
We are currently in a world where all domestic sectors – at least in advanced economies – tend to pursue an ex ante savings surplus. Unless the emerging world (40% of global GDP) accommodates this by accepting a deteriorating current account balance, this trend implies continued slow global activity.
On the basis of sectoral financial balance developments, it therefore seems that the best way forward for the world would be to accept a temporary deterioration in advanced economy public sector financial balances, preferably combined with an attempt to make the corporate sector reduce its surplus.
If the corporate sector does not of its own volition reduce its surplus, there are a number of possible policy tools that can be used as inducements to attempt to achieve the same result.
The European Commission decided against fining Spain and Portugal for their persistent fiscal deficits, with Pierre Moscovici, EU economy and finance commissioner, hinting that the decision was partly influenced by the rising Euroscepticism across the continent. Nevertheless, the zero fine was accompanied by tighter fiscal targets for both countries, which we believe are not likely to be met, especially in Spain.
Meanwhile, on the data front, the EC’s Economic Sentiment Indicator rose marginally in July, confirming that the sentiment in Eurozone has not been strongly affected by Brexit. This start to the Q3 survey data appears to indicate that the economic rebound in H2 will only be marginally affected by the Brexit-related uncertainty.
As expected, the FOMC kept rates unchanged. The key change to the policy statement was the insertion that "near-term risks to the economic outlook have diminished." This, coupled with a more upbeat view of the economy, supports our forecast that the FOMC raises rates as soon as September.
The FOMC refrained from providing a clear signal as to the timing of the next rate increase. We did not expect the Fed do so, since telegraphing the possibility of an imminent rate hike in the spring proved premature.
Reflecting firmer economic data, including the strong June non-farm payroll and retail sales data, Fed officials painted a more upbeat view of the economy.
In particular, policy makers pointed to further tightening in the labor market.
The Fed funds futures market now sees odds of a September or December rate hike at 26.4% and 45.2%, respectively.
Not surprisingly, Kansas City Fed President George once again dissented in favor of an immediate 25 basis point rate hike.
June plunge in civilian aircraft orders rendered a whopping 4.0% decline in June durable good orders. Excluding civilian aircraft and related parts orders durable good orders would have risen by 0.2%.
our July global macro chartbook we summarise key global themes
and our asset views. We also highlight contributions of our recent research.
Much of the focus in Saudi Arabia has been looking at the impact of a plunging oil price on a deteriorating public finance position. But we believe it is also important to analyse a worsening balance of payments situation, and predict future trends based not only on changes in the oil price but also due to the implementation of the country’s Vision 2030, post-oil plan. Our main conclusion from the analysis is that Saudi Arabia should not only maintain adequate foreign reserves, but that pressure on its currency peg will be limited and that growth will steadily recover, though it does leave the Kingdom more vulnerable to renewed external shocks.
The overall balance of payments plunged into its first deficit since 2009 last year at US$115bn. A 47% drop in the oil price saw the current account post a deficit of US$53bn, its first since 1998. The financial account was in deficit at US$62bn, resulting in net foreign assets falling to US$609bn by end-2015. We see the overall balance of payments in deficit by a further US$111bn in 2016.
But the outlook looks more promising over the medium-to-longer term. Not only will a gradually rising oil price narrow the current account deficit, but other developments are forecast to be increasingly positive, too. These include reforms to boost non-oil exports, FDI and portfolio flows, and a switch increasingly to financing the budget deficit via international bond and syndicated loan issues.
We see the current account deficit moving into broad balance by 2020, with surpluses thereafter. The financial deficit is forecast to halve between 2016 and 2020 and continue to decline. The overall balance of payments is projected at just US$35bn in 2020, around one third its size in 2016. This will mean that the pace of decline in net foreign assets will slow and still represent 17 months of import cover and 125% of GDP in 2020. Furthermore, in the longer term, it is likely that the creation of the world’s largest sovereign wealth fund and partial sale of Saudi Aramco will have additionally positive impacts on the balance of payments.
Positive data on the monetary front today. Both money and loan growth in the Eurozone picked up in June. Meanwhile, credit flows to the private sector also increased over the previous month on the back of strong numbers for household lending. Overall, figures continue to show that the healing process of lending in the Eurozone, although uneven, remains in place.
Consumer sentiment indicators for Germany, Italy and France corroborate the notion suggested by the data published last week that the confidence shock stemming from Brexit has been, so far, rather tame. In Spain, retail sales for June confirm that consumers continue to ignore the country’s political turmoil.
As expected, the preliminary estimate for Q2 GDP came in strong with quarterly growth of 0.6%. But this was largely due to an exceptional April performance, after which there was a notable loss of momentum.
The weak May and June mean a soft launchpad for Q3 even before the impact of Brexit is factored in. Therefore, the stronger Q2 is likely to represent one last hurrah before the economy enters a softer and more turbulent period.
We use a ‘scenario tree’ approach to look at the possible outcomes of the negotiations around the UK’s exit from the EU. Given how little common ground there is between the two sides, we find that a relatively loose relationship is the most likely outcome, with the UK set to leave the EU by mid-2019.
The negotiating positions of the UK and EU are diametrically opposed. The UK wants to end the free movement of labour, cease making contributions to the EU budget and regain ‘sovereignty’ from Brussels, while retaining as much access to the single market as possible. But the EU’s starting position is that single market access is dependent upon agreeing to the four freedoms and that this is non-negotiable.
So far all signs are that the UK will prioritise the ability to control immigration over single market access. Thus the EEA and EEA-minus options are very unlikely to be viable over the longer-term – our scenario tree analysis gives them a probability of just 6% and 12% respectively – though these may be adopted as an interim step.
If the EU takes a mercantilist approach, it will have little incentive to come to an agreement with the UK over single market access for services, given the UK’s large trade surplus with the EU for these activities, implying that UK firms may face growing non-tariff barriers after the UK has left the EU. The UK’s large deficit on goods trade with the EU gives a better chance of agreeing a FTA for goods, though with any FTA requiring agreement from all 27 members, the UK would have to be prepared for lengthy negotiations and make extensive concessions. Therefore, we think that a reversion to WTO rules (40%) is slightly more likely than agreeing a FTA (37%).
A relatively quick Brexit would appear to benefit all sides because it would reduce the degree of uncertainty and mean that the UK leaves the EU prior to the 2019 elections for the European Parliament and the 2020 UK General Election.
CPI inflation rose by only 1% y/y in Q2 and is forecast to remain below target for much of 2016. The weak CPI outcome supports our view that the RBA will cut interest rates in August to a fresh record low of 1.5%. Another interest rate cut cannot be discounted but see limited room for more stimulus. Instead fiscal policy, in the form of government investment, needs to do more to support domestic demand.
There are seven caveats signalling current equity prices have outrun underlying macro fundamentals. Foremost, while equity bulls cheer the latest strength in the macro data since it could boost corporate revenues, this also provides reason for the Fed to raise interest rates more than the market expects. Equity prices will likely pull back moderately in H2 2016.
Low interest rates have helped propel equity prices higher as S&P 500 dividend yields have outstripped bond yields. If interest rates start to rise, this will dampen some of the current capital flows from bonds into stocks.
Similarly, as the labor market has reached full-employment, workers' wages should continue to rise. This places downward pressure on profit margins. The positive offset is that productivity growth should rebound as well, but it may lag behind.
We believe equity bulls are overestimating the strength of the economy following the strong gains in June non-farm payrolls and retail sales. While economic growth is rebounding from the languid Q1 performance, we expect it to average around 2.5% for the remainder of this year. While this is rapid enough to persuade the Fed to raise rates, it is not strong enough to spur a sharp upturn in corporate revenues.
With the Fed raising rates while other major central banks are leaning in the other direction, the dollar likely appreciates further. This is another headwind for equities.
Sluggish global demand should continue to weigh on exports and corporate earnings.
We do not anticipate support to equities from a further expansion in PE ratios at this mature stage of the business cycle.
However, improved credit conditions should provide downside support in the near-term, while a rebound in productivity growth should provide medium-term support.
Economic activity expanded by 1% on the month in May recovering most of April's lost ground (-1.2% m/m). Yet, we think GDP growth will slow to 2.2% y/y in Q2, from 2.8% in Q1. For 2016 as a whole, we forecast GDP will grow by 2.4%.
On the external front, the trade deficit of US$7.2bn in H1 was in line with our forecast. For the remainder of the year, we expect both exports and imports to contract sharply, taking the trade deficit to its highest level since 2008.
Consumer Confidence Index essentially unchanged at 97.3 in July. Current Conditions remain strong and should support consumer spending, concerns about six-months expectation less volatile with news cycle.
Policy simulations using the Oxford Economics Model suggest that the combined effect of monetary and fiscal ease would give a major temporary boost to growth. But the fiscal effects inevitably fade and a lower exchange rate has a significant influence on outcomes.
As the UK prepares to leave the EU, we look at contrasting experiences of three EFTA members (one of them former): Norway, Switzerland and Austria. Focusing on the latter two as counterfactuals, we find that Switzerland's delayed participation in the single market led to meaningful productivity losses, while Austria's EU accession was accompanied by restructuring and competitiveness gains, leading to stronger economic growth.
Rather than a conscious policy choice, the respective modes of cooperation in Norway and Switzerland were a consequence of circumstances. Both applied to join the EU along with three other EFTA members, but failed to do so as a result of their referenda. Norway was left with a single market membership (EEA), while Switzerland, where even the EEA was rejected, had to go through seven years of negotiations of piecemeal bilateral agreements.
Switzerland's delayed and partial integration with the EU appears to have entailed productivity losses. In Austria, in contrast, EU membership and associated reforms have boosted productivity and added around 0.5pp to its annual GDP growth in the first decade of membership. Later studies suggest this gain has risen to a 1pp gain.
The risk of productivity losses is exactly what has been flagged in various ex ante studies on Brexit. The available historical evidence from Switzerland seems to suggest that pursuing a route of protracted bilateral negotiations and compromises would represent a step back for the UK economy.
However, neither the Swiss nor the Norwegian options seem acceptable to the UK given their embrace of all four freedoms, including free movement of people. This makes it more likely that the eventual agreement may end up being more restrictive for the UK and hence entail higher productivity losses.
The European Commission will decide tomorrow whether to fine Spain and Portugal for their failure to tighten fiscal policy as requested. But the maximum 0.2% of GDP fine seems unlikely, as Italy and France are likely to oppose it.
Italy has created a second private sector bank rescue fund: Atlante 2. With an expected €4bn of capital, the fund should help recapitalise Monte dei Paschi di Siena (MPS) with minimal public funds.
The EU refugee-deal with Turkey continues to hang by a thread with Turkish President Erdogan accusing the EU of not sticking to its promises.
Following an upwardly revised Q1, GDP growth accelerated in Q2 supported by a rebound in consumption and solid pick-up in capital investment.
Looking ahead, the outlook for H2 is clouded by the ongoing corporate restructuring drive in Korea and a challenging external outlook.
The FOMC will stand pat this week. However, we see high odds of a rate hike at the September 20-21 meeting since the labor market is back to full employment, inflation readings are firming, growth is poised to be 2.5% on average Q2-Q4, and strains in the credit markets have eased.
The immediate market tumult following the post-Brexit vote and the rising uncertainty surrounding the global economic outlook have kept the Fed in a watch and wait mode.
However, with financial markets settled and many policy makers expecting little medium-term impact from Brexit on the US economy, this should not be a constraint to Fed tightening.
The bond market is pricing in rising probability of a rate hike by year-end, though the odds are still below 50% at this point.
The FOMC only publishes its policy statement on Wednesday – there will be no updates of macro forecasts, dot plot estimates or press conference.
We do not expect the Fed to telegraph in its forward guidance that an imminent rate hike is coming since doing so in the spring proved premature.
The policy statement should include a more upbeat assessment of overall economic conditions, particularly with regards to the labor market in light of the strong rebound in job gains in June. Moreover, inflation readings are firming.
A key concern for the Fed as it considers a prospective rate increase will be how the dollar reacts. A surge in the value of the dollar could forestall rate increases.
The disappointing performance of many activity indicators justifies the RBI’s accommodative policy stance. But with inflation hovering around the upper end (6%) of RBI’s target range and monsoon-related risks lurking in the background, we expect it to err on the side of caution and keep interest rates on hold until the risks to inflation appear more balanced. But the prospect for further easing now also depends on the leanings of the incoming RBI Governor; however, the government has yet to make an announcement on the appointment.
Indeed, political developments are a key focus at the moment: PM Modi has reshuffled his cabinet (affecting some key portfolios) this month and efforts to pass the Goods and Services Tax (GST) bill have also intensified. An increasing number of state governments are now supporting the GST and expectations of the bill being passed in the monsoon session of the Parliament have risen. However, we remain cautious.
We expect GDP growth of 7.5% this year, led by private consumption, but we remain concerned by the sluggish performance of investment.
June data hint at the start of a general improvement in regional trade across Asia, with export volumes higher than a year earlier for an increasing number of countries. However, looking forward, the recovery is likely to be modest – given the subdued prospects for US, Chinese and EU import demand – and vulnerable to setbacks, particularly in the next couple of quarters. Nevertheless, it is a less gloomy background than has generally been the case over the last 18 months.
July’s modest fall in the German Ifo survey confirms that the initial impact of the UK referendum on Eurozone business and consumer sentiment has been small. This support our view that further ECB action is far from inevitable –a view which Governing Council member Ewald Nowotny appeared to echo on Friday when he noted that QE changes in September were unlikely.
Our Economic Presidential Election Model shows Democrats earning 50.5% of the two-party votes in the upcoming presidential elections.
Solid growth in real disposable, modest inflation and a low unemployment rate are the main factors giving the slight economic edge to Mrs. Clinton.
Monthly economic data suggest that growth may be gaining some momentum. Exports in US$ terms maintained their recent upward trajectory in June while household spending indicators picked up. With regard to the second half of 2016, although prospects for exports are clouded by heightened global uncertainty, we believe that domestic growth will be supported by healthy private consumption and higher infrastructure spending.
Having implemented 100bp of easing in H1, Bank Indonesia’s policy stance during H2 will be influenced by how markets respond ahead of the next US interest rate hike, which we expect in September. Meanwhile, the latest data do not warrant any immediate action from the central bank. As such, unless there is evidence that the domestic economic recovery is suddenly losing momentum, we do not expect the central bank to unleash further easing in the next couple of months.
Although the Eurozone PMIs weakened slightly in July, the fall was much smaller than anticipated by most in the wake of the Brexit vote. Accordingly, we maintain our view that, after a sluggish Q2, growth in the Eurozone should remain fairly solid in the second half of the year.
The manufacturing PMI fell sharply in July but activity in the services sector showed remarkable strength and remained broadly unchanged over the previous month. Once again, the Germany’s service index very strong, reaching the highest level in over two years, as the European locomotive shrugged off Brexit woes. Growth in France, on the other hand, remains weaker, although the composite PMI climbed to 50 points.
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