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The BCB cut the Selic policy rate by 25bp to 14% this week – the first rate cut in four years. We believe the Copom will lower the policy rate by an additional 50bps in November as inflation will continue to fall and the government is likely to approve a 'spending cap bill' in Congress before their next meeting.
With both inflation and economic activity falling at the margin, we forecast a total loosening cycle of 300bp by Q2 2017, taking rates to 11.25%. Meanwhile, we only expect inflation to converge to the 4.5% target by Q2 2018.
Canadian policy makers are facing mounting opposition to trade deals in their top two foreign markets. Failure to ratify new trade agreements will limit the potential upside of export growth in coming years.
The consumer took centre stage this week. September’s retail data saw sales volumes remain flat for a second successive month, though over the course of Q3 as a whole sales were up 1.8%, the strongest outturn since late-2014. This will help to ensure that next week’s preliminary estimate for Q3 GDP growth remains comfortably in positive territory.
Both the retail sales and inflation releases suggested that price pressures are on the turn. We expect CPI inflation to accelerate sharply from this point onwards, averaging 2.7% in 2017. This will severely squeeze household spending power and cause spending growth to slow sharply.
The labour market release was a mixed bag, with the level of unemployment rising slightly compared with three months earlier, but employment also increasing.
After the volatility of the previous couple of weeks, financial markets have been calmer over recent days. But with sterling now 18% below 23 June levels against the dollar, November’s MPC decision is no longer a foregone conclusion.
We judge the risk of recession to be unchanged from last week at 20%.
The ECB’s survey of professional forecasters showed that short-term inflation expectations have edged down further. Economists now see 2018 inflation at only 1.4%, rather than 1.5% previously, as they expect 2018 growth to be weaker (1.6% rather than 1.7%) and the output gap to close more gradually.
The controversial EU-Canada comprehensive trade agreement (CETA) has hit another roadblock, as the Walloon government in Belgium continues to reject the deal. This makes it highly unlikely that the deal can be ratified before the EU-Canada summit on 27 October. Meanwhile, we expect DBRS – the only agency that rates Portugal above junk status, thereby ensuring its eligibility to QE – to reaffirm its rating today.
A fiscal deficit of £10.6bn in September was the highest for that month in two years and left borrowing in the fiscal year-to-date only 5% down on the level in the same period in 2015-16.
So the OBR’s expectation for borrowing this fiscal year is looking more unattainable even before a likely downgrade to its growth forecast in the Autumn Statement. But with gilt yields still exceptionally low and the private sector at risk of retrenching, the case for a fiscal stimulus remains strong.
The central bank of Turkey (CBRT) unexpectedly paused its easing cycle today, leaving all its rates unchanged for the first time in eight months.
President Draghi was very tight-lipped at the ECB’s latest press conference and some long monologues on the detail of the recent Bank Lending Survey were reminiscent of a US Senate filibuster. While Draghi did not rule out any action in December, the reluctance to provide guidance on the form of any policy action at the next meeting is perhaps a sign of large divisions within the Governing Council over what the next step should be.
Based on Draghi’s latest communications, the ECB remains in data-dependent mode. We remain comfortable with our out-of-consensus assessment that the ECB will taper QE beyond the current March 2017 termination date.
Against our expectations and those of the markets, Bank Indonesia (BI) lowered its new policy tool – the 7 day reverse repo rate – to 4.75% at the October policy meeting. The move, the sixth rate cut this year, was facilitated by calm financial markets and low inflation but also perhaps spurred by concerns about the strength of the domestic economy.
However, going forward, we continue to expect that Indonesia's policy path will be largely determined by the US policy outlook. And as we expect the Fed to hike in December, we think that BI will now keep interest rates on hold.
Today’s fall in the euro dollar exchange rate suggests markets are expecting ECB President Draghi to signal decisive action in December later today. Our expectation is for more QE in the form of tapering from next March, less than the market is expecting.
The Eurozone current account surplus rose to €29.7bn in August due to further rises in the trade surplus and FDI inflows.
Though retail sales were flat in September, over Q3 as a whole they were up by 1.8%, the strongest performance for seven quarters.
But the strength in retail sales volumes has been largely founded on deep discounting. We are now moving away from this environment, with the sharp depreciation of sterling increasingly feeding through to prices. This is likely to mean that the strong Q3 data represented one last hurrah for the high street.
Our analysis of long-term potential output suggests that Chile, Colombia and Peru are best-placed to deliver the strongest catch-up stories in Latin America. On the other hand, we have downgraded our long-term outlook for Mexico on the back of lower potential growth in the US. As such, we now see the region's second largest economy stuck in a sort of middle-income trap.
Meanwhile, Brazil and Argentina, the other two large economies in the region, are expected to catch up only very slowly with the more advanced economies in the coming two decades. Their inability to maintain a stable macro framework and to use the commodity-related revenues from the 'boom' years to boost their capital stock and total factor productivity (TFP) mean that these two countries have actually damaged their potential growth. Thus, although we forecast some catch up from current levels, their GDP per capita relative to that of the US will still be lower in 2036 than it was at their respective peaks of the early 2010s.
Venezuela is in a league of its own. A prolonged period of disastrous economic policy has undermined the potential of both the oil and non-oil sectors. So much so that by 2036 it may be the poorest of the major Latin American countries, having been the richest nation in the region in the 1990s.
Overall, our new estimates put Latin America's potential growth at 2.3% per year in 2017-26, which represents a marked slowdown from the 3.2% pace seen in 2005-14. Weaker growth from key trade partners, such as the US and Europe, and smaller gains from terms of trade will constrain TFP and capital accumulation in the coming decades. However, the key factor behind the slowdown in potential output in the long term will be demographics, as most LatAm countries will not be able to add as many workers to the labour force going forward as they did in the past two decades.
On the back of a downward adjustment to our forecast for total factor productivity (TFP) growth in 2016-25, we have lowered our estimate for Dutch potential output growth over the next decade from 1.4% to 1.1%. As a result, we have also cut our GDP growth forecasts by a similar amount.
Since its nasty "double-dip" recession, the Netherlands has staged a relatively robust recovery. Here, we take stock of the permanent damage to potential growth from the "Great Recession" and assess the medium- and long-term growth prospects.
There seems little evidence to suggest a rise in the structural unemployment rate or a permanent decline in labour supply following the crisis. Furthermore, demographic trends up to 2025 are slightly better than the Eurozone average. This should ensure that labour's contribution to growth picks up over the next decade.
Since the global financial crisis, capital has boosted potential GDP growth by a solid 0.6pp a year. Looking ahead, we expect fixed investment growth to ease after the recent period of strength. But more importantly, the depreciation rate will remain high by historical standards, meaning that the capital stock will grow at a slower pace than in 2008-15 and boost potential output by only 0.4% per year.
Finally, we expect the sustained weakness of TFP growth, which was a feature of the economy even before the onset of the global financial crisis, to continue. We now expect TFP's contribution to annual potential growth over the next decade to be 0.4pp on average, down from our earlier estimate of 0.7pp. But this still represents a modest improvement from the weak contribution of 0.1pp between 2007 and 2015.
Policymakers could raise potential growth via growth-enhancing reforms. But the easiest option, namely labour market reform, has been largely exhausted and on balance the risks to our forecasts still lie to the downside. Secular stagnation, which implies no rebound in productivity, could mean that the potential growth might even be below the already-low 1.1%.
The Bank of Canada left the policy rate at 0.5% but marked down its growth forecast. We expect the Bank will keep the policy rate on hold through 2017 to support stronger growth. We continue to expect that the next move will be a rate hike in Q1 2018.
Yesterday, in a widely expected move, the board of the Chilean central bank (BCCh) decided to leave its key policy rate on hold at 3.5%.We maintain our call that interest rates will remain at 3.5% in the final two months of 2016 and throughout 2017 – provided that the economy does not show further signs of weakness and inflation expectations remain well-anchored.
The latest monthly indicators have been mixed, indicating that the recovery is still shaky. External trade data, though dragged back by temporary factors, took a turn for the worse in September, while the manufacturing PMI fell to its lowest level in 14 months. However, consumer confidence remained quite solid in September, which points to continuing robust retail sales growth.
The economy faces several headwinds. In addition to the uncertain external situation, the ongoing corporate restructuring in parts of industry could have unexpectedly serious fallout (such as a protracted rise in the unemployment rate which would have the potential to weigh on consumer spending). Thus, while we do not expect the central bank to cut interest rates in the coming months, any serious derailing of the domestic recovery would trigger further easing from the central bank.
Although the ECB’s October meeting is the focus of attention in the Eurozone this week, trade ministers from EU member states are meeting in Luxembourg in an attempt to ratify the CETA trade deal with Canada. But due to ongoing opposition from Belgium, any decision has been pushed back to Friday.
Meanwhile, construction recorded a monthly contraction in August, declining by 0.9%. However, as the fall follows a sharp 1.5% jump in July, it does not alter our view of relatively strong growth in the Eurozone in Q3.
Real GDP growth held steady again at 6.7% y/y in Q3 and nominal GDP growth increased. In addition, investment momentum has improved in recent months amid a stronger property sector. However, industrial production slowed in September, underscoring that downward pressures on growth remain.
While the GDP growth target for this year is “in the bag”, the big question going forward is whether the authorities will eventually start to rein in the pace of credit expansion. While there are no signs of this happening yet, we do think that the likelihood of a shift in macro policy will rise over time. This would mean lower but more sustainable growth in the coming years.
Labour market data for the three months to August saw little in the way of noticeable developments. The LFS unemployment rate was unchanged at 4.9% and pay growth remained subdued.
The failure of earnings growth to respond to a tight jobs market means that rising inflation will exert an increasing squeeze on living standards. But fears of a sizeable post-referendum hit to employment are looking misguided.
Germany remains on track to grow at a solid pace in the near term before slowing in the medium term as capacity constraints start to bite. Business surveys appear to paint conflicting messages about the near-term outlook, but for now we think that the weak PMI survey probably paints an overly gloomy picture of growth. Meanwhile, the activity data overall suggests that the recovery may have picked up a bit of momentum in Q3 – our GDP indicator is consistent with growth of 0.4-0.5% in the quarter, compared with 0.3% in Q2.
But while our GDP growth forecasts for this year and next – at 1.8% and 1.5% – are unchanged, we have lowered our assessment of the medium- and longer-term outlook. With GDP set to rise above potential next year and our average annual potential growth forecast for the next decade or so revised down to only about 1%, we expect growth to ease sharply to just over 1% in 2018-19 and then fall below 1% in the early part of the next decade.
September CPI up 0.3%, slightly more than expected while core prices rose 0.1%, slightly below expectations. We expect that the FOMC will have further confirmation of progress on both inflation and employment by the December meeting, enabling it to tighten policy at that time.
The recent activity indicators suggest that the economy has slowed a little in recent months, with the manufacturing and services PMIs both in contractionary territory in September (49.8 and 48.9 respectively). But there are positive signs in the consumer sentiment survey and recent export data, and we expect the pace of activity to accelerate in the coming quarters, supported by one final interest rate cut from the RBA (expected in November). GDP growth is still seen at 2.9% this year and 2.7% in 2017, with potential growth over the next decade estimated at 2.4% pa.
Plentiful natural resources and commodity-hungry China have buoyed Australia's economy over the last 15 years. Moving into the next decade this channel will offer less to economic growth, but favourable demographics and good policy will enable the non-mining sector to pick up the slack. As a result, Australia is set to out-perform most developed economies in the long run.
Australia's substantial endowment of natural resources and the capital investment needed to exploit it have driven potential output growth over the last decade.
The economy has also been supported by high rates of net migration, which has led to a relatively rapid expansion in the work force, government investment in infrastructure, a well-developed financial system and benign institutional environment.
The sharp slowdown in mining sector investment in the last couple of years means that capital accumulation will contribute much less to supply side growth over the next decade. But further increases in output in the sector (which will drive productivity growth), continuing favourable demographics, human capital improvements and technological progress will limit the slowdown in growth of the economy's supply side capacity over the next decade. We expect Australia's potential GDP to rise by 2.4% pa over the next decade.
September’s sharp rise in inflation is likely to mark the start of a steep ascent, which will likely see the CPI measure peaking above 3% in the middle of next year. The initial momentum will come through base effects but the main thrust will come from the pass-through of the sharp depreciation of the pound. However, inflation is likely to then fall back rapidly in 2018 to average 2.2%.
The CPI measure of inflation reached a near two-year high in September. This was partly a function of last autumn’s sharp falls in petrol and energy prices dropping out of the calculation, but it also reflected a continuation of the recent pickup in core pressures.
The degree to which inflation accelerates from this point will depend upon the pass-through of the weaker pound. The literature suggests that the maximum impact on inflation will come after a year, but there is some variation in the estimates of the degree of pass-through. Studies conducted over a long period suggest the degree of pass-through may have become smaller over time.
We expect the weak economic backdrop to limit the extent to which the weaker pound pushes up inflation, though we still see the CPI measure averaging 2.7% in 2017, with a brief period in the middle of the year where inflation exceeds 3%, hastening a letter of explanation from the Governor of the Bank of England to the Chancellor. However, we would not see this prospect as a serious impediment to a further rate cut, given that the MPC has made it clear that it is prepared to tolerate such an overshoot.
Inflation should then drop back through 2018 as sterling recovers and the 2017 acceleration provides powerful base effects. This is somewhat at odds with the Bank of England’s latest forecast, which shows inflation lower in 2017 but then accelerating in 2018, implying a much more protracted pass-through.
The ECB bank lending survey for Q3 showed that demand for loans continued to increase in the Eurozone, primarily driven by the low level of interest rates. But the reported planned tightening in credit conditions for firms in Q4 is a bit of a worry and perhaps increases the chances that further measures from the ECB to boost the supply of bank credit will eventually be forthcoming. Finally, suggestions from the banks that asset purchases have hit profits may diminish support within the ECB for a continuation of QE in untapered form.
CPI inflation reached a 22-month high of 1.0% in September, pushed up by base effects and stronger core pressures.
This is likely to mark the beginning of a steep upward trend in inflation, as last autumn’s falls in food, petrol and energy prices continue to drop out of the calculation and the impact of the sharp depreciation of the pound steadily feeds through.
We present a detailed study of developments in capital flows to emerging markets (EMs) over recent years, especially the slump in inflows from 2011-16. The drop in inflows was large, involved all categories of flows and occurred across a wide range of countries. A recovery has been underway since Q2 2016 but examination of key drivers of inflows and of episodes of past recoveries suggest the current recovery in not certain to continue.
We identify four ‘waves’ of capital inflows to EMs since the 1980s, consisting of surges followed by slowdowns, with the latter generally of long duration at 5-7 years. In these periods, different kinds of inflows – FDI, portfolio investment and bank and other flows – have often moved together but have not been fully synchronised.
The scale of slump in inflows from 2011-16 was, at 7% of EM GDP, very large by historical standards, larger than the declines seen in 1996 or the 1980s. Furthermore, inflows remain depressed around the trough for longer than any previous slump. It culminated with capital inflows to EMs falling to 1% of EM GDP, the lowest level ever.
This slump affected virtually all EMs. It affected even those non-commodity oriented countries experiencing positive terms of trade shocks. It also affected all types of flows including FDI, in contrast to previous episodes and was divided into two distinct phases – the first featuring lower cross-border bank flows, the latter lower portfolio investment.
Following the long slump of 2011-16, capital Inflows have been recovering for six months. But we cannot be certain this recovery will continue: yield attraction may not be enough if commodity prices weaken again, or risk appetite wanes. Analysis of past recoveries in inflows suggests that if the recovery lasts for four quarters or more, it has a good chance of sustaining for several years – on this basis, the ‘make or break’ point for the current recovery could come around Q1/Q2 2017.
Industrial production edged up in September, driven by manufacturing and mining output. In Q3, industrial production was up 1.8%, the largest increase since Q4 2014.
The government has announced its 2017 budget, which projects the budget deficit falling to 2.7% of GDP from 3.3% this year, and below the 3% target of the Stability and Growth Pact. The decline will be helped by spending cuts focussed on central government and social security, but the target could be missed if economic growth comes in lower than the government’s relatively optimistic assumptions.
Our GDP growth forecast is unchanged at 1.3% this year with high frequency data pointing to a rebound in both household spending and investment in Q3, rising to 1.5% in 2017. However, we have lowered our long-term outlook for potential growth to 1.1% from 1.3% due to a smaller contribution from capital accumulation and thus a slower rise in total factor productivity going forward.
The pick-up in Government borrowing costs since August, a development which has accelerated in recent days, has been interpreted by some as heralding a loss of confidence in the UK economy.
But there are good reasons to avoid alarmism: (i) yields remain below their level on 23 June, in contrast to other major economies, (ii) the cost of borrowing is still remarkably low by historical standards, (iii) the increase in yields since August is entirely accounted for by a rise in inflation expectations, not real rates, and (iv) rising yields have been accompanied by rising equity prices.
With no action likely at the October ECB meeting, the key focus will be on what signals President Draghi provides about any action in December. We expect no clear hints – Draghi will probably say that no decision has been taken and that the ECB’s next move will depend on data developments.
Annual consumer price inflation in the Eurozone was confirmed at 0.4% in September. We believe that this is the start of an upward trend.
Italian exports increased by 2.6% on the month in August. But we still expect net trade to be a drag on growth in Q3, after a strong Q2.
External trade slowed in September, with lower energy shipments dragging USD exports down on a year ago again. However, the deceleration was not strong enough to stall the upward growth momentum. Also, real exports recorded positive growth for the second consecutive month.
Though exports remained below year ago levels in Q3, the pace of contraction eased in line with our expectations. We expect the improvement in export growth to continue into the final quarter of the year. But against the backdrop of gradual global trade recovery, we remain cautious about the pace of improvement.
September's trade data suggests that exports ended Q3 on a positive note with the possibility that Q3 GDP growth was not as weak as the advance estimate indicated. Nonetheless, we still look for growth to have contracted in the last quarter and a technical recession cannot be ruled out. Against this backdrop, we continue to see room for the MAS to ease policy and we also expect further action on the fiscal front to support domestic demand.
Despite the pick-up in GDP in Q2, there have been renewed signs of weakness in Q3. As a result, we have held our forecast for GDP growth in 2016 at 0.1%. For 2017, we project growth of 1%, followed by 2-2.5% a year in 2018-19.
With headline inflation in August falling into the central bank's 3-6% target range for the first time this year, we have lowered our forecast for average inflation in 2016 to 6.4% (previously 6.8%). However, base effects will see inflation rise again in the coming months, with additional upward risk stemming from ZAR depreciation. As such, we maintain our baseline scenario for a 25bp rate rise by end-2016.
The Italian economy stagnated in Q2, with quarterly GDP growth confirmed at zero, after growth of 0.3% in Q1. The recent indicators for Q3 are mixed. Survey indicators have been quite soft, with the composite PMI for Q3 slightly lower than in Q2, due to weaker manufacturing numbers. However, industrial production has been quite strong, growing by 0.7% m/m in July and 1.7% m/m in August. This represents an upside risk to our quarterly growth forecasts, still seen at 0.2% for Q3 and Q4.
We see GDP growth of 0.8% in 2016 and 0.9% in 2017. But there are some downside risks to our forecast for next year, if the constitutional referendum in early December does not pass.
As expected, the Peruvian central bank (BCRP) decided to leave interest rates unchanged at 4.25% at its October meeting.We remain confident that diminishing upside risks to inflation coupled with an expected economic recovery over the next few quarters will mean that the BCRP stays ‘on hold’ over the next year.
Retail sales rebounded in September, but core sales momentum has slowed. We expect real PCE to have risen 2.7% in Q3, moderating from 4.4% in the prior quarter, but remaining solid overall and continuing to be the main driver of real GDP growth. Our estimate for Q3 GDP growth is 2.4% annualized.
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