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The FOMC minutes from the September 16-17 meeting underscored policymakers’ prudence in the face of global headwinds. However, most participants noted that conditions for policy firming had been met or would likely be met by the end of the year.
We maintain our expectation for a December rate liftoff but acknowledge the downside risks to growth and inflation. As such, we place the odds of a December decision at 55%.
Although China’s stock market turmoil and exchange rate depreciation shook global markets and sentiment, China’s economic slowdown so far this year has been gradual instead of steep. Data problems possibly qualify the picture from the official data but do not overturn it. Growth is likely to weaken into 2016, though we expect a soft landing, secured by further policy easing.
This was a very vague set of minutes, with the Committee reluctant to draw conclusions about recent developments until they have been through next month’s Inflation Report forecasting process. As such, there is no reason to revisit our call that the first hike will come in May 2016.
Hints that some members had become more concerned about global growth prospects gave the minutes a slightly dovish tilt, even though domestic prospects remained solid. But the desire to defer any serious discussion until the November meeting confirms that the proposal to reduce the number of meetings from 12 per year to 8 is unlikely to have a material impact on decision-making.
Consumer price inflation was unchanged at 9.5% y/y in September, but we expect price pressures to intensify on the back of further depreciation of the real. We have revised up our 2015 and 2016 inflation forecast, to 9.6% and 6.6%, respectively.
The central bank finds itself in a challenging situation, having stated – optimistically – that interest rates are at a level consistent with inflation converging to target. We think interests rates will stay on hold until Q4 2016, but think there is a significant possibility that rates could be forced much higher.
We focus on the long-run outlook for Russia and conclude that its growth potential is under threat from a number of key factors. These include a dearth of investment, which will be held back by lower oil prices, sanctions, and a lack of structural reforms.
Based on detailed analysis, we have lowered our forecast for Russia's potential growth over the next decade from 1.7% pa to 1%. With oil prices expected to remain lower for longer, Russia's insufficiently diversified economy will struggle to find new drivers of growth.
Adverse demographic trends will be a drag on potential growth, while a weaker investment climate will deprive the economy of crucial technological transfers and investments needed to fuel growth through capital accumulation. Meanwhile, stalled reforms will translate into slower productivity growth over the next decade, eroding an important source of the economy's potential growth.
With elections around the corner, policymakers were surprisingly swift in passing a short-term continuing resolution to fund the government through mid-December.
That’s good news as it pushes back the spectre of another government shutdown. The bad news is that the deadline has only been pushed back to early December and that it will coincide with the need to raise the debt ceiling –which could spell trouble for the US economy and financial markets.
Overall, government finances appear much healthier than a few years back with the federal budget deficit expected to fall to 2.5% of GDP in fiscal 2015. However, increased pressures on outlays – including interest rates – over the longer-run will push the deficit and debt ratios up.
External and domestic activity indicators have diverged in recent months, with exports remaining weak in Q3 but domestic demand picking up – helped by loose policy and the resumption of normal spending patterns after the MERS outbreak. However, some of the weakness in US$ export values is explained by lower prices for commodity exports and indeed export volumes have been subdued this year rather than fallen sharply. And there are signs of improvement, with electronics and auto exports gaining in September and ICT equipment investment rebounding. Looking forward into 2016, exports should gradually build momentum, helped by solid US and EU demand and hopefully less of a drag from China. Against a background of volatile financial markets, the won has depreciated against both the yen and the US$ and we see the won staying weak in the coming months. But provided the global outlook improves, Korea’s large external surplus and solid macro fundamentals should drive an appreciation of the won over the medium term. The Bank of Korea (BoK) has cut rates by 100bp since mid-2014 and we now expect rates to be left on hold until early 2017. However, a severe slowing in China or an aggressive expansion in Japanese quantitative easing would undermine the fragile recovery. In such a scenario, the BoK would act to boost the economy.
After showing some unexpected resilience over the previous months, August industrial production numbers for both Germany and Spain finally started to reflect the impact of the adverse global environment on European businesses, with industrial output plummeting in both countries. While monthly industrial data is noisy by nature, the latest numbers combined with the factory orders and PMI figures released earlier this week corroborate the notion that the recovery in Europe is likely to be driven by consumers and the services sector for the time being.
Having shrunk in July on a monthly basis, manufacturing output saw a surprise spurt in August, rising by 0.5%. And overall industrial production put in an even better performance, up by 1%. However, base effects played a role in boosting output. And with sluggish overseas demand and domestic activity weakening recently, the performance of the ‘makers’ in Q3 overall looks like having been a soft one.
Strong dollar and weak foreign demand lead to sharply wider deficit. Looking ahead, exports are expected to remain weak while imports will grow on the back of resilient domestic demand. Net trade will drag on real GDP growth through the rest of the year and into 2016.
Indications are that oil production was well in excess of 10m b/d for a seventh successive month in September at 10.3m b/d and we expect the Kingdom to remain committed to the OPEC policy of preserving market share. The authorities believe the policy is working, with slower growth in non-OPEC production and US oil output falling in recent months. However, there are signs that growth in the non-oil sector is softening. The PMI fell to a three-month low in September and credit growth has fallen to its weakest since mid-2011. The authorities are also more actively talking about cutting spending, not just of waste, but also infrastructure spending and even petrol subsidies as they seek to limit the size of the budget deficit that is due to reach a huge 17% of GDP this year. After remaining flat in 2015, government spending is forecast to be cut 8% next year and this will contribute to a slowdown in non-oil growth to 2.2% from 3.0% in 2015. With only modest increases in oil production expected going forward, overall GDP growth is seen decelerating to 1.9% from 3.6% this year.
The centre-right coalition (comprising the Social Democrats and the Popular Party) led by Pedro Passos Coelho won last Sunday's parliamentary election, becoming the first government to be re-elected among the five Eurozone states that required financial help between 2010 and 2013.
But as we had anticipated, it lost its overall majority in the National Assembly and, as a grand coalition will not be negotiated, the new government's viability will depend on the Socialists, the main opposition party. Socialist leader Antonio Costa conceded defeat and promised not to block the new government (even though left-of-centre parties have a majority in the National Assembly). Significantly, though, he also promised not to betray the voters who had trusted him to reverse the austerity measures.
Costa's promise not to block a new government should ensure that President Cavaco Silva accepts the new administration. However, the medium-term risks are significant. Portugal has long experience with minority governments but, at a time when the debt-to-GDP ratio is at historically high levels, Coelho will probably put sustainability of public finances high on his agenda, which will present a challenging conundrum for the Socialist Party.
Although the further sharp fall in German industrial orders in August makes pretty grim reading, we would be cautious about assuming that this will inevitably result in sharp falls in production too. Historically, orders tend to be more volatile than production and the recent plunge in orders contrasts with survey-based measures of activity and sentiment which remain at solid levels. While we expect GDP growth to slow in Q4 after solid summer growth, we still think that the risks to the consensus outlook for 2016 lie to the upside.
Slower but still solid pace of expansion in the non-manufacturing sector. The sub-indices point to continued growth in the coming months.
Increased global productivity could boost real wages, consumption, fiscal positions and alleviate fears of secular stagnation. But will it? Puzzles relate to the longer term global slowdown; and to some countries’ recent productivity-less recoveries in jobs. We assess various explanations including mismeasurement, secular stagnation; financial sector malfunction and increased labour market flexibility. Our baseline is for a moderate pro-cyclical recovery in productivity; we show how downside risks imply it could be anaemic.
September’s final Eurozone PMI confirmed our view that services sector strength will continue to drive the Eurozone recovery, and help to insulate the region from the risks of the emerging markets slowdown.
The Spanish composite PMI eased in September, perhaps indicating growth might have peaked over the summer. Encouraging, final readings in France confirmed our view that the country is slowly catching up with the rest of the Eurozone.
Evidence of weaker activity along with continued disinflation arising from the strong pound and ‘noflation’ abroad should rule out any change in monetary policy in October'S MPC meeting (which concludes on Thursday 8 October). And the risks to our prediction of a rate hike occurring in Q2 2016 remain firmly to the downside.
A fall in the headline activity balance of September’s CIPS services survey to a 28-month low indicates that services are not immune from problems in the global economy. Moreover, the weakening in the services sector pushed down the composite PMI to a level not seen since early 2013. Granted, the surveys still point to expansion, but GDP growth in Q3 is likely to have slowed a touch to 0.6%.
Soggy employment data on a soggy Friday. Weak headline payrolls gain, downward data revisions, lower participation and flat wage growth. However, don't throw the baby out with the bathwater! Employment growth was expected to slow and the trend remains solid. More important is whether wage growth can pick up the baton.
The ONS has carried out its annual re-write of UK economic history with the publication of the latest Quarterly National Accounts data. The strength of the pre-financial crisis period was downgraded a little, but the 2011-13 period is now much stronger and overall, the post-financial crisis recovery now appears in a much better light, with no double-dip – let alone triple-dip – recession. Both the scale of the gap with the pre-crisis trend and the size of the ‘productivity puzzle’ have been reduced. Growth in Q2 2015 was left unrevised at 0.7% q/q, but high frequency data suggest a slight loss of momentum though Q3 and as such, we have nudged down our estimates for growth this year and next to 2.5% and 2.6%. Meanwhile, recent commentary from the MPC has been fairly dovish, with minutes from the September meeting notable for numerous mentions of the problems in China with members concerned that that this could weigh on the domestic economy. We expect the first rate rise to come in May 2016, with the risks skewed towards a later move.
Construction spending kicks into high gear bolstered by rising housing demand. Housing activity will accelerate in the months ahead and lead to stronger residential investment.
Growing concerns regarding the international outlook, including China, the effects of a stronger US dollar, and reduced oil capex. Global headwinds are unlikely to dissipate overnight and will continue to weigh on manufacturing activity. Fortunately, activity in the services sector appears robust.
Pressures on China's economy persist with the downturn in real estate dampening output in heavy industry and mining. In addition, several industries are scaling back output since they accumulated significant excess capacity in recent years. While housing sales momentum has picked up in recent months, housing starts continue to remain very weak amid large inventories. This suggests that activity in the sector will not recover quickly. Moreover, the Caixin manufacturing PMI slipped again in September to 47.2. And exporters are suffering from a strong currency (because of the dollar's sustained appreciation) and lacklustre global demand. However, private consumption and the services sector continue to provide a helpful cushion against the weakness in industry with spending on tourism, hotel and catering, smartphones and online retail remaining healthy. This is also reflected in the Caixin services PMI which suggests continued expansion. Further easing of monetary policy and increased fiscal expenditure will provide additional support to growth. However, with turnover on the stock market down because of the plunge in prices since June, the financial sector should add much less to GDP growth in H2. Overall, we forecast the economy to grow by 6.6% on average this year and to slow to just below 6% in 2016.
The Saudi peg has in common with other pegs been under pressure recently, with one year dollar riyal forwards spiking at over 425bps at one point in late August. But we think that the Saudi authorities are very unlikely to abandon their SAR3.75/US$1 peg.
The peg has been successful in providing monetary policy credibility and delivering low inflation and low inflation volatility. It makes little economic sense to abandon it particularly given the dominance of oil in the economy and a narrow industrial base.
The peg has been intact for nearly 30 years and withstood more difficult periods than now. The authorities remain very committed to the peg reinforced by a recent public statement. And the Kingdom remains in a strong position to withstand further pressures given its still ample policy and external buffers.
September’s manufacturing PMI confirmed that the recovery in the Eurozone is mainly confined to the domestic sector. The final release for September edged down to 52 with the index for the quarter unchanged in Q3.
At the national level, the German and French numbers were slightly unchanged from the flash estimate (respectively at 52.3 and 50.6), while the ones for Italy and Spain were at seven and 21 month lows respectively.
Overall, stronger activity in the services sector, with the service indicator from the European Commission at the highest in eight years, and robust consumer confidence suggest that domestic activity remains the main driver of the recovery. Thus, the Eurozone should fare relatively well despite ongoing concerns regarding the global economy.
September’s CIPS manufacturing survey shows that a meaningful recovery in the manufacturing sector still looks a distant prospect. The PMI ticked down a three-month low of 51.5, a level broadly consistent with stagnation in the sector. The relative weakness of export orders continued a familiar story, offering further reason to believe that the strength of the trade data in Q2’s GDP release will have been fleeting.
The high frequency data continue to show a sluggish growth performance. In the wake of subdued global and regional demand, both exports and domestic production remain in a downtrend. Moreover, private discretionary spending, which had held up earlier in the year, appears to be showing signs of cooling now. At present we are maintaining our 2015 annual GDP growth forecast of 4.8%, banking on a pick-up in government expenditure as disbursement of funds for infrastructure projects accelerates.
Implementation of reforms and an uncertain policy environment are key risks to the outlook, particularly with domestic demand losing momentum. Given the sluggish external background and soft domestic activity, we have reduced our 2016 growth forecast to 5.3% from 5.5% previously. Beyond 2016, GDP growth should be boosted by a recovery in domestic economic activity as Bank Indonesia shifts policy to a more accommodative stance.
Real GDP grew 0.3% in July, a second consecutive monthly increase, on stronger manufacturing, services and energy sector activity. Activity will likely post a modest rebound in H2, but we caution that the drag from lower oil-related activity will linger.
While Korea's authorities care deeply about the exchange rate, in our view the Bank of Korea's interest rate policy is largely driven by domestic considerations. In our baseline forecast for the economy, these domestic factors should make Bank of Korea (BoK) leave interest rates unchanged at the current historically low level of just 1.5%. However, given the uncertain regional and global growth outlook, the downside risks to growth are currently elevated and we discuss how we think the BoK would respond if these risks were to materialize.
World broad money growth continues to trend upward. Based solely on money developments, the world economy should see output grow well above trend in 2015 and 2016. Moreover, money developments are broadly based among major economies.
The money numbers provide an alternative and more optimistic view of the underlying fundamentals of the global economy.
‘Quantitative tightening’ (the sale of foreign exchange by central banks to stop their currencies falling) is unlikely to have much of an impact on world broad money developments.
Today’s data releases point to a renewed drop in inflation in September, mainly caused by lower energy prices. However this trend should not be sustained throughout the rest of the year. Meanwhile the unemployment and consumption numbers did little to alter our view that the Eurozone is enjoying a resilient recovery
The upgrades to GDP growth published in the latest set of National Accounts are the latest in a series of upward revisions which have changed our understanding of the period since 2011. The new data confirms there was no double-dip – let alone triple-dip – recession and further reduces both the scale of the gap with the pre-crisis trend and the size of the ‘productivity puzzle’.
These revisions have important implications for policymakers. We would expect both the OBR and the Bank of England to respond by reducing their estimates of the degree to which financial crisis has permanently damaged the productive potential of the economy, rather than reducing their estimate of the output gap.
But the new data places the performance of tax revenues in an even poorer light and the OBR could decide that it means that the Chancellor will not achieve his planned budget surplus without further fiscal consolidation.
The latest National Accounts leave the economy’s expansion since 2010 looking stronger and better-balanced. Revisions to historical GDP mean that output in Q2 is now judged to have been 5.9% above the pre-crisis peak compared to a previous estimate of 5.2%. Moreover, the latest data showed the current account deficit narrowing sharply to a two-year low.
Consumer confidence climbs despite financial market volatility. A jump in the present situation sub-index drove the gain. Despite a slight slip in the expectations sub-index, consumers overall remain positive on the outlook. Employment gains and stronger wage growth will underpin household spending.
Germany’s relatively large export exposures to China and other emerging markets have ignited fears that the wider recovery in the Eurozone’s largest economy could be under threat. In this respect, the threat to passenger car production and exports from the diesel scandal could not have come at a worse time. But these concerns may not be quite as great as they initially seem. Our view remains that the German economy will outperform the consensus expectation next year.
Quarterly GDP growth in Q2 came in surprisingly strong at 0.5%, after a 0.7% gain in the previous quarter. The expenditure breakdown showed growth was fueled by soaring government spending and strong investment on the back of government policies in an electoral year. External trade, on the other hand, continued to exert a drag on growth. We have revised up our 2015 GDP growth forecast to 1.3%, from 0.4% previously. However, as this expansion has relied on unsustainable public spending, further exacerbating economic imbalances, tougher measures will need to be undertaken by the new administration next year, particularly given the deteriorating external environment threatening the balance of payments. We now expect GDP growth of 1% in 2016, down from 1.5%, previously.
Brazil is now in danger of experiencing the kind of shock ‘mega’ rate hike seen last year in Turkey and Russia. The currency has lost a quarter of its value in three months and the yield curve has steepened violently. Our modelling suggests short rates might have to rise by several hundred basis points to stabilise the situation. We estimate the current probability of such a ‘mega-hike’ at around 30%. This would rise if the currency suffers a further significant round of losses.
Using the Oxford Global Model we estimate that the depreciation seen over the last three months, if sustained, could see inflation rise above 11% and the policy (SELIC) rate rise to around 18% from the current 14.25%.
The alarming rise in long-term interest rates in recent weeks suggests a crisis of confidence in the central bank’s inflation-fighting policy. Neither the steady rate hikes of the last year nor alternative policies such as drawing down reserves or letting the currency ‘go’ may now be enough to restore credibility.
Brazil’s economy has entered a deep recession, which is some brake on inflationary pressures. But with foreign investors dumping Brazilian assets in the face of low growth, weak commodity prices, concerns about policy credibility and the current account deficit at 4% of GDP, Brazil’s financial stability is under threat and a major policy shift may be needed to arrest the downward spiral.
Following today’s 50bp cut, the RBI likely to pause during the rest of 2015, as it monitors monetary policy transmission and awaits more clarity on US Fed policy. However, the risks are skewed towards further rate cuts given the escalating worries about Chinese and Asian growth – provided that the latter are not so severe that they lead to a sharp drop in the Indian rupee.
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From the Financial Times:
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Click here to watch the full interview at www.cnn.com.