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BanRep left the policy rate unchanged at 4.50% today, as expected. The decision was unanimous, and the communique and post-meeting conference speaks to a more dovish policy bias amid rising external demand risks. We now believe the pause in the policy cycle could be considerably longer than previously expected.
Falling commodity prices and the prospect of weaker Chinese demand has led to a modest downgrade to GDP growth in 2015 to 2.7%. This would have been larger if the A$ had not tumbled in September. The A$'s depreciation may add around half a percentage point to GDP growth over the next 18 months. In addition, interest rates are expected to remain on hold at the record low level of 2.5% well into 2015, with the first interest rate hike now not expected until September.
The BCB’s decision to hike rates last night was surprising as it speaks to a potential front-loading of the rate-hike cycle, let alone immediate efforts to restore policy credibility and signal an impending macro-policy adjustment. However, we sense there remains much uncertainty, especially as it relates to the depth of the coming tightening cycle. Still, we view the BCB’s new-found hawkishness as bullish for the currency in the near-term, while we still remain NEURTAL on rates.
Strong real GDP growth in Q3, but US economy still on the mend. Final sales posted a solid advance while inventories subtracted from growth. Unfortunately though, contributions from consumer spending, business and residential investment were underwhelming. Net trade provided a strong boost while stronger defense spending temporarily surged. Overall, Oxford Economics see growth firming at 3% in 2015.
The European Commission’s index of Economic Sentiment improved slightly in October to 100.7 from 99.9, in line with our forecast, after four months of decline or stagnation. The improvement was broad-based across economic sectors and countries (except Spain). The pickup in optimism was especially strong in the services and construction sectors. This, together with today’s surprising decline in German unemployment in October and robust Spanish growth of 0.5% q/q, contrasts with recent disappointing Eurozone data. Overall, today’s figures support our view of a small expansion in GDP in Q4 and a strengthening in momentum from 2015.
The September data releases continue to point to generally-weak momentum in the Chilean economy, evidencing weak consumption figures, and improving, yet still subdued manufacturing activity. The figures affirm our recent decision to revise down our year-end 2014 GDP growth forecast to 1.7%, with 2015 GDP now at 3.4%.
Despite being less dovish than expected, we believe the FOMC struck the right tone in its policy statement. The statement supports our call that the Fed will initiate rate lift-off in June 2015. The FOMC was more upbeat in its assessment of the US economy, highlighting the continued gradual diminishment of labor slack. Policy makers largely discounted the recent decline in market-based inflation expectation measures, though Minneapolis Fed President Kocherlakota dissented and thought the Fed should continue QE. However, as anticipated, the FOMC officially ended QE. The FOMC did not alter its forward guidance, though it added some needed language that clarifies the guidance – all a step in the right direction in our view.
The BCB unexpectedly raised the Selic rate by 25bps to 11.25% today. This much-welcomed decision points to a re-focusing of monetary policy aimed at containing inflation, and restoring market confidence in the BCB’s policy credibility. We now look to the COPOM minutes, however, to gauge the extent of the tightening cycle.
After winning the second-round presidential runoff on 26 October by the tightest margin since 1985, President Rousseff will probably be forced by markets and by the threat of Brazil losing its investment-grade status to re-orient policies towards less intervention in the economy. That said, any expected adjustment in policy is likely to be gradual and guarded, and will crucially depend on the composition of her new economic team. For now, we keep our forecast of zero GDP growth this year, and 0.9% in 2015.
Elections to the Ukrainian parliament took place on October 26. Preliminary results indicate that the party of President Poroshenko appears to have won most seats, with the People’s Front of PM Yatsenyuk second. The results indicate a strong result for pro-western parties, but despite this default risk in Ukraine remains high and splits in the country (and the governing coalition) could easily reopen.
The yen has weakened sharply since late 2012 in a number of phases, but the outlook remains uncertain. In our baseline forecast (60% probability) the yen weakens to 113/US$ by end-2015 as interest differentials with the US become more unfavourable and monetary policies diverge. But we attach a considerable (25%) probability to the yen weakening much further, to 125-130/US$ if the ‘Abenomics’ experiment falters and the Bank of Japan (BoJ) is forced into radical action to avoid a slide back into deflation. Nor is the risk only one way: although the yen’s status as a ‘safe haven’ currency has been tarnished a little over recent years, it has not disappeared entirely. We attach a 15% probability to the yen strengthening to 102/US$ by end-2015 based on a scenario in which there is a sharp weakening of global growth and a spike in global risk aversion, again ultimately implying the need for more BoJ action. Our average forecast across scenarios is for a yen/$ rate of 116 by end-2015; as a result, yen exposures look unattractive.
September’s household borrowing data should further quell concerns about the supposed threat posed to the economy by the housing market. Total net borrowing fell back, with little signs of a return to the credit-fuelled days of pre-2008. Moreover, a fall in mortgage approvals to a 14-month low should strengthen the MPC’s hunch that recent weakness in housing activity is more than a temporary blip related to the implementation of the Mortgage Market Review.
Industrial production has been on a downward trend for the past two quarters, but September’s numbers suggest that the manufacturing sector is likely to stabilise in the latter part of 2014. Industrial output was up 2.7% on the month, the best outturn since January, driven by an improvement in consumer demand. However, the industrial sector is unlikely to provide much impetus to growth in the near term given high inventory levels and the ongoing drag from the consumption tax.
Voters are set to cast their ballots for midterm elections next week. Republicans will likely maintain their majority in the House of Representatives and win a simple majority in the Senate. However, we believe gridlock will prevail in the 114th Congress, minimizing the chance of discernible change to fiscal policy in the near term. Each party will try to push forward on its agenda while looking to minimize political volatility in the run-up to the 2016 presidential election.
Consumer confidence climbs to a multi-year high. The key expectations sub-index surged to an almost three year high, while the present situation sub-index also reported a gain. Consumers remain optimistic as lower oil prices and an improving labor market more than offset worries about increased market volatility and slowing global economic growth. This bodes well for prospective US economic growth. We expect upbeat confidence readings to underpin higher consumer outlays, leading to GDP growth around 3% in H2.
Durable goods miss expectations. Durable goods orders suffered a second straight month of declines as core capital goods orders fell the most since January. Shipments fared marginally better. While the effects of the recent global slowdown may be starting to appear in US economic data, we see the economy remaining on a solid footing and expect business investment to rise 6% in H2.
President Rousseff’s re-election spurred a sharp market sell-off, as expected. Still, the downturn is less severe than expected, and given important economic demands and political pressures, there is growing hopes that Ms. Rousseff’s near-term policy stance may be slightly more market-friendly than initially anticipated. We sense markets may be slightly too pessimistic, yet market behavior in the months ahead will be driven by looming cabinet changes and potential policy announcements.
Following a few months of weakness, retail sales have now posted two solid monthly gains in succession, including a rise of 2.7% in September. Japan is thus unlikely to have fallen into recession in the previous quarter. This will give the government some confidence to proceed with the second sales tax hike late next year. However, now that retail spending has recovered to its pre-tax levels, sales growth is likely to slow again towards the end of the year, and we believe that the impact of the tax on real incomes will continue to constrain consumption going into 2015.
The preliminary estimate for Q3 GDP reported that the UK economy grew by 0.7% on the quarter, down slightly on the 0.9% achieved in Q2. However, as ever it is not difficult to see areas where the data could subsequently be revised upwards, and it is the slowdown in services activity that looks most suspicious this time around. That said, recent survey data suggest that the momentum behind the UK economy is gently cooling. Overall, GDP is forecast to grow by an above-trend 3% this year and 2.6% in 2015. Meanwhile, the recent sharp decline in oil prices has led us to cut our forecast for CPI inflation next year to just 1.4%, with the early part of the year set to see it flirt with the 1% rate that would trigger a letter of explanation from the Governor. Against this backdrop we now expect the first interest rate rise to come in Q3 2015, not Q1.
The combination of a modest growth outlook in China, with its adverse implications for commodity prices, and a sufficiently positive one in the US economy that the Fed can contemplate a gradual tightening of monetary policy is a threatening one for many emerging market economies. Our scorecard of vulnerabilities and risks suggests that Turkey and South Africa are the two leading emerging economies most exposed to a major deterioration in the global and economic financial situation – partly reflecting their large external imbalances and low levels of real interest rates. This is unchanged from when the scorecard was introduced in April. However, Brazil's ranking is now the third most vulnerable under the impact of a stagnating economy and deepening fiscal and external deficits. Moreover, the outlook will most probably deteriorate further with the re-election of President Rousseff. China's relative position has also worsened over the last six months but it still has huge resources that should help it to weather all but the most severe shocks. By contrast, the rankings of Poland, Malaysia and Indonesia have all improved since April, underpinned by reasonably solid growth prospects and positive real interest rates.
The August GDP proxy contracted 0.9% m/m for a y/y decline of 1.2% y/y; both well below estimates, and further evidence that economic activity remains under serious constraints. Still, the release should help ease, at last somewhat, worries over the normalization of the data reporting process. We keep our GDP forecast unchanged.
The headline numbers look modest enough. Just 8 banks failed the latest round of European stress tests and were adjudged to have insufficient capital to weather a major downturn in European demand with a cumulative shortfall of just €6.4bn. But this rather misses the point that some €56bn of new capital has already been raised this year in anticipation of the exercise. This undoubtedly leaves the euro area banking sector in a stronger position and adds grist to our view that there may be upside risks to bank lending next year as the recovery gathers momentum.
European banks need just €10bn in additional capital, but issues remain
Rousseff’s second term will likely be marked by four more years of complacency with high inflation, low productivity, rising public debt and reduced capacity to attract private investment. For us, the key question surrounding the outlook is whether she will re-orient policies and regain market’s confidence. If not, Brazil may lose its investment-grade status and struggle to finance its debt.
Despite heightened market volatility provoked by rising fears of a sharp global economic slowdown, we expect the FOMC to affirm the end of QE asset purchases at its October 28-29th meeting. US economic domestic fundamentals are the strongest since the Great Recession and external headwinds are limited in our view. We continue to see the Fed initiate rate lift-off in June 2015. The Fed is not likely to alter its forward guidance just yet.
The August IGAE GDP proxy disappointed to the downside, with activity contracting 0.2% m/m for a below-consensus 1.3% y/y print. The monthly reading was weighed down by calendar effects and evidence of still-weak domestic demand trends during the period. Despite the weak reading, we remain optimistic on the Mexican recovery.
Three words that Eurozone economists have had little need to use in the same sentence over the past few years are upside, surprise and GDP. But despite recent financial market turbulence, weakening sentiment indices and August’s ugly German industrial data, we think that the time has come to assess the potential effect of a period of stronger than anticipated growth in the Eurozone. Our model suggests that a combination of a weaker euro, easing credit conditions and an associated improvement in business and consumer confidence, eventually augmented by a modest fiscal boost from Germany, could prompt Eurozone GDP to expand by 2% or more over the next three years. But recent events have demonstrated the Eurozone’s vulnerability to external shocks, implying that a fairly benign global backdrop may be needed for the upside scenario to materialise fully. Accordingly, we attach a 20% probability to such an upside scenario taking place.
New home sales remain on a modest trend. Sales rose in September, but August data were revised down sharply. Looking forward, our outlook for housing activity is cautious, but we expect a gradual rebound in labor compensation, modest home price inflation and lower mortgage rates to allow for a gradual release of pent-up demand in late-2014 and into 2015.
Fighting in eastern Ukraine this week was probably the most intense since the ceasefire agreement which was signed in September. There is a risk that tensions might escalate further soon.
The rouble remains under significant pressure. It is currently trading just below 42 against the dollar, almost 25% weaker than in January. As a result, we expect the central bank to raise rates by 0.5% points at next week’s meeting to support the currency.
Probability of negative conflict scenario: 15% (last week: 15%)
With 2014 slowly coming to a close we reflect on the economy’s 3% growth miss with a special emphasis on the disappointing housing sector. After slowing down sharply in the latter half of 2013 and being severely hit in early 2014 by extreme weather, the housing recovery failed to materialize in 2014. Why did this happen? What impact did this have on the economy? Could this repeat in 2015? Using Oxford Economics’ Global Economic Model, we examine the impact of a failed housing lift-off in 2015.
GDP rose by 0.9% q/q in Q3, in line with our expectations and up from 0.5% q/q growth in Q2. The authorities announced 11.7trn won of stimulus in July and aided by this, private spending and construction both picked up markedly. Very expansionary monetary and fiscal policy will feed through to broader activity in coming quarters but machinery investment fell by 0.8% q/q in Q3, under pressure from the weak external outlook and marking the second decrease in three quarters. Indeed net exports subtracted from headline growth as goods export volumes fell by 3.1% q/q, the biggest drop since 2008. We are becoming increasing cautious about growth prospects in China and subdued Chinese demand is likely to continue to dampen trade prospects for the region.
House prices fell by 1% on the month in September and contracted for the first time year-on-year in this downturn (-1.3%). The number of cities experiencing an annual fall in prices increased sharply and is already close to the peak seen in 2011/12. With developers under sever funding pressure and excess supply at a record high, the current downturn will likely be deeper and longer lasting.
Although industrial activity fell in September, the pace of decline was less severe than was projected by the Q3 advance GDP estimate of last week. As a consequence, Q3 GDP is likely to be revised up slightly to 2.5% y/y versus the initial estimate of 2.4% y/y.
This morning’s data confirms that UK growth has peaked and is now gently cooling, but we remain on course for growth of 3% for 2014 as a whole, which is likely to top the G7 rankings. And as ever we would not be surprised if the ONS were to subsequently revise up the latest quarter, particularly for services output. That said, momentum has cooled a little and we are likely to see the economy continue to grow at this slightly slower pace in the short-term.
The September trade figures point to a sharp erosion, with the surplus narrowing to $7.7bn on a 12-month basis, down from $8.0bn in August. Lower global commodity prices, reduced external demand and restrictions on USDs are undermining export growth. We’re thus lowering our trade surplus forecast for this year and 2015.
Inflation continues to push higher, up 0.50% 2w/2w during the first half of October for a headline reading of 4.32%. Much of the upside price surge stemmed from rising electricity rates and seasonal price trends, and we anticipate sustained price pressure throughout the remainder of the year, with a headline CPI forecast of 4.0%.
A broad-based pick-up in trade flows, with the exception of Singapore, should have provided some positive news on Asia, something which is increasingly hard to come by at present. But unpicking the data, and aligning it against survey data on future prospects, suggests further weakness ahead.
The global outlook into 2015 is fraught with noted challenges and rapidly-shifting policy dynamics that threaten to pressure the world economy. However, after a slippery start, a recovery in the Mexican economy is evident and seemingly sustainable into 2015 and beyond. Demographic advantages, productivity gains, the reform agenda and sound macroeconomic stability underscore our constructive view on the long-term Mexican macro outlook. Despite clear domestic and external challenges, the country is well positioned to extend the Mexico moment.
The Philippine central bank has interrupted its tightening cycle after inflation dropped to 4.4 % in September. Lower inflation along with a moderation of money growth will have influenced the stance as previous rate hikes are gradually taking effect. However, in light of the lower target range for inflation next year and higher US interest rates, we still expect another 25bp rate hike this year and further tightening throughout 2015.
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