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Saturday 13th May 2017
Hi Friend,
Inflation Report .. Governor warns of greater monetary tightening ...
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Inflation Report this week. The MPC voted 7 -1 to hold the bank rate at 0.25%, maintain the stock of government bonds at £435 billion and to maintain the purchases of corporate bonds at £10 billion. Good to know the Bank is easing borrowing costs for the likes of Apple Inc, with a market cap of $800 billion and cash reserves of $250 billion. Excellent!
The Old Lady's corporate bond purchases are an indicator of the drift in policy away from market reality. The UK corporate bond market is one of the few remaining investment niches in the investor search for Alpha. Valued overall at around £130 billion, best for the Bank to stay out. Otherwise the MPC will create the biggest "corporate bond bubble in history", just as has been done with gilts.
So why are rates on hold? The Bank has adjusted the forecast for growth in the current year to 1.9% from 2.0% in February. It is a modest adjustment. A mere typo in publications from the Office for National Statistics. The Bank remains concerned about the prospects for household spending given rising inflation and the slow growth of wages. Inflation is set to peak towards the end of this year at just under 3%. Earnings are set to rise around 2%, hence the arithmetic squeeze on real incomes.
The good news, slowing household spending will be offset by growth in investment and net trade. Business surveys and bank agents reports, imply that investment growth will be higher in 2017 than previously expected. The bank also believes that stronger growth in world trade and a weaker sterling will lead to an improvement in the net trade balance.
Growth in world trade will lead to an increase in imports, this is true. The problem is exports have a high degree of import dependency. There is little or no substitution effect from sterling weakness. The growth in investment may well hold. The trade deficit (goods) will increase to over £140 billion this year.
So what of growth? Growth in the first quarter was around 2.4% according to the preliminary estimate of GDP released at the end of April. The latest data for manufacturing and construction confirm our Q1 estimates of GDP growth. The portent for a larger trade deficit is also confirmed with an ominous rise in the first quarter trade gap.
So what of rates? The Governor warns that if "the economy follows the path broadly consistent with the May projection, then monetary policy could need to be tightened by a somewhat greater extent than the yield curve would currently imply". And that is about as hawkish as the Governor has been for some time! Kristin Forbes was the only member of the MPC to vote for a rate rise this month. If the data unfolds as we expect others will be set to follow ...
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In other news this week ...
The trade deficit in goods increased to £37 billion in the first quarter. This compares with a shortfall £32 billion in the same period last year and in the final quarter of 2016. For the year as a whole we project a trade in goods deficit on £144 billion compared to £134 billion last year. So much for the ephemeral benefits of sterling depreciation, as we have long explained.
Growth in Europe and the rest of the world will stimulate demand for exports. Domestic growth and a high dependency on imports will compound the trade balance deterioration. The deficit in goods was offset by growth in the service sector surplus of £26 billion. The service sector, particularly tourism, enjoys much higher price elasticity [than goods] and profits from world growth. The overall trade in goods and services deficit for the year as a whole is likely to be over £45 billion compared to £37 billion last year. As the deficit moves to 2.5% of GDP, the Bank of England will be forced to review the accommodating monetary stance before markets force the call.
Manufacturing growth increased by 2.3% in March and by 2.5% in the first quarter of the year. Construction growth increased by 1.8% in the same period. It's a "mixed bag". New housing was up by 4.3%, Commercial real estate growth was up by 7.3%. Infrastructure spending was down by 4.2%. Industrial building was down by 18%. The overall data for manufacturing and construction were in line with the preliminary GDP estimates. There has been no change to our outlook for the current year. We still expect growth to be between 2.0% and 2.4%. Strong growth, rising inflation and maturing trade gap ... time to tighten by a somewhat greater extent!
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Comey you're fired ...
The White House had a bad week this week. A really, really bad week. The President fired James Comey, director of the FBI. Democrats were outraged, Republicans were shocked. The White House team were caught off guard and inadequately briefed. James Comey was on a visit to the Los Angeles office. During the briefing, news broke on CNN. Spoof was the original reaction, receipt of the letter confirmed the bad news.
"Whilst I greatly appreciate you informing me on three separate occasions, that I am not under investigation, I nevertheless concur with the judgment of the Department of Justice, that you are not able to effectively lead the team". I wish you well in your future endeavours, [as long as it has nothing to do with me and the Russians, OK].
In an interview with NBC, Trump changed tack. Nothing to do with any recommendations from anywhere, the president explained, he was going to do it anyway. Sean Spicer, trapped by White House correspondents in the grounds of the White House on Tuesday was asked to explain. Off the record, lights off and in the dark, the Wall Street Journal reported the story, then was forced to retract and reissue the statement.
"Spicer huddled with his staff, among bushes near television sets on the White House grounds not in the bushes as the story originally stated." And thus history is written.
What was said, we may never learn. The situation in the White House deteriorated when Trump appeared to warn Comey (in a tweet) there may be tapes of private conversations with the former FBI director. Has Trump been taping? Later he denounced the FBI director as "A showboat, and a grand stander".
Not much hope of getting the job back. Sean Spicer's own job came under threat. "As a very active President, with lots of things happening, it is not possible for my surrogates to stand at the podium and speak with perfect accuracy" he wrote on Twitter. It may be better, suggested the President to "cancel the White House briefings altogether." Better a written statement or follow the Twitter stream perhaps, like everyone else.
Not since Watergate, has a president dismissed the person leading an investigation into occupants of the White House. Comey had resisted calls for loyalty to the President allegedly. The Russian rumble continues.
Trump broke protocol and met with the Russian Foreign Minister. US press denied access, the President was outraged when photos appeared on TASS the Russian news agency. There must have been a camera in the microwave. "Infamy" denounced Trump, "we have been tricked by those lying Russians".
In other news, Trump gave an interview with The Economist. Claiming to have invented the Keynesian term "Prime the Pump" in relation to his fiscal policy. Readers will recall the tax proposal covers one page, seven
numbers and two hundred words. "Have you heard that expression used before" asked Trump. "Because I haven't heard it. I mean, I just ... I came up with it a couple of days ago and I thought it was good".
Unfortunately, Keynes got there first! The Economist team were not impressed. "Impulsive and shallow, the President threatens the economy and the rule of law" the verdict.
In the quote of the week, the President explained his policy priorities. "If you have a bad knee, I would rather the federal government focus on North Korea than fixing your knee." Excellent, there is a man with a grasp of world affairs and the human anatomy ...
That's all for this week from The West Wing, Whisky, Tango, Foxtrot ... You can check out the series of blog posts here or check out the Facebook page here
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So what happened to Markets?
The Dow closed at 20,919 from 20,944. The FTSE closed up at 7,386 from 7,297.
Sterling was down against the Dollar to $1.289 from $1.296 and was up against
the Euro to €1.186 from €1.179. The Euro moved down against the Dollar to 1.086 from 1.099.
Oil Price Brent Crude closed at $50.77 from $48.96. The average price in May last year was $46.74. The inflation impact fades into the second quarter of the year.
UK Gilts
- yields moved up. UK Ten year gilt yields closed at 1.15 from 1.12. US
Treasury yields moved up to 2.38 from 2.36. Gold closed at $1,224 from $1,225.
John
That's all for this week. Don't miss our economics update at PwC Manchester on the 18th May. It's usually a sell out so make sure you book now! As always we appreciate your support. "Join the Club" for those special insights into currencies and markets. Your support will boost our research and improve the products we offer.
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