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Tapering - Global Economics Weekly


Global Economics Weekly Brief

Rarely has doing nothing prompted such a big market reaction. Investors had convinced themselves that the US Federal Reserve would have started “tapering” its quantitative easing purchases last week. This would have been the first move towards tightening monetary policy. The Fed surprised markets by standing pat.

This sent government bond yields lower and stock markets higher. Forward guidance was supposed to increase transparency and reduce uncertainty about the Fed’s thinking but that’s tough when the number of factors affecting decisions is large and when market participants hear something different from what the central bank says. Markets may now have a little less confidence in future Fed communications. The US debt is $17 trillion and rising rapidly `every day`!

Tapering tapered for this month!

Fed surprise. The US Federal Reserve was widely expected to slow its quantitative easing (QE) purchases last week, but surprised the markets when it maintained its bond-buying at $85bn a month. Expectations had seen interest rates across the economy rise more than 1 percentage point since May, leaving households paying more for their mortgages and higher financing costs for businesses too. The Fed, worried that this tightening in financial conditions could dampen the economic recovery and the labour market, thus refrained from reducing its stimulus programme. The reaction from the markets was instant, with the dollar slipping 1% and government bond yields around the world falling. More challenges on the way!

A long path back to higher US interest rates. In addition to the US Fed's QE announcement, committee members published their estimates for growth, employment and interest rates to 2016. For the last year of the forecast, the central bankers think growth will be above its long term rate and that unemployment will have fallen to 5-6%. In other words, the economy will be performing strongly. Yet despite that strength, many on the committee expect interest rates to be 2% or less - rates previously consistent with recessions. The path back to normal monetary policy conditions will be very long.

Is there a UK house price boom? (London only). Probably not, although there is a range of estimates. For July, the ONS says average prices grew 3.3%y/y. This is considerably lower than the Halifax number of 5.7%y/y. Nationwide says 3.9%y/y while the Land Registry tells us that for England and Wales prices only grew 0.8%y/y. What they have in common is London house prices growing considerably faster than the UK average. This complicates the picture for the Financial Policy Committee should it decide to intervene in the market - how to calibrate policy to one part of the UK, whilst not overly harming others. The danger is the housing bubble will burst again and the `hype` of higher house prices is for `new` houses over the UK, just look at the very high profits housing building companies are making!

Catch 22. The minutes of September’s Monetary Policy Committee (MPC) meeting acknowledged growing upside risks to growth and that the MPC’s unemployment forecast is sensitive to "relatively small changes in assumptions". The implication: unemployment might fall below 7% earlier than expected. While the MPC reiterated that 7% is not a trigger for rate rises, they are in a bit of a Catch 22. They want borrowers to believe that interest rates will remain low to support the recovery. But if borrowers believe this, and expectations of growth improve, then rate hikes will start to look more imminent.

Retail sales disappoint in August. Excluding auto fuels, retail sales fell 1.0% on the month - the first m/m fall since April and the biggest fall in more than a year. It seems July's burst of indulgence, which saw the strongest food sales in two years, left us feeling a little guilty. Food sales were the largest contributor to the decline. This is the first sign that the recent flurry of economic activity may have been getting a little ahead of what the economy is currently capable of. After all, though CPI inflation fell slightly in August, to 2.7%y/y from 2.8% in July, it is still well above average wage growth. Watch very carefully the interest rate rises in the future!

Some respite for the public finances. The government deficit was £13.2bn in August, lower than the £14.4bn shortfall recorded in August last year. While the books remain far from balanced, stronger growth has supported a marked rise in tax receipts. This helped reduce government borrowing by £3.6bn over the first five months of the fiscal year. While these data are volatile and subject to revision, it is pleasant to see growth providing some help to the beleaguered public finances. The UK government must learn to operate without continuous borrowing which will impact on the future survival and success of the UK!

Ireland grows again. Ireland came out of recession in Q2, helped by exports and consumer spending. Good news for the Celtic nation, though the 0.4%q/q growth was much weaker than expected. Ireland will continue to benefit from loose monetary policy across the euro area. Eurozone inflation fell to 1.3% in August, from 1.6% in July, and is expected remain below the European Central Bank’s (ECB) 2% target through 2014. This should give the ECB plenty of scope to keep interest rates “at present or lower levels for an extended period of time”, as stated by President Draghi. Excellent news - the future have many challenges to be successful!

With the Bank of England linking changes in Bank Rate to the unemployment rate, the monthly labour market release assumes greater importance and last week’s modest fall in joblessness caused a flurry of excitement. The housing market, too, is beginning to draw glances. Not so long ago people were worried about the effect of falling house prices on the recovery. But with housing activity heating up, the debate has turned 180 degrees. Given the importance of both issues, expect them to be in the spotlight for some time to come. Very interesting information on how media coverage can change why people buy houses! Also, there are less people claiming benefits as being unemployed, therefore the figures will reduce the unemployment total!

UK unemployment falls to 7.7%. Under its forward guidance, the Bank of England (BoE) will not think about raising Bank Rate until unemployment falls to 7%, unless inflation is a threat or the financial system looks unstable. Unsurprisingly then, unemployment falling from 7.8% to 7.7% in the three months to July saw a flurry of excited media reaction. Employment rose, with full-time employees accounting for all of the increase. Although the employment rate is still 1.3% below where it was at the start of the crisis, the number of people in employment is now 1% above the pre-crisis peak. Falling public sector employment was again more than offset by job growth in the private sector. Very encouraging facts!

Speed bumps please. A busy week for the Royal Institute of Chartered Surveyors (RICS). First, they released their monthly gauge of housing market activity. Like the BoE, they did not see evidence of a national bubble but the concern is this may not be true for all parts of the UK. Their survey shows a market recovering strongly but not dangerously. Yes, it was the strongest indicator for price rises since 2006 and price expectations are at their highest since 2002. But these are encouraging folk to sell too, so supply's on the up which should help keep a lid on price rises. Second, RICS suggested the BoE develop 'speed bumps' to help curb price rises and "create a more sustainable housing market". Expanding housing activity is boosting the construction industry. Overall construction activity rose by 2.2%m/m in July, with Q2 new housing orders recording their highest volume since the end of 2007. The UK subsidy for buying new houses as seen new house prices rise rapidly, plus house builders profits are rapidly rising, could there be another housing bubble in a few years time?

Real wages continue to fall. Rising employment is helping to get a little more income circulating through the economy. Good news. But this is, to an extent, being offset by continued weak wage growth. Regular pay growth slowed from 1.1%y/y to 1%y/y in the three months to July. However, when we consider the impact of inflation the real value of workers income continues to fall. Despite the recent run of good economic data, the squeeze on incomes remains. Wages stagnate and all prices across the board are rising with energy prices about to rise again in the last quarter of 2013!

US retail sales lose momentum. In spite of increased demand for cars and other big ticket items, US retail sales struggled in August. Up 0.2%m/m, this was the slowest rate of growth for four months and well below market expectations. With the University of Michigan consumer sentiment index falling 5.3 points to 76.8, the lowest since April, are there signs the US consumer is beginning to toil a little? This will be part of the Federal Reserve’s debate this week as it considers whether to start easing back on its quantitative easing programme. Major challenges ahead!

Slowly but not that surely. Having just come out of recession in Q2 (are they out of recession?), some recent economic indicators seemed to suggest that the Eurozone recovery might be gaining a little bit of momentum. However, July’s industrial production data threw a large bucket of cold water on that. Factory output across the region declined by 1.5%m/m. Production fell in peripheral countries like Italy, Greece, Portugal and Ireland. Factories in France reduced their production by 0.6%m/m but the main surprise came from Germany where output declined by 2.3%m/m. The European Central Bank’s warning that the recovery will be only gradual and slow, with plenty of potholes on the way, looks right. Rapid unemployment still a major issues in many European countries!

China experiencing a little pick-up…for now. Data for August confirmed that the Chinese economy is experiencing a ‘little’ rebound. Industrial production grew by 10.4%y/y - the fastest pace since early 2012. But as usual it's investment and the state-run sector that are driving growth. More encouraging would be a flourishing private sector and greater consumption. Credit growth accelerated sharply to 25%y/y. This is a short-term positive for the economy but it is also an addiction that China is in desperate need of weaning itself off of. The bigger picture is one of a long-term slowdown in growth while financial risks continue to grow.

Lands of opportunity. Everyone seems to agree that a sustainable UK recovery involves boosting exports. But where are the best opportunities?

Global Economic Outlook for 2013 revealed - United Nations ...

* `10-Step Double-Dip Recession Survival Guide` - click on the connection below for comprehensive information.


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