UK MPC more pessimistic about supply growth

Posted on Thursday, August 3, 2017 at 04:03PM by Registered CommenterSimon Ward | CommentsPost a Comment

A key take-away from the UK August Inflation Report is that the MPC has lowered its estimate of potential GDP growth to only about 0.4% per quarter. With the economy judged to be operating close to full capacity, a rebound in actual quarterly growth to above 0.4% could be sufficient to trigger an early rate hike.

GDP growth is now forecast at 1.7% in 2017 and 1.6% in 2018 versus 1.9% and 1.7% respectively in May. The downgrade partly reflects higher interest rates: the average level of Bank rate in 2018 implied by the market curve is 15 basis points higher than in May. Despite weaker growth, however, the three-year ahead inflation forecast is essentially unchanged – 2.22% versus 2.26% in May. Softer demand, in other words, is balanced by weaker potential growth.

The increased pessimism about supply-side potential is shown more clearly by inflation forecast based on an unchanged 0.25% Bank rate – the three-year ahead projection of 2.47% is up from 2.36% in May.

According to the latest policy statement, “GDP growth remains sluggish in the near term …” but “… picks up to just above its reduced potential rate over the balance of the forecast period”. GDP growth is projected at 1.8% at the end of the forecast so this suggests potential expansion of 1.6-1.7%, or about 0.4% per quarter.

The MPC expects quarterly GDP growth to remain at 0.3% in the third quarter before picking up slightly at the end of the year. A rebound to 0.5%, therefore, could be sufficient to persuade several more members to vote for an early hike.

Monetary trends are giving a more hopeful message for economic prospects: six-month growth of real narrow and broad money recovered significantly in June, reflecting a combination of stronger nominal expansion and a moderation of six-month inflation – see chart.

G7 money surge suggesting too-loose policies

Posted on Thursday, August 3, 2017 at 09:34AM by Registered CommenterSimon Ward | CommentsPost a Comment

Six-month growth of global real narrow money* continued to strengthen in June, signalling a likely pick-up in economic momentum in late 2017 / early 2018, after a modest near-term slowdown. Monetary acceleration suggests that major central banks are falling further “behind the curve” and will be forced to tighten policies significantly as economic growth and inflation rebound.

Six-month growth of global (i.e. G7 plus emerging E7) real narrow money, adjusted for Indian demonetisation, bottomed in February 2017, rising for a fourth consecutive month in June to its highest since September 2016. Allowing for an average nine-month lead, this suggests that six-month industrial output growth will strengthen from around November – see first chart.

Economic momentum is likely to moderate shorter term, reflecting a fall in real narrow money growth between August 2016 and February. This is also the message from the global leading indicator tracked here: it typically leads by four to five months and its six-month growth declined again in June**. The one-month change in the indicator, however, rose for a second month, suggesting an imminent turn in the six-month measure – second chart. Such a turn would confirm the signal of economic reacceleration from late 2017 from monetary trends.

Coincident economic news remains mostly solid but is cooling at the margin. The Citigroup G10 economic surprise index turned significantly negative in June and has remained weak – third chart. The global manufacturing business survey indicator tracked here ticked down in July, while the MSCI All-Country World Index earnings revisions ratio was negative for a second month – fourth chart. The Euroland ratio has reversed particularly sharply, partly reflecting the strong euro, consistent with the expectation here of weaker economic news – fifth chart.

The pick-up in global real narrow money growth has been led by the G7 and the US in particular. G7 real money growth is now well above the India-adjusted E7 level, questioning the sustainability of recent EM asset outperformance – sixth chart. E7 real money growth is respectable in absolute terms but has been held back by moderating – though still solid – Chinese expansion and a contraction in Mexico following recent significant monetary policy tightening.

*Narrow money = currency in circulation plus demand / overnight deposits. Financial sector holdings excluded where possible. Real = deflated by consumer prices, seasonally adjusted.
*June estimate based on partial data.

UK inflation: temporary reprieve

Posted on Wednesday, July 19, 2017 at 09:47AM by Registered CommenterSimon Ward | CommentsPost a Comment

UK CPI inflation surprised on the upside in May and on the downside in June. The “big picture” is that it is above the MPC’s forecast and will probably still reach 3.0% later in 2017, despite lower-than-expected energy prices.

Annual CPI inflation fell from 2.9% (2.87% before rounding) in May to 2.6% (2.64%) in June. Lower motor fuels inflation accounted for 11 basis points of the decline (i.e. about half) with the remainder due to “core” components.

CPI inflation averaged 2.74% in the second quarter, above the MPC’s forecasts of 2.65% and 2.43% in the May and February Inflation Reports respectively. The overshoot would have been larger but for a lower crude oil price than the MPC assumed.

Reasons for expecting inflation to reach 3.0% later in 2017 include:

1)    Despite a slower monthly gain in June, core* prices rose at a seasonally adjusted annualised rate of 3.0% in the latest three months from the previous three – see first chart. Annual core inflation of 2.4% in June would rise to 2.9% in October if this pace of increase were to be sustained.

2)    Annual core** producer output price inflation rose to 2.9% in June and usually peaks ahead of core CPI inflation, i.e. it also suggests a further increase in the core CPI rate – second chart.

3)    The headline / core gap is likely to remain positive and may widen, reflecting stronger food price inflation and a stabilisation of energy inflation after a recent slowdown (assuming stable crude energy costs). CPI food inflation rose further to 2.6% in June but is significantly lower than would be expected based on historical relationships with producer output price inflation for food products (5.8% in June) and the annual increase in the FAO’s global food commodity price index, expressed in sterling (19% in June, down from a peak of 36% in January) – third chart.

*Excluding energy, food, alcohol, tobacco and education, and adjusted for the estimated impact of VAT changes.
**Excluding food, beverages, tobacco and petroleum.

Chinese money trends still expansionary

Posted on Tuesday, July 18, 2017 at 10:57AM by Registered CommenterSimon Ward | CommentsPost a Comment

A fall in Chinese money growth since late 2016 has been reflected in an easing of inflationary pressures rather than a loss of economic momentum. Current monetary trends are judged here to remain consistent with respectable economic expansion, while the PBoC has started to reverse recent policy tightening, which may prevent a further slowdown.

Annual growth of real GDP was 6.9% in the second quarter, unchanged from the first quarter and above the consensus forecast of 6.8%. Nominal GDP growth fell from 11.8% to 11.1%, reflecting a slowdown in the price deflator – see first chart.

The decline in nominal expansion is consistent with an earlier fall in annual narrow money growth, as measured by “true” M1*, from a peak in August 2016. This eased further to 13.9% in June but is much stronger than in 2014 / early 2015, when the economy was at risk of serious weakness / deflation – second chart.

Similarly, broad money growth, as measured by M2 excluding financial sector deposits**, fell to 10.3% in June but has retraced less than half of its rise between mid-2015 and late 2016 – third chart.

The transmission of slower money expansion to prices rather than activity is highlighted by producer price / industrial output data. Six-month PPI inflation eased from 5.8% in February to 0.7% in June, while six-month industrial output growth rose to 4.7% in June, a 42-month high – fourth chart.

A further monetary slowdown would raise the risk of economic damage but easing inflation and currency stability have allowed the PBoC to start reversing first-half policy tightening. Three-month SHIBOR has fallen back to its April level, although seasonal factors may also have played a role – fifth chart.

A constructive economic view will be maintained here barring a further decline in money growth. External risks may be more significant – a change in US trade policy and / or a strong rebound US economic growth later in 2017, resulting in upward pressure on US rates / the dollar and a reacceleration of Chinese capital outflows.

*True M1 = currency in circulation plus corporate / household demand deposits. The official M1 measure includes only corporate deposits.
**Financial sector deposits are volatile and contain little information about future spending on goods and services. Such deposits surged in 2014-15 but have stagnated in 2016-17, i.e. they gave a significant boost to M2 growth in 2014-15 but are now exerting a drag.

US ISM strength: signal or "head fake"?

Posted on Thursday, July 13, 2017 at 03:17PM by Registered CommenterSimon Ward | CommentsPost a Comment

A rise in the US ISM manufacturing purchasing managers’ index to a 34-month high in June, reported last week, presents a challenge to the view here that global economic momentum peaked in spring 2017 and will moderate into the fourth quarter. The ISM PMI is widely regarded as a reliable gauge of global as well US industrial activity; indeed, it exhibits a slightly higher correlation with global than US industrial output growth*.

A provisional judgement is that the ISM surge is a reflection of earlier economic strength and will be swiftly reversed. This is supported by three observations.

First, the forward-looking new orders component of the PMI, while rising sharply in June, remained below its level in February / March.

Secondly, the ISM surge is at odds with the Conference Board CEO confidence survey for the second quarter, also released last week, which reported weaker business expectations among manufacturers. The CEO expectations measure usually aligns with the trend in ISM new orders – see first chart.

Thirdly, the ISM result also contrasts with a fall in the IBES US equity analysts’ earnings revisions ratio in June, to an 11-month low. A rise in the revisions ratio in May had suggested that ISM new orders would rebound in June – second chart.

As previously discussed, the global slowdown is expected to be modest and temporary, with money trends now signalling economic reacceleration in late 2017. Near-term negative economic surprises may focus on Euroland, partly reflecting consensus over-optimism.

*Contemporaneous correlation with six-month industrial output growth over 1996-2016: global (i.e. G7 plus E7) +0.77, US +0.71.