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Two weeks ago we entitled our Bulletin ‘Pre-Election Blues’, suggesting that, even with a large Conservative majority following the general election, the prospects for the UK and the health of its economy were not altogether bright. Since then the outlooks, both political and economic, have become considerably darker.
Last week’s economic releases were particularly dispiriting, especially after the previous week’s weak CIPS survey results. The inflation figures showed the targeted CPI measure at 2.9%, compared with the median forecast of 2.7%. What was more surprising was the Bank of England’s comment that inflation would now peak at a higher level than it had predicted and, probably worse, was likely to remain above its 2% target for several years. The markets received further bad news when the latest retail sales figures were released, showing that the annual growth rate had dropped to 0.9%, the lowest level in the past four years and way below the median forecast. There had been considerable confidence that the minimal level of GDP growth in the first quarter would prove to be a one-off, but it becomes increasingly clear that the hard-pressed UK consumer will be unable to inject much of a boost in the near future.
In the midst of the gloom it came as a bit of a surprise to find the MPC voting 5–3 to maintain base rates at 0.25% On this occasion Kristin Forbes, previously a solitary voice, was joined by Ian McCafferty and Michael Saunders in voting for a rate hike. Some have suggested that this voting pattern was a scene-setter for an increase in rates in August if the CPI measure were to exceed 3%. We feel this is very unlikely. Quite apart from the hawkish Kristin Forbes now leaving the MPC, Mark Carney and the Bank of England cabal on the MPC have plenty excuses to ‘look through’ current inflation levels. He can now point to the negative real increase in average earnings being disinflationary, as well as the exchange rate impact dropping out of the index next year. Meanwhile Kristin Forbes is being replaced by Silvana Tenrayo, previously a professor at the LSE, but with no known form to determine whether she has the hawkish attitude of her predecessor.
Of course, most people looking at the current state of the economy would consider it unthinkable that anybody would increase rates in the current circumstances. That would be true if the MPC had followed a more responsible attitude in the past and increased base rates when the UK was enjoying decent levels of GDP growth. However, having failed to do so, to the extent of not even reversing the totally panic-driven post-referendum monetary support package, it is almost inevitable that base rates will get hiked at precisely the time when consumer debt will have grown to a level which will make it extremely painful. While we may be fairly confident that a rate hike is unlikely this year, the market is trading on the assumption that the 0.25% base rate will survive through to the second half of 2019. With rates being normalised in the US and the ECB starting to consider pulling in the reins on its monetary strategy, this would seem like an extreme form of optimism.
However, it is difficult to reconcile monetary tightening with current, medium and longer-term rates, with the five and 10 year swap rates trading at just below 0.75% and only fractionally above 1.00% respectively. The potential implications of the arrival of the youth vote do not seem to have been appreciated by the markets, despite the shock result of the recent election. It is a great shame that this was not awakened at the time of the EU referendum, but with the 18-24 demographic having now appreciated that walking to the nearest polling station is not too taxing, and nor is acquiring a postal vote, it was clearly used with a vengeance at the recent election. This is most unlikely to be a one-off. Furthermore, the anti-Conservative vote seems to have been influenced just as much by austerity as it was by opposition to a hard Brexit. It is very difficult to see how the current government is going to build any rapport with younger voters who think, reasonably, that the middle-aged and the old have fast forwarded their inheritance, leaving them to cope with an underfunded NHS and public sector. One dreads to think what the enquiry into the horrendous Grenfell tower disaster will uncover, but it would be astonishing if it were not a combination of lack of relevant, qualified human resource, cost-cutting, and poor management failing to put into effect the recommendations following the Southwark fire four years ago. One may claim that loose fiscal management is not the way to reduce the current deficit, but that is hardly likely to be a successful argument if you are going to be out of government. The fact that the Conservatives can only survive for any period with the support of the DUP will only hasten the temptation to loosen the purse strings before Jeremy Corbyn can show how to do it – in spades.
Watching the Federal Open Market Committee (FOMC) raise the Fed funds rate to 1.00-1.25% last week came as an interesting contrast to the MPC. Both US and UK economies are enjoying very low rates of unemployment, but while UK inflation is zooming upwards, US inflation has just fallen to 1.7%. In order to return to normalisation, Janet Yellen is willing in the short term to ‘look through’ what the Fed believes to be a temporary phenomenon – the exact opposite of Mark Carney’s call. For good measure, the FOMC also announced measures by which it will, very gradually, start to reduce its QE stockpile of bonds.
There is little in the way of economic releases to excite the market this week, with just the public finances out on Wednesday (likely to be higher than last year) and the CBI industrial trends survey on Friday. The problem with the latter is reconciling it with the actual manufacturing output figures, so while this survey has shown a strong result over the past year, on the back of a weak pound, this should now start to peak. However, the commencement of the Brexit negotiations, with today’s meeting between David Davis and Michel Barnier, will doubtless keep the media enthralled.
All views expressed here are the author’s own and are based on information and data available at the time of writing.
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