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Last week saw another swathe of reasonably strong data releases for the UK. Retail sales for August were only just below the massive, unexpected rise from July which sees sales running at an unforeseen high compared to the general consensus of early summer. Inflation also remained unmoved at 0.6%, although whether this is good or bad will depend on who you speak to. On Wednesday the BoE even increased its GDP growth figures for Q3 from 0.1% to 0.3%.
The BoE’s meeting on Wednesday also announced that base rate would remain constant at 0.25%, with a continuation of the asset purchase plan which started last month. Interestingly, despite inflation remaining at 0.6%, as mentioned above, they are still anticipating that within nine months a rise in food prices, will lead it close to the 2.0% target again. It will be interesting to see whether this actually occurs and, if it does, where it will leave the price of a family food shop relative even to 2014. That may sound like an arbitrary year to choose as an example, but since then there has been a notable shift downwards in the cost of food in the UK created by a perfect storm of lower input costs and price wars between supermarkets. The rationale for higher food prices is the assumption of a weaker pound leading to more expensive imports, but with the current trend for most supermarkets to focus on ‘UK-sourced’ one has to wonder if this fear is overhyped.
Last week JCRA attended a conference attended by large corporates and some PE fund managers in which, one of the major talking points was the impact on their businesses of the referendum outcome. The overwhelming response was positive, with most CEOs and all bar one of the fund managers saying their business plans either hadn’t changed or only required minor alterations. Compare this with the views of most major economists and many financial market participants, who are still expecting another base rate cut before the end of the year and potentially, further asset purchases.
This highlights an important epidemic in the world economy: the disconnect between central banks, financial markets and the real economy. If that conference is representative of the wider opinion of the actual economy, then why are financial markets still so pessimistic as to expect further rate cuts and stimulus? Further, why is the central bank, whose role is to support and stabilise the economy, following suit and likely to provide what financial markets want? The answer may be that Mark Carney is sitting on a mass of information unbeknownst to the rest of us, or perhaps he is a clairvoyant, but neither is likely.
In various countries across the world, people are losing faith in central banks. Many say they cannot be trusted, or that they are not effectively communicating with the market, or that they simply do not know what they are doing. One can see the reasoning behind this lack of trust, particularly in the US where the Fed has consistently moved its own goalposts for years whilst suggesting when rates would rise. What has actually happened is that central banks have shifted from stabilising the real economy to stabilising financial markets, which are two entirely separate things.
The problem with this shift was epitomised by the taper tantrum in the US during 2013 when the Fed suggested that it was going to cut back on monetary stimulus. Markets went bananas and bonds yield surged. The central bank was then forced to retract on its stance to calm the markets. Meanwhile, to everyone who didn’t spend their day staring at a Bloomberg terminal, nothing had changed. The initial intent was to return the economy to its default state by reducing the involvement of the central bank. What actually happened was that the markets learned that if they acted in a certain way they could change the actions of the central bank.
This is what has led us to where we are today. Unfortunately, we shall never know whether or not the UK would have slipped into decline over the summer without further stimulus from the Bank of England. What we do now know is that in many respects, it seems to have been led by big moves in financial markets rather than major redundancies from corporates. In all likelihood, there will be further data releases of a similar ilk to those of the summer. Some strong, but many remaining constant with a few blips which should just mean a continuation of current monetary policy. If that expectation should occur, but policy continues to be loosened, it would confirm that the cart is now leading the horse - which bodes ill for the long term as central banks officially lose control.
The major event of the week is the Federal Reserve’s monthly meeting and funds rate target on Wednesday evening. It is unlikely that another upward move will be made, but with most of the market predicting another increase before the end of the year people may be caught off guard. In Europe the only significant release comes on Friday via the PMI data. There is nothing to suggest that this will alter much from the moderate expansion that was posted last month, although of more interest will be the breaking down of the figures to observe the performances of individual countries, with Italy, ahead of November’s referendum, a crucial focus.
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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