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A change of focus in economic policy in 2017?

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20 th December 2016
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The same Christmas present as last year was doled out at the US Federal Reserve meeting last Wednesday, in the form of a 0.25% hike in its repo rate. As it had been fully anticipated (markets had already priced in near 100% probability of this) the decision to raise the repo rate to 0.50 – 0.75% was less interesting than the message that accompanied it. When the Fed increased rates last year, it was regarded as the first step on the path to ‘normalisation’ and the expectation was that the repo rate would rise at least twice during 2016. These expectations slowly faded, as the Fed trotted out various excuses such as China’s economic problems and Brexit as external factors that might impact on the slowly reviving US economy and the gradual decrease in unemployment.  

Twelve months later we are in a not-dissimilar situation, with the FOMC hinting that the market might expect up to three further rises across 2017. Accompanying this was an upwards revision to the dot-plot, which is the graph of where each individual Fed member thinks rates will be at a given time. Combining both these factors sent both interest rates throughout the yield curve and the USD sharply higher. The impact of this potential doubling of the repo rate during the course of 2017 was not just restricted to the domestic market, with UK yields also moving sharply higher (the UK five-year swap rate opened 10 basis points higher on Thursday morning).
 
An important caveat revealed during the subsequent press conference is that this hawkish sentiment is based on current fiscal policies and gives no consideration to changes in policy as a result of the impact of President-elect Trump. Markets will be waiting again for March’s meeting, once the new Trump administration has set out some of its aspirations, hopefully in a considerably more cogent manner than the soundbites–through-Twitter by which most of the President-elect’s thoughts on economic management have been distributed thus far. However, from Trump’s comments to date there seems little doubt that the US appears to be the first of the major economies that will switch from boosting the economy through fiscal measures rather than relying on very lax monetary policy. Whether or not his massive infrastructure plans will see the light of day, together with expenditure designed to revive long-obsolete and uncompetitive industries, it is clear that fiscal policy is going to have a much greater impact than it has for very many years. The prospect of the Fed being able to return to a more balanced monetary stance should be greatly enhanced. There should be much greater confidence in the prospective rate hikes for 2017 than in those forecast for this year.
 
If the US is to shift the prime driver of economic policy from being fostered by loose monetary policy to the primary influence being a much more expansive fiscal policy, it will be interesting to see how that plays out on the political stage. 2016 has seen a succession of shocks to the political establishment. These were not limited to Brexit and the US election results, nor to the rise of either left or right wing parties. The Brexit result was brought about by voters across a wide spectrum voting to leave the EU, and the election of Donald Trump was only possible because States normally regarded as secure Democrat territory failed to get Hillary Clinton elected. Mario Renzi has just had his reform package defeated by a combination of left-leaning parties, while Austria only just fallen short of electing an extreme right wing President.
 
To date, none of these political upsets has had very much impact on economic policy, but I doubt that this will continue to be the case. There are notable elections to be held in the Netherlands, France and Germany during the course of 2017. Even Angela Merkel, despite huge personal approval ratings, has started to move to more populist measures, and we are likely to see a much greater shift in other countries.
 
If a return to the primacy of fiscal policies does occur in 2017, it may well be accompanied by the return of inflation. Particularly in the UK, that it is now feared to rise worryingly fast. Back in January, every central bank in the western world was worried about the prospect of their economies heading for deflation, largely due to the fall in oil prices. They then spent much time considering strategies to move the indicator back towards target levels, the ECB being the major one to act by expanding its quantitative easing program twice during the year. Unfortunately, that had minimal effect at best. Only Britain has seen CPI return back towards almost certainly exceeding the target level of 2.0% in the year to come, but even Europe has now stopped worrying about deflation.
 
This week is fairly light on economic announcements. UK government spending figures are released on Wednesday morning, and expected to show a small reduction. On Friday we will see the final Q3 GDP figures, in which there is not expected to be any change from the 0.5% quarter-on-quarter growth shown at the last revision. Thursday brings the equivalent US GDP figures, with a slight upward revision to be made from 3.2% to 3.3%. At the same time will come the final US jobs report for the year.
 
Tuesday will see Theresa May appear before the Commons Liaison Committee, which is comprised of the heads of each select committee. They will be quizzing her on her plans to lead policy in each of their areas during 2017. This is likely to mean certain policy areas, about which little or nothing has been disclosed, may have to start seeing the light of day. Although not likely to affect UK markets to the same extent, a much more interesting political interview occurs on Thursday when Vladimir Putin has a four-hour conference with the media.
 
As this is the final Weekly Bulletin of 2016, may we take this opportunity to wish you a most enjoyable Christmas and New Year break. Normal service will be resumed on 9 January.

 

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