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Rough terrain ahead for May

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The UK Government all but shut up shop this week for the summer recess, offering the Government a much-needed opportunity to regroup after a disastrous few months. The Prime Minister might have been better advised to have taken a more relaxing holiday than the walking one she has planned. Rested or not, she will need to hit the ground running if she is to present a reinvigorated and unified party at the Conservative conference in early October.
 
Most pressing on the growing list of challenges awaiting her return will be the monumental task of passing the first of at least eight EU withdrawal bills. With no majority and a divided cabinet this will be no walk in the park, as she finds emboldened Remainers and an apparently resurgent opposition intent on disrupting her progress. She is likely to find, to her frustration, that the debate around Brexit and its make-up has only just begun.
 
This will be against a backdrop of the ongoing negotiations in Brussels, where substantive progress must be made on the terms of the ‘divorce’ so that discussions can turn to constructing a free trade agreement. However, if this week’s negotiations were anything to go by, this is likely to be an uphill slog. Thankfully there are signs that the Government is slowly realising that it doesn’t ‘hold all the cards’, as once claimed by Michael Gove, and is willing to adopt a more pragmatic approach to negotiations. Some clarity was forthcoming at the end of last week, with suggestions that the Government would look for a two-year transitional agreement to avoid the ‘cliff-edge’ exit that business leaders fear. This concession would see the continuation of freedom of movement and the European Courts of Justice’s jurisdiction in the UK – both originally labelled as ‘red lines’ by ministers. Judging by how the negotiations have been progressing to date, Gove and other cabinet colleagues would be well advised to put down their summer novel and get some practice playing cards.
 
After a hapless election campaign May must also address a stagnating economy that is now growing more slowly than the eurozone. It would be naïve to read too much into last week’s fall in CPI (2.6% vs a consensus of 2.9%) and increase in retail sales (2.9% y/y vs consensus of 2.5%).  Both will be temporary, with inflation likely to rise to 3.0% by the end of the year and consumer spending certain to slow. Whether inflation remains stubbornly high next year as oil and currency effects fall out of the basket will be dependent on whether higher prices begin to influence wage negotiations. Whilst there is little evidence of this as yet, in the face of falling real wages and a household savings ratio at the lowest levels since records began something will have to give. Ongoing uncertainty and the short-term easing of inflation will mean the MPC is unlikely to raise rates in August, even though GDP growth figures on Wednesday are likely to show a modest increase in growth from the 0.2% registered in Q1.
 
May is not alone in looking to use the summer ‘calm’ to think of ways to relaunch her premiership. In the US President Trump would be wise to seize the same opportunity, having made no significant progress on his much-heralded domestic policies of tax reform, infrastructure and healthcare, the latter collapsing this week despite a Republican majority in both legislative chambers. If Trump isn’t able to demonstrate progress on his pro-growth policies of tax cuts, fiscal expansion and deregulation then we could see a reversal of the stalled Trump trade that swept the markets earlier this year. Whilst a continued failure to introduce such reforms would not be a disaster for a US economy that is continuing to grow and at full employment, it would certainly rattle the financial markets with the dollar likely to suffer. Also, with no economic leadership from the White House, expect an increased focus to be on the Fed’s policy decisions.
 
The summer will be a surprisingly bullish one for the eurozone. Having halted the march of populist parties on the periphery of the political spectrum, and now supported by relatively strong economic growth, talk is turning to reform. EU technocrats would be wise not to use this as an excuse to push ahead with their vision of the European project and instead shore up its faltering foundations, and in doing so address the electorate’s concerns. Failure to do so will only embolden Eurosceptic sentiment. Well aware of the challenges still facing the eurozone, Draghi confirmed the ECB’s ongoing commitment to their asset purchasing programme. Whilst talk of tighter monetary policy is premature, the fact that it is now on the table is evidence of the eurozone recovery.

 

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