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Unwelcome uncertainty

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Theresa May’s faltering election campaign finally caught up with her this week as the latest polls put the Conservative lead at 5 points having been as high as 20 at the start of the campaign. 

Own-goals such as the U-turns on ill-conceived social care policies, a centrepiece of the Conservative manifesto, as well as unrealistic and undetailed immigration targets have only undermined her soundbites of ‘strong and stable leadership’. A less than convincing appearance on the BBC last Monday compounding issues and only serving to lessen the pressure on the hapless Labour front bench who seem incapable of landing any credible blows of their own. Whilst a Labour victory remains highly unlikely with the bookies suggesting only a 20% chance, the markets remain nervous of an indecisive vote on June 8th and the uncertainty it would cause in the imminent Brexit negotiations. As a result, sterling dropped to a one-month low of 1.2772 against the dollar with further volatility expected over the coming weeks. 

The markets will expect more clarity and conviction from the leaders in their various high-profile televised appearances over the coming week. However, neither should expect the task to get any easier following the scathing criticism both received from the Institute of Fiscal Policies regarding their manifesto pledges. The independent think-tank was particular aggrieved by sizeable gaps in proposals for social services as well as unconvincing plans to boost economic growth: the latter being of particular concern as GDP growth for Q1 was revised down to 0.2% from 0.3%. However, positive business survey data released this week, as well strong consumer credit numbers on Wednesday, should signal GDP growth rebounding in Q2 by as much as 0.5%. Whilst this will be welcome news, policymakers can ill afford to continue to drive economic growth through consumption alone.

Accounting criticism was even more blistering in the US with Trump’s first budget being labelled innumerate by some commentators following its release on Tuesday. As well as claims of double-counting, one particular area of contention is the assumed growth that underpins the Presidents claim that his administration will eradicate the deficit within 10 years. This is at odds with many commentators, including the Congressional Budget Office, which has lower growth forecasts as a result of slow population growth, an ageing population and lacklustre productivity growth in the coming years. Failure to communicate a robust and compelling economic plan has added to scepticism in the market regarding the extent and timing of Trump’s pro-growth policies, including tax cuts and deregulation. As a result, many analysts have lowered their projections for where the 10-year US Treasury will finish the year by up to 0.25%. However, short-term expectations remain unchanged with many analysts now pricing in a 0.25% Fed rate rise in June.

A lack of clarity has also led to frustrations on the global stage, with Merkel claiming that Europe could not rely upon America or Britain. Her comments followed Nato and G7 summits at which Trump’s failure to endorse mutual defence among Nato members, the Paris climate accords and less than flattering comments on German trade only served to rile his allies.

Whilst international dialogue is proving frustrating, domestic economic performance continues to be welcomed by EU leaders. Economic data released this week will see the EC Economic Sentiment Survey exceed 110, levels not seen since August 2007, and Wednesday should see unemployment falling to 9.4% from 9.5%. However, with inflation data on Tuesday expected to show annual growth falling to a five-month low of 1.4% as energy effects fade, any talk of a rate increase remains very premature. Yet, as strengthening economic momentum continues, with annual GDP growth for this year expected to be 2%, the case for both a strengthening euro and pound against the dollar continues to have merit.

Meanwhile the Greeks, who have met their creditors demands, moved very close to securing the next tranche of their bailout which would, in turn, allow them to meet more than €7bn of debt repayments due in July. By all accounts, a compromise should be achieved between Germany and the IMF at the next meeting on 15 June, with the latter insisting a programme of debt relief is necessary. The relatively upbeat European news is expected to continue with the Italian GDP growth figures on Wednesday which are expected to show growth of 1.8% this year.

An economic event that has added to the uncertainty but that passed with little attention was Moody’s decision last week to downgrade China’s sovereign credit rating, citing rising debt, a slow pace of reforms and slower potential growth. Whilst the world’s second largest economy vigorously defended itself and the market's response was agnostic, investors should prepare for the possibility of doubts over China causing market volatility over the summer months.

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