The main economic theme over the last month has been the change of tone from the central banks. The Bank of Canada, Bank of England and the European Central Bank (ECB) now seem more likely to follow the US Federal Reserve’s (Fed) lead and raise interest rates, although it is far from certain.
The US economy is continuing to strengthen, with employment rising faster than expected, adding 222,000 jobs in June. The US Labor Department has revised the job creation estimates to 207,000 in April from 174,000 and to 152,000 in May from 138,400. Employment growth has averaged 180,000 per month so far this year and averaged 187,000 per month in 2016. The employment being created has encouraged more people to start looking for work and this is behind the slight increase in the unemployment rate to 4.4% in June from 4.3% in May. This is a vote of confidence in the jobs market, however, a report by the US Labor Department stated there are 5 million Americans working part-time, who would like to have full-time work.
Despite positive news on the employment front, wage growth remains subdued, with average wages up 2.5% year-on-year. The jobs market still appears to have room to improve.
Donald Trump’s Presidency has been side-tracked by politics, such as the alleged Russian involvement in the US Presidential Election, with very little time to implement his economic policies. One of the risks to the US, as well as to the global economy, is Donald Trump being excessively delayed in implementing his economic and tax reforms. Provided the US economy continues to grow as expected, the Fed is planning one further interest rate rise this year and three more in 2018.
Although the Bank of England Governor, Mark Carney, has indicated that the removal of monetary stimulus is likely to become “necessary”, he has made it clear that changes would be gradual and limited in scope. The UK economy also appears to be slowing down, which may delay the Bank of England tightening monetary policy.
The inconclusive General Election result has increased political and economic uncertainty. The result has also increased speculation that government spending will rise and this is already impacting the government bond market.
Economic data has been disappointing. The productivity of UK workers has dropped to the pre-financial crisis levels in 2007. The Office of National Statistics (ONS) said that hourly output fell 0.5% in the first three months of the year. ONS Head of Productivity, Philip Wales, said, “UK labour productivity has struggled since the 2008 economic downturn, and the fall in the first quarter of 2017 brings to an end a recent run of quarters of positive growth”.
The ONS has also revealed that real household disposable income in the UK is falling at its steepest rate for more than 5 years. The amount that households have to spend, after tax and benefits are taken into account, fell by 2% in the first quarter of 2017, compared to 2016. The main reason for the fall was the rise in inflation, which as measured by the Consumer Prices Index, rose 2.3% in the year to March. The real household disposable income measure is adjusted for inflation, meaning that rises in the cost of living results in lower disposable income. Over the same period, wages rose by 2.1%.
Other UK economic data has also been weak. Output in manufacturing declined 0.2% in May, compared to April. Manufacturing was hit by a 4.4% drop in car production. Construction output fell 1.2% in the three months to May. This is the sharpest decline since October 2015. The construction sector appears to have been impacted by economic and political uncertainty. The trade deficit in goods and services has widened by £1 billion to £3.1 billion between April and May.
In June’s Monetary Policy Committee (MPC) meeting, 3 out of 8 members voted to increase interest rates in order to combat the recent spike in inflation. This is a significant narrowing from the May vote when only 1 member voted to raise rates. However, the disappointing economic data points to the Bank of England delaying raising interest rates in the near future. It will be interesting to see how many members of the MPC vote to raise interest rates at the next meeting.
Although the ECB has kept its interest rates unchanged, there has been subtle changes in its guidance and forecasts. The ECB has dropped its guidance that interest rates might fall further, saying that it now expects borrowing costs to stay at present levels for an extended period. In addition, previous wording in the ECB introductory statement characterised the risks faced by the economy as tilted to the downside, and this has been modified to indicate that risks are now broadly balanced given the pick-up in growth. The ECB did warn that inflation remains subdued; therefore, the economy requires continued easing in monetary policy.
The ECB has marginally raised its 2017 Eurozone GDP growth forecast to 1.9% from 1.8%, whilst reducing its 2017 inflation forecast to 1.5% from 1.7%.
The Eurozone’s first quarter GDP growth has been revised upwards from 0.5% to 0.6%. The expansion in output continues to be largely attributed to domestic demand.
The European banking system still possesses a big risk, with the ECB warning that Popolare di Vicenza and Veneto Banca were failing or likely to fail their capital requirements. The two banks have now been taken-over by Intesa Sanpaolo, with help from the Italian government. The total cost to the Italian government bailout is 17 billion Euros.
The European Union and Japan have formally agreed an outline to a free-trade deal. Although this is positive for both economies, few details are known.
Japan is continuing to show signs of strength in its economy, with the latest Bank of Japan Tankan survey showing stronger than expected business sentiment among major Japanese manufacturers. In May, real exports increased 1.9% month-on-month. This figure followed a robust 4% expansion in the previous month. There are no signs that Japanese interest rates will rise.
The economic landscape of the developing economies is still favourable despite the US recently raising interest rates for the third time in 6 months. Mexico has followed the US, raising interest rates from 6.75% to 7%.
The MSCI have decided finally to include some of China’s domestic A-shares (shares that were previously unavailable to international investors) in its global indices, although the market reaction was muted, with only a tiny weighting set to be added in mid-2018. The Indian government has implemented the Goods and Services Tax, which is seen in the long term as a benefit for the economy, however, in the short term it may result in a dip.
The decision by Saudi Arabia and three other Arab nations to sever diplomatic ties and transport links with Qatar has not impacted energy supplies as feared. The price of Brent oil has fallen from over $50 per barrel to $48 per barrel. The relatively weak oil price has reduced inflation expectations in the US and Europe and is the main reason why Russia has reduced its interest rates by 0.25% to 9%.
The global economy, led by the US, is continuing to expand, which is resulting in many central banks looking towards raising interest rates. This looks like being a long process and even when interest rates start to rise globally, interest rates are likely to remain relatively low. The subdued oil price has reduced inflationary expectations in the US and Europe, which should delay interest rate rises. The implementation of Donald Trump’s economic policies will be a key factor as to when and how quickly interest rates will rise. If Donald Trump’s policies are delayed excessively then interest rate rises will probably be delayed.