Conflict at the Bank of England – weekly update 26 June

A look back over macroeconomic and market events for the week ending 23 June. The week was quiet for most major asset classes, except oil, which slipped into a technical bear market. Signs of conflict at the Bank of England (BoE) caused sterling to see-saw through the week. It’s a fairly quiet week ahead on the data front, with final Q1 GDP revisions and inflation data the most noteworthy releases.

The oil price continued to slide, entering a technical bear market

The oil price fell more than 20% from recent highs of US$54.45 a barrel in February to an end of day low of US$42.18 on Wednesday for West Texas Intermediate Crude, a fall of 21.9%. Concerns are growing that production cuts agreed with OPEC and its partners don’t go far enough and may not be fully adhered to. At the same time, the number of shale oil rigs in the US has been steadily rising since last year as the oil price has recovered, taking advantage of the rapid turnaround time for these activities and adding to global supplies. These factors have been enough to overwhelm some of the price-supportive indications this week – US oil inventories actually fell slightly further than expected (a fall of 2.5 million barrels, compared to 2.1 million expected), whilst Tropical Storm Cindy has so far shut down 17% of production capacity in the Gulf of Mexico. We remain concerned that the supply and demand dynamics in the oil complex will cap upside potential and we therefore remain sceptical on the medium-term outlook, though current levels do look fairly depressed.

Clear signs of conflict at the Bank of England

There was conflict at the Bank of England’s Monetary Policy Committee, which caused sterling to whipsaw. On Tuesday, the Bank’s Governor, Mark Carney, gave a decidedly dovish speech in the City, citing concerns over wages growth and consumption and declaring that “now is not the time” to be tightening policy. However, just a day later, Chief Economist Andy Haldane spoke about the likely need to start tightening in the second half of the year to avoid falling behind the curve as downside risks fell away – a surprisingly hawkish sentiment from a BoE official. These opposing views come as headline inflation has been surging (CPI was 2.9% year on year in May) and the MPC surprised markets with a closer-than-expected vote of 5-3 in favour of keeping interest rates unchanged.

Our view remains that the Central bank will sit on its hands while the transitory effects on inflation move out of the numbers and the political dust settles. It is also worth remembering that, while 5-3 appears to be a tight vote, the outlook is not as tight as it may seem. One of the dissenting members (Kristen Forbes) is standing down before the next meeting and her replacement (Silvana Tenreyro) is thought to be more dovish, while the dovish Chair (Mark Carney) breaks any tie.

Global PMI numbers were slightly disappointing

The US Markit Composite PMI slipped from 53.6 to 53.0, with unexpected weakening from both the Services and Manufacturing components (Services also fell from 53.6 to 53.0 against expectations of 53.7, Manufacturing fell from 52.7 to 52.1, 53.0 expected). It wasn’t quite the same story in Europe, where Manufacturing PMI rose from 57.0 to 57.3 (56.8 expected), but Services PMI fell from 56.3 to 54.7 (56.2 expected). In Japan the Nikkei Manufacturing PMI fell from 53.1 to 52.0 (53.4 expected). Although there have been a lot of misses here, these numbers come as the indices are generally at quite elevated levels. They are an aspect to watch, but nothing unduly concerning at this stage.

Last week’s other events

• Eurozone construction output fell from 3.8% to 3.2% year on year in April, while Consumer Confidence for June rose from -3.3 to -1.3 (-3.0 expected), the highest reading in 16 years

• Japan’s exports were up 14.9% year on year in May, an improvement over the 7.5% from April, but below the 16.1% forecast

• In the US, the Kansas Fed Manufacturing Index rose from -1 to 23.

The markets

Aside from the further decline in the oil price, it was another typically subdued week in markets.

Equities – The MSCI Emerging Markets index was the strongest of the major regions, returning 1.4% for the week. Developed market equities only returned 0.2% (MSCI World), and within the major developed regions, Japan was the strongest mover (though with just a 1.0% rise on the TOPIX). In the US, the S&P 500 returned 0.2%, while Europe (measured using the MSCI Europe ex UK) was flat and UK equities were down -0.5%.

Bonds – It was similarly quiet on the sovereign bond front: 10-year UK gilt yields rose two basis points (bps) to finish at 1.04%, the equivalent US Treasury yields were three bps lower to 2.14% and 10-year German bund yields were down two bps to 0.26%.

Commodities – Oil fell further to enter a technical bear market last week, with Brent crude falling as low as US$44.47 a barrel, before recovering slightly at the end of the week to close at US$45.68 a barrel. After early falls, gold rallied in the second half of the week to finish slightly higher than it began at US$1,256.77 an ounce, while copper rose to US$2.63 a pound.

Currencies – After falling sharply early in the week on the back of Mark Carney’s comments, sterling had something of a rally, but remained down on the week. Sterling closed Friday at US$1.27, €1.14 and ¥142.

1 month performance of major asset classes

The week ahead

There are a few data points of note next week. On Monday, US Durable Goods is reported in the afternoon and will give some further indications on the state of the US economy (-0.5% month on month expected from -0.7% previously). On Thursday, we have Eurozone business Confidence reported. Friday will be a particularly busy day, with inflation for Japan, the Eurozone and the US (PCE measure), and Manufacturing PMI data from China the highlights. Final Q1 GDP numbers will also be confirmed for the US and UK, with the details of potential interest. Elsewhere:

Monday: Ahead of US Durable Goods, the German IFO Business Climate survey results for June are released in the morning. In the afternoon, the US will also report the Chicago Fed National Activity Index and the Dallas Fed Manufacturing Index.

Tuesday: The Bank of England releases its Financial Stability Report in the morning, then in the afternoon we have US house prices and the Consumer Confidence measure from the Conference Board.

Wednesday: It’s a quiet mid-week. In the US, Wholesale Inventories and Pending Home Sales are the main data on the day.

Thursday: In the morning, German Consumer Confidence is reported, ahead of the Eurozone Business Confidence mentioned above, and UK Consumer Credit.

Friday: Friday marks a busy end to the week. UK Consumer Confidence is out just after midnight, followed by a slew of Japanese data, including household spending, unemployment, inflation and industrial production (all that before 2am, UK time). Chinese official Manufacturing and Non-Manufacturing PMIs are reported around 2am. German Retail Sales and Unemployment are out before the UK GDP revisions data at 9:30am. Eurozone inflation is expected to have slowed from 1.4% to 1.2% year on year, and the result will be known at 10am, UK time. In the afternoon, as well as US GDP revisions, the Personal Consumption Expenditure Price Index is expected to have slowed from 0.2% to 0.1% month on month; Personal Income and Personal Spending numbers will also be released.