UK inflation data remains elevated – weekly update 20 November 2017

UK inflation was unchanged at 3.0% year on year

This is as measured by CPI, with core CPI also unchanged at 2.7%. Both were slightly shy of forecasts for a marginal 0.1% increase, with the food and non-alcoholic beverages component a major driver, up 4.1%. At this stage there are too few data to form much in the way of a meaningful trend, but as we’ve highlighted previously, we do believe that the UK’s relatively high inflation is primarily transitory and related to the Brexit-induced currency depreciation, so should start falling back towards target over the next twelve months.

Regardless of the cause, however, real earnings remain negative, with UK nominal average weekly earnings growth holding steady at 2.2% year on year (though still slightly ahead of the 2.1% forecast). Retail sales highlighted the stress being felt by the UK consumer – despite being slightly ahead of forecasts, UK Retail Sales fell for the first time since 2013, down -0.3% year on year (from 1.2% growth previously, and forecasts for -0.5%) with food sales and clothing particularly hit.

Chinese data also pointed towards a slowing economy

Retail sales growth fell from 10.3% to 10.0% year on year, defying forecasts for an increase to 10.5%. In a sign that global investors are starting to become wary, Foreign Direct Investment growth slowed sharply from 17.3% year on year in September to 5.0% in October, though September’s reading was unusually high. Industrial Production slipped from 6.6% to 6.2% year on year (6.3% was expected), while money supply growth continued to slow. Perhaps recognising some of the concerns building in the market, the Peoples’ Bank of China sought to calm nerves with a US$47 billion injection into the system, nudging sovereign bond yields down. A Chinese economic slowdown is all but inevitable and largely anticipated by markets – the main questions now are around the speed and scale of the cooling.

US CPI inflation softened in October

It was down 0.2% to 2.0% year on year and in-line with expectations, though the core measure, which excludes the volatile food and energy components, unexpectedly rose from 1.7% to 1.8% (no change was expected). This helped real earnings remain positive, though real weekly earnings did slip from 0.6% to 0.4% year on year. Retail sales normalised, falling from a spike of 1.6% month on month in September to a more typical 0.2% reading in October, which was nonetheless higher than the 0% that was forecast. Core retail sales (measured as the control group) slipped 0.1% to 0.3% as expected. There was good news from the business side too, with Industrial Production rising faster than expected, from 0.3% to 0.9% month on month (0.5% expected), and the Capacity Utilisation rate was reported by the Federal Reserve as increasing from 76.0% to 77.0% (76.3% expected). This supports our view that the underlying US economy remains solid, though from an investment perspective valuations remain unattractive – we also see a latent risk of higher inflation that the market is not currently pricing in.

Last week’s other events

• Eurozone industrial production fell from 3.8% to 3.3% year on year (forecast was 3.2%). The first estimate for third quarter GDP came in at 2.5% year on year, as expected and no change from the previous reading. Business expectations improved, with the ZEW Survey index for expectations rising from 26.7 to 30.9. Construction Output increased from 1.6% to 3.1% year on year.
• In the US, the NFIB Small Business Optimism index rose from 103.0 to 103.8 (104.0 expected). The Empire Manufacturing index slipped from 30.2 to 19.4 (25.1 was forecast), and the Kansas City Fed’s Manufacturing Activity index was also down, from 23 to 16 (21 expected).
• Japanese GDP for the third quarter came in at 1.4% annualised, down from 2.5% in the second quarter, and slightly worse than the 1.5% that was expected, dragged down by weak private consumption and business spending components.

The markets

There was a minor reversal of movements from the previous couple of weeks. Core sovereign bonds rallied, while equities were marginally off.

Equities – Japanese equity markets gave up gains over the past couple of weeks, as the TOPIX fell -2.0% last week. The other major developed equity markets were also in the red, though only marginally. The MSCI United Kingdom index finished down -0.7%, with MSCI Europe ex-UK down -0.8%. Across the Atlantic, the S&P 500 index of US equities slipped -0.1%. Emerging Markets fared slightly better, as the MSCI Emerging Markets index returned 0.3% for the week.

Bonds – Major sovereign bonds largely made back their losses from the previous week. Looking at the core 10-year yields, all were approximately 5 basis points lower – UK gilts finished the week at 1.29%, US Treasuries ended at 2.34% and German bunds were last seen yielding 0.36%.

Commodities – Oil slipped from recent highs, but remains elevated by recent standards, with a notable rally on Friday that left Brent Crude at US$62.72/barrel. Copper was little changed overall on the week, ending at US$3.07/lb, while fresh interest on Friday saw gold jump to US$1,292/ounce.

Currencies – The yen and the euro both gained on the pound last week, while the US dollar was slightly weaker. Sterling closed on Friday at US$1.32, €1.12 and ¥148.

1 month performance of major asset classes

The week ahead

A shortened week in the US because of Thanksgiving sees a relatively quiet week ahead. In the UK, the Chancellor of the Exchequer will present the Autumn Budget on Wednesday, which generally has little macroeconomic impact these days – it’s mostly relevant to personal finances – but could provide some insight into future government fiscal policy. US Durable Goods on Wednesday are forecast to have fallen from 2.0% to 0.4% month on month. There are also Purchasing Manager Index (PMI) readings due from the Eurozone and the US: Eurozone Manufacturing PMI is expected to remain strong, but slip from 58.5 to 58.2, with Services PMI moving in the other direction, from 55.0 to 55.2. The US Markit PMI numbers are forecast to show an increase in Manufacturing PMI (54.6 to 55.0) and no change for the Services PMI at 55.3. Away from the data, there will also be plenty to watch on the political front, with fresh political discussions now due in Germany following the collapse of coalition talks, the US tax bill working its way through the Senate (though no vote is likely until after Thanksgiving) and the level of the UK’s Brexit bill all hot topics. The daily breakdown is as follows:

Monday: The US Conference Board’s Leading Index of economic indications is the only release of note, expected to have improved from -0.2% to 0.7% in October.

Tuesday: Japan reports sales from supermarkets and department stores in the morning, as well as the All Industry Activity Index. Later, the UK government reports the latest borrowing requirements, and the Confederation of British Industry updates its latest industry trends numbers.

Wednesday: The main events mid-week will be the UK’s Autumn Budget and the US Durable Goods report, covered above. In addition, there will be the latest Consumer Confidence numbers for the Eurozone and the minutes from the recent FOMC meeting to read through.

Thursday: The second reading of the UK Q3 GDP print is reported in the morning, and will come with additional details and any revisions. Later in the day we will also have the monetary policy meeting accounts for the latest ECB meeting.

Friday: Closing the week out, Japanese Manufacturing PMI will be reported together with the Leading and Coincident economic indices. Later in the morning, German business surveys will be released by the IFO before the US Markit PMIs are out in the afternoon.