UK interest rates on track to be raised – weekly update 23 October 2017

Interest rates in the UK are likely to be raised

This is despite weak retail sales numbers, which saw a sharp fall in growth from 2.4% to 1.2% year on year, well below average forecasts for 2.1%, and below even the most pessimistic estimates recorded on Bloomberg. Despite the fall in volume growth, consumers are still spending significantly more: 4.4% more in year-over-year value terms to be precise. While average weekly earnings growth inched up 0.1% to 2.2% year on year (against expectations for no change at 2.1%), headline CPI inflation increased to 3.0%, meaning real wage growth remains firmly negative. On Friday, markets were still pricing in just under 80% probability of a hike in November, despite two members of the MPC – Deputy Governor Jon Cunliffe and new joiner Dave Ramsden – signalling they don’t currently support an increase and another, Silvana Tenreyro, already known to be decidedly dovish.

The 19th Party Congress is well under way in China

Economic data releases suggest continued economic strength. Third quarter GDP slowed as expected by 0.1% to 6.8% year on year, but remains well ahead of the 6.5% full-year target. Retail Sales increased to 10.3% year on year from 10.1% (10.2% expected) and Industrial Production was up from 6.0% in August to 6.6% in September (6.5% was expected). CPI inflation was lower as expected, down 0.2% to 1.6% year on year. It wasn’t all good news though: Fixed Asset Investment slipped more than expected, falling 0.3% to 7.5% year on year (7.7% was forecast). With high levels of corporate debt, and the impact of a fading credit impulse from the start of the year, we believe China will continue to see a slowdown towards the end of this year and into early 2018, though a so-called ‘hard landing’ seems unlikely in the absence of a serious policy error.

Last week’s other events

• As Japan went to the polls, Industrial Production fell 0.1% to 5.3% year on year, whilst Capacity Utilisation rebounded from a -1.8% fall in September to a 3.3% month-on-month increase in September. The general election saw the Liberal Democrat-led coalition keep hold of its two-thirds ‘super majority,’ paving the way for further stimulus and potentially a revision or reinterpretation of the country’s pacifist constitution.
• Eurozone Construction Output slowed from 3.4% to 1.6% year on year. The ZEW business sentiment survey measure saw the Expectations index fall from 31.7 to 26.7.
• US export prices were up 2.9% year on year in September, following a 2.3% rise in August, whilst Import Prices increased 2.7% (from 2.1% previously). Industrial Production rebounded from a -0.9% month on month fall in August to 0.3% growth in September.

Markets

Markets were fairly subdued last week, with Japanese assets (both currency and equities) the primary winners.

Equities – Japanese equities had a positive week going in to the election, as the TOPIX index returned 1.3%. The US trailed with the S&P 500 returning 0.9%. Europe scraped out just a 0.1% gain, as measured by the MSCI Europe ex-UK index. The UK was the biggest disappointment, as the MSCI United Kingdom fell -0.3% on the week. The MSCI Emerging Markets index was also down, falling -0.1%.

Bonds – 10-year gilt yields fell 4 basis points (bps) on the week, to 1.33%, heading in the opposite direction to other core global sovereign bonds. In contrast, 10-year US Treasury yields rose 11 bps to 2.38%, and 10-year German Bund yields were 5 bps higher to 0.45%.

Commodities – Oil remains at the upper ends of its recent trading range, with Brent Crude having risen to US$57.75/barrel by the end of the week, though it peaked above the US$58/barrel mark mid-week. Gold slipped back below US$1,300/ounce to end the week at US$1,280.47, whilst copper was little changed, ending at US$3.17/lb.

Currencies – The US dollar weakened through the period, whilst the yen was the key strengthener heading into the election. Sterling closed on Friday at US$1.32, €1.12 and ¥150.

1 month performance of major asset classes

The week ahead

All eyes will be on the European Central Bank (ECB) when it meets on Thursday to consider when and how to start scaling back its quantitative easing programme. There are also a number of other important data releases ahead. UK GDP on Wednesday is expected to have slipped 0.1% to 1.4% year on year growth, and this will be followed by US Q3 GDP on Thursday which is forecast to have slowed from 3.1% to 2.5% annualised. US Durable Goods orders will also be of interest on Wednesday (a slowdown from 2.0% to 1.3% month on month is expected), whilst Tuesday gives us PMI readings from the US, the Eurozone and Japan (details below). The daily breakdown is as follows:

Monday – it’s a quiet start to the week, with UK Business Optimism from the Confederation of British Industry and Eurozone Consumer Confidence the only releases of note.

Tuesday – a bumper day for PMI readings. Early in the morning, UK time, Japan releases Manufacturing PMI numbers, with the Eurozone reporting later in the morning (markets are forecasting the composite to slip from 56.7 to 56.5, with both sub-components lower). In the afternoon, we have US Markit PMI numbers out – forecasts are for Manufacturing PMI to tick up by 0.1 to 53.2, but Services to have slipped down by 0.2 to 55.1.

Wednesday – ahead of the UK GDP releases, we will be watching the latest IFO business survey results released in Germany. UK GDP and US Durable Goods will be the focus, covered above.

Thursday – it’s a quiet morning before the ECB meeting concludes at lunchtime (12:45 UK time). Following this, there are Jobless Claims and Pending Home Sales data released in the US.

Friday – Japanese inflation data are printed just after midnight, followed by Chinese Industrial Profits reported at 2:30am. In the afternoon, the Q3 GDP print for the US is the main release.