Macro insights

US payrolls signal easing, UK election seems inevitable and ECB between a rock and a hard place

A mixed batch of numbers from the latest US payrolls report last week left our outlook as expecting another easing in the US Fed Funds Rates in next week’s Federal Open Market Committee meeting. Headline payrolls growth slowed to 130,000 in August, confirming a softer pace of employment growth that has been in place for most of this year. However, labour supply was firm in August, unemployment was stable around decade lows at 3.7% and earnings surprised to the upside with an upwards revision to July - to 3.3% from 3.2% - and a solid August. The coming week sees Producer Price Index (PPI) and Consumer Price Index (CPI) inflation data released, as well as retail sales for August. Core CPI inflation is expected to rise to 2.3% - a one-year high – and while retail sales are likely to have been soft in August, previous gains suggest another solid quarter’s consumption growth in the third quarter (Q3). The US Federal Reserve is likely to be caught between weak financial market sentiment and solid economic data. However, with the Fed in purdah this week and not able to provide additional guidance, we forecast a 0.25% easing in September’s meeting to 1.50-1.75%. Looking ahead, trade developments remain one of the broader uncertainties. Discussions over the weekend suggest that trade talks with China will resume in October. However, with this suggesting a repeat of a well-trodden route to disappointment, we continue to expect fresh headwinds over the coming weeks.   

UK output data for July was published this morning including GDP, industrial and construction output. The data remain consistent with softer GDP growth, although we continue to expect a rise in Q3 GDP, after Q2’s contraction. Tomorrow sees July’s UK labour market release, with some deceleration expected from the strong 115,000 employment gains posted in Q2. However, economic data will be eclipsed by political developments in the UK. The past week saw a furious pace of developments as Prime Minister Boris Johnson’s Brexit plans appeared to crumble around him and Parliament reasserted some control over the process, introducing legislation to rule out a no-deal Brexit on 31 October. PM Johnson’s problems were compounded by the resignation of his brother Jo as a Member of Parliament and cabinet minister and, over the weekend, by senior cabinet minister Amber Rudd. The Prime Minister’s attempts to get out of the corner he finds himself in will continue today as he is expected, once again, to seek an early election – something that once more looks set to be denied for now. Parliament appears likely to only schedule a new election after an extension to the Brexit deadline with the European Union (EU) has been agreed. However, so far the developments in Westminster do not appear to be affecting polling data: the Tories remain some 13 points ahead in recent polls, with Johnson considered a much more suitable Prime Minister than Labour leader Jeremy Corbyn. With an early election seeming inevitable over the coming months, these may ultimately be the more important economic data over the coming weeks.

The ECB will be between a rock and a hard place when it meets on Thursday this week. The European Central Bank (ECB) will have to deliver a “package” of measures, having so heavily telegraphed the likelihood of additional easing over the last two months. Additionally, the data flow has continued to deteriorate since June, suggesting that the associated macroeconomic forecasts which will be released with this meeting are likely to signal another downward drift in GDP growth and the inflation outlook. The basis of such an easing package is likely to be another deposit rate cut, by 10 basis points (bps) in our baseline, with some probability of a larger cut. To facilitate even more negative interest rates, we also expect the ECB to introduce ‘tiering’, reducing the impact of negative rates on some financial institutions’ balance sheets. Moreover, we expect the ECB to restart a relatively small quantitative easing (QE), i.e. a time-limited buying programme at a fairly low monthly pace, consistent with the current limits of QE. We expect €25-30bn a month for six months, shared across corporate and sovereign bonds. As often with the ECB, efficiency and political acceptability criteria are likely to be blurred at the cost of policy efficacy. In our view, even with tiering, a deposit rate cut is not going to spur the economy much and the takeaway from Thursday’s meeting could well be disappointment. 

China enacts reserve requirement ratio cuts to counter ongoing trade woes: Both China exports and imports resumed declines in August, suggesting no respite from front-loading purchases in the US ahead of the new tariffs and continued softness in the Chinese economy. Total export growth fell by 1% year-on-year (yoy), spearheaded by the 16% decline in shipments to the US. The latter points to little evidence of pre-emptive buying ahead of the September/October/December tariffs, and the existing taxes on $250bn of products have continued to cause malaise. In addition to the US, export growth to the eurozone and emerging markets also slowed, suggesting generalised weakness in global demand. On the flipside, a deeper contraction in Chinese import growth (-5.6% from -5.3%) is consistent with the domestic economy losing further steam. Beijing has recently ramped up policy easing, with last week’s cut to the banks’ reserve requirement ratio (RRR) the latest move to halt an increasingly worrying trend of growth slowdown. This move was consistent with our call for two RRR cuts in the second half of the year, coupled with a rising likelihood of medium-term lending facility rate cuts leading to lower loan prime rates in the coming months. However, while these actions are, in our view, enough to keep growth above 6% this year, they are insufficient to counter the economic headwinds in 2020. We have, hence, downgraded our forecast for next year’s growth to 5.8% from 6.1%, following this year’s 6.1% growth.

Upcoming events

US: Producer Price Index (Wednesday), Consumer Price Index (CPI) (Thursday), retail sales, preliminary Michigan consumer sentiment (Friday)

Euro Area: German current account (Monday), French and Italian industrial production (Tuesday), Spanish industrial production (Wednesday), Euro Area industrial production, ECB announcement and press conference (Thursday), informal Economic and Financial Affairs Council (ECOFIN) and Eurogroup meeting (Friday)

UK: EU Withdrawal Bill expected to return to Commons, Bank of England’s Gertjan Vlieghe speech in London, monthly GDP, industrial production, manufacturing and construction output (Monday), unemployment (Tuesday), prorogation of Parliament (no later than Thursday)

China: Trade balance (Monday), CPI (Tuesday), total social funding (this week)

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