The Week In Hindsight, 18 July 2014
The UK economy continued to strengthen during June according to a raft of data released this week, prompting renewed speculation over when the MPC will be likely to begin raising interest rates. The most notable of these was CPI inflation, which rebounded from 1.5% to 1.9%; a level that is within an inch of the BOE’s target. The unemployment rate also declined for the fourth consecutive month, from 6.6% down to 6.5%; a new five year low.
On the downside, the quarterly average earnings index fell by 0.5% during the last three months when compared with the same period one year ago. This poses a problem for policy makers as well as interest rate hawks. This is because low, and in some cases falling, wages are a key policy maker indicator of excess slack in the labour market.
In addition to this, the entire time that wage growth remains below the pace of inflation, real incomes are being eroded.With consumers still highly leveraged following the phase of credit expansion which helped create the conditions necessary for the financial crisis to take hold, any upward movement in interest rates could ultimately drive consumers into retrenchment, leading to lower levels of spending and slower growth.
Further from here, higher rates would also have a substantial impact upon the housing market. This would be at a time when mortgage approvals are already falling as a result of the new regulatory regime (MMR) which came into effect in April this year.
In short, while economic growth in the UK has accelerated throughout 2014; the recovery remains tentative and risks continue to exist both at the national as well as international level. With much of the improved sentiment and activity so far having stemmed from the housing market, and given the sensitivity of this area to interest rate movements; the MPC is unlikely to alter policy if it perceives such action as presenting a risk to the recovery.
In addition to this, inflation has held itself firmly within a downward trend throughout the year to date, while the current consensus among analysts and economists continues to suggest that further downside is likely over the months ahead.
For these reasons, our view is that the week’s data has done little to alter the interest rate outlook and we continue to see policy maker action in 2014 as highly unlikely. Having said that, a Q3 or Q4 rebound in wage growth and price pressures would serve to negate this view.
The next major event for the UK economy is the release of Retail Sales data for June and Q2 Preliminary GDP figures, which are expected at 0930 next Thursday and Friday respectively.
FTSE 100 goes full circle for the week
The FTSE 100 appeared to be headed toward a flat performance for the week, with better than expected Chinese economic data being offset by the resurgence of risk surrounding Ukraine. This follows the missile attack upon a Malaysian Airlines plane which resulted in the loss of 298 lives.
In detail, Chinese GDP data showed that the economy grew at an “above expectation” pace of 7.5% during the second quarter as opposed to the forecast level of 7.4%. Industrial Production data for June also came in ahead of consensus with output accelerating at a pace of 9.2% relative to the same period a year ago, which compares favourably with the initial forecast of 9.0% output.
A positive operations update from Rio Tinto also helped to drive the index higher as Iron Ore production and shipments increased ahead of expectations during the first half of the year. The Chinese data goes some way toward easing concerns that the world’s largest economy could be headed for a hard landing however, it does not negate the risks to financial stability or medium term expansion.
Going forward, UK GDP and US inflation & GDP figures for Q2 will be key drivers of growth sentiment over the weeks ahead. While “at or above” expectations figures would hold positive connotations for sentiment over this period, the risk of further sanctions against Russia and the consequent potential for a greater deterioration in international relations here adds to downside risks facing markets and is likely to weigh on prices.
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