By Neil Staines
"The Humble are in danger when those in power disagree” - Phaedrus
In our most recent postings, we have maintained our view that both the UK economic recovery and the imminent (Q4) monetary normalisation remains on course. Last week and earlier this week, we also discussed the risk that the market had overreacted to the recent weakness in wage growth. We argued that the likelihood of at least one dissenting vote from the MPC in the August BoE meeting was being roundly ignored by the market and that any such dissent would likely counter the near term dovish GBP sentiment.
BoE’s Weale’s come off…
The release of the August minutes yesterday duly announced the dissenting votes of McCafferty and Weale, who both voted in favour of an immediate 25bp rate hike. In many respects, this signals the start of the Monetary policy debate in earnest. Our central expectations remain that economic strength in Q3 (which we expect to at least match the Q1 and Q2 growth pace of 0.8% q/q), coupled with gradually rising wage pressures (as unemployment continues to decline) and, the desire for the path of gradual rate rises, warrant a UK rate rise in Q4 2014.
Our relative hawkishness is further supported by recent evidence that suggests that the second half of 2014 will be (potentially significantly) stronger than was expected as recently as May. This theme was explicit in the minutes and while the BoE forecast for 2014 was raised to 3.5% from 3.4% (as well as revising expectations of a slowdown in H2, to a maintained pace of growth throughout H1 and H2), we see scope for somewhere closer to 4.0% for the year as a whole. In addition to this, the Confederation of British Industry (CBI) released its latest survey yesterday which highlighted 29% of respondents reporting stronger orders than usual. Further confounding expectations of a growth slowdown in H2, 42% of industrial businesses expect output growth in the quarter ahead.
Outliers or advance party?
The market reaction to the split MPC vote was minimal, as many chose to classify Mssrs Weale and McCafferty as outliers and not merely the advance (hawkish) party. The minutes stated that "Consumer spending, household and business investment were all anticipated to make positive contributions to growth throughout the forecast period” and, from our perspective, these contributions warrant a Q4 rate hike as we progress to a normalisation of UK rates.
Bank staff will also be conducting further analysis regarding the evolution of labour supply over the coming months (as they try to further understand the sharp dichotomy between concurrent job gains and wage weakness), the findings of which could also be key to confirming or disputing a rate hike in Q4.
Fed on the Turn?
From our perspective, the minutes of the July FOMC meeting constitute a further hawkish progression from the Fed. Statements such as "Many Fed officials said job gains might bring a rate rise sooner” and "Participants saw the job market noticeably closer to normal”, were clear signs that the bias at the Fed is turning. To draw an analogy, with the size of the Fed balance sheet and the sensitivity of international markets to the Fed normalisation process, the ‘turn’ may be as gradual as that of the QE2. Nonetheless, it is a turn.
While some may continue to argue about the level of ‘economic slack’ in the economy, overall we continue to see strength and depth. We thus maintain our (very) long held view that the first rate hike in the US comes in Q1 2015 – earlier than market consensus. We will have to wait for next week for any significant input from a data perspective, but rising US yields (particularly as they are led by the front end of the curve) continue to support USD gains in the near term. The annual Central Bankers’ meeting at Jackson Hole gets underway tomorrow, and while it is unlikely that it is the stage for new policy revelation, it would be foolish not to pay heed to the possibility.
"A change of rhythm is needed” Pierre Moscovici
In Europe, the situation is becoming more complicated on many levels. This morning’s German PMI data highlighted a more moderate slowdown in August than the market had expected. However, the Eurozone-wide measure highlighted a more pronounced deterioration pointing to more acute deterioration in the periphery. Throughout H1, the PMI data has been a poor barometer for GDP growth in the Eurozone, as thay have maintained the trajectory of expansion, while the official GDP figures have fallen into stagnation (or worse!). On this basis, it is worth paying attention to the consumer and economic sentiment data, which is more closely correlated to GDP.
The other rising concern in the Eurozone is the growing political tension. France remains the main ‘anti- austerity’ protagonist, as continued economic stagnation raises the volume of the calls for delays in the deficit cutting targets. Pierre Moscovici commented overnight that the "weak EU growth justifies deficit flexibility”, and government spokesman Le Foll said yesterday that France wants "Eurozone crisis taken into account”, citing low inflation and weak growth. As Germany become increasingly frustrated with the resistance to austerity and lack of progress on structural reform, the situation in France shows little sign of improving. It is generally accepted that France needs an annual GDP rate of around +1.5% per annum in order to create new jobs. With no growth in H1 this year and an official forecast of "no more than 1.0%” in 2015, French unemployment is likely to continue to rise well into next year. The French dissent has potentially only just started!