Global Daily – Seven the magic number?

by: Nick Kounis , Philip Bokeloh

140123-Global-Daily-Insight.pdf ()
  • UK unemployment almost at 7% BoE threshold, setting the scene for early hikes
  • BoJ sticks to its guns, but additional monetary stimulus still likely
  • RBA still set to cut rates despite higher than expected inflation

Upbeat UK labour market numbers

There was another set of strong labour market numbers in the UK, which underlined the view that the BoE could well be the first major central bank to hike rates, though it will still likely not be for some time. The ILO unemployment rate fell to 7.1% in the 3-months to November reflecting a 280K surge in employment. This took it within touching distance of the BoE’s threshold, while the further decline in the more up-to-date claimant unemployment numbers suggests that it could fall below the 7% level in the next few months (see chart). It is amazing to think that not long ago, the BoE forecast that this would not happen until well into 2016. This says something about the momentum in the economy, as well as the perils of forecasting! In any case, the MPC has been busy playing down the relevance of the 7%, signalling it should not be seen as a magic number. In the minutes of the January MPC meeting, the Committee noted ‘it saw no immediate need to raise bank rate even if the 7 percent unemployment threshold were to be reached in the near future’. So clearly BoE rate hikes are not imminent. Having said that, with the economic recovery likely to continue, and the unemployment rate set to fall further, the UK central bank could move earlier than other central banks. Our base case sees the first hike early in 2015, but the risks are skewed towards a move at the end of this year. Against this background, implied rates on interbank futures still have room to move upwards, even after Wednesday’s jump. Similarly we see room for further sterling strength against the euro even after the appreciation following the jobs data.


BoJ holds firms, dampening speculation of early move

The BoJ yesterday left its monetary policy unchanged. The central bank said that it sees signs of a broadening economic recovery and that it will stick to its upbeat growth and inflation outlook. This decision dampened speculation on financial markets that the BoJ will adjust its semi-annual forecasts downwards. Such an adjustment would have bolstered chances that monetary easing measures are brought forward, a prospect that would have triggered a further weakening of yen. Instead the BoJ voted unanimously to maintain its pledge of increasing base money at an annual pace of 60 to 70 trillion yen. Yet, doubts remain whether the BoJ is right in holding on to its economic outlook. The recent rise in inflation is attributable to the rise of import prices as a result of the depreciation of yen, rather than to an increase in domestic demand on the back of improving labour market conditions. Japan’s base wages excluding bonuses and overtime for instance fell from a year earlier in November for the 18th month in a row. Indeed, it will prove difficult for the BoJ to keep its promise to push inflation to 2% as soon as possible. In our view additional monetary stimulus measures remain warranted as the implementation of the sales tax rise in April will put a brake on growth. The BoJ will meet twice before the tax rise will take effect. The JPY strengthened briefly after the decision. However, JPY strength was short-lived as the market continues to expect a divergence in the monetary policy and growth outlook between the US and Japan to push USD/JPY higher, as we do.

Rate cut in Australia still on the cards

The AUD (another one of our high conviction shorts versus the USD) rose overnight after inflation in the fourth quarter came in higher than expected, reducing the flexibility for the RBA to increase monetary stimulus in the coming months. The rise in inflation was driven by seasonality and weather effects, which we do not expect to continue. Though the weaker exchange rate has pushed up tradable inflation, we expect the decline in non-tradable inflation (due to a weak economy and a rising unemployment rate) to more than offset the potential rise in tradable inflation given its heavier weighting in the CPI. We continue to expect the RBA to deliver a final 25bp rate cut and a lower AUD/USD of 0.85 later this year.