- BoE Governor Carney hinted that an early rate hike was unlikely, hurting sterling
- Japan’s GDP slump reflects tax hike, though overall picture supports further BoJ stimulus
- China lending drops sharply, but authorities will likely prevent abrupt deleveraging
Dovish BoE comments drag down sterling
BoE Governor Mark Carney struck a relatively dovish tone in presenting the central bank’s latest quarterly Inflation Report. He signalled that a rate hike is not imminent even though the central bank raised its forecast for GDP growth over the next two years, reduced its estimate for the unemployment rate and admitted that slack was being used up at a faster pace than the MPC had previously anticipated. The explanation for this apparent inconsistency can be found in the behaviour of wage growth. Wage growth has been much weaker than expected, and the Governor, and at least a majority of his colleagues on the Committee, judge that this means there was more slack in the economy in the first place. Following the comments, financial markets priced in lower short term interest rates, pushing back the timing of the first rate hike to next year. As a result, sterling took a significant knock. Our central view remains that the central bank will raise rates later this year. Given the momentum in the economy and the labour market, we think wage growth will turn up in the coming months. However, the risks are now skewed towards a later BoE move.
Tax increase hurts Japanese economy
Japan’s first preliminary release of second quarter GDP showed a contraction of 1.7% qoq and 6.8% qoq annualized, coming down from 1.5% qoq and 6.1% qoq annualized. These rates were close to market expectations. The weak data mirrors to a large extent the impact of the 3 percentage point VAT hike implemented in April, which disrupted spending patterns. Indeed, both consumer spending and housing investment fell significantly in the second quarter following a pre-tax hike demand surge in the first quarter. In any case the contraction more than wiped out the earlier gain and was greater than the expectations of policy makers in Japan. It was also stronger than the previous tax hike in 1997. We think that the weak growth performance in the first half of the year (taking the two quarters together) makes additional quantitative easing in the coming months more likely, even though moderate growth is to be expected in coming months. In addition, we see clear signs that underlying inflationary pressures remain very weak. An extension of quantitative easing in Japan, when the Fed is moving slowly in the other direction, will likely weaken the yen, which is consistent with our USD/JPY forecast for this year.
Chinese lending dropped sharply in July
On Wednesday, China published a number of monetary and economic activitydata. Most striking was the sharp drop of aggregate financing and new loans, which reached the lowest levels since the global financial crisis. While there are some seasonal effects at play (these aggregates typically fall sharply in July) and there seems to be some payback for developments in June, the drops were much larger than expected. Monetary aggregates also grew more slowly than expected. These developments do not result from monetary policy, with the Bloomberg index showing a clear easing of monetary conditions over the past quarter. According to the PBOC, the drop in lending is related (next to seasonal factors) to a tightening of regulation (particularly for shadow banking), increased risk control at banks and a slowdown of loan demand. The PBOC added that it expects growth of money supply, credit and aggregate financing to remain stable, with no major monetary policy changes foreseen. Meanwhile, annual growth of industrial production and retail sales came in somewhat weaker than expected dropping by 0.2 %-points, though export data released earlier this month were more encouraging. In our view, the latest data highlight the downside risks for the economy, which is undergoing a necessary deleveraging given China’s high debt levels. Nevertheless, we expect the authorities to continue with their policy of targeted stimulus and to do even more should that be needed to prevent the deleveraging from becoming disorderly.