GBP continues to enjoy the summer months. Will autumn prove as kind?

Headlines

Australia: The core ‘trimmed mean’ CPI rose 0.5% q/q in Q2 to bring the annual rate of increase to 2.7% and hence below the consensus forecast for an unchanged 3.0%. This brings the rate of inflation back within the RBA’s target band of 2-3%. However, the headline rate rose to 3.1% from 2.9%.

Australia’s main opposition, a Liberal-National coalition of centre-right parties, has said that it would trim the company tax rate to 28.5% from 30% if it is elected to office in a poll due August 21st .

Japan: BoJ board member Hidetoshi Kamezaki said Japan’s said “The economy’s levels are still lower than the levels before the Lehman shock. This means it is not yet in a strong recovery led by sustainable moves in domestic demand”. Kamezaki also said that EUR weakness against the JPY could affect Japanese firms’ export competitiveness, which could hurt the overall economy.

Global: The IMF’s First Deputy Managing Director John Lipsky said “The most likely prospect is for a moderate, multispeed recovery with significant downside risks … The overarching policy challenge is to sustain the recovery while restoring confidence”.

China: The IMF’s summary of an annual review of China’s policies has omitted any reference to the CNY being “substantially” undervalued – a phrase used as recently as June by Managing Director Dominique Strauss-Kahn. Although several members of the IMF’s 24-member executive board believe the Chinese currency is ‘too cheap’, others said a structural reduction in the balance of payments surplus was already unfolding thanks to past steps to boost consumption.

Citing the China International Capital Corporation Limited, the South China Morning Post writes that fourteen listed banks would report lower non-performing loan balances, further improved coverage ratios and stable credit costs over the second quarter.

Euro-zone: In an interview with the FT, Greek Finance Minister George Papaconstantinou said the country is determined to show it can outperform tough fiscal targets set by the EU and IMF. Papaconstantinou said that while the Greek government still faces strong resistance to structural reforms, it has taken more measures than were necessary to cut the deficit this year from 13.6% to 8.1% of GDP.

UK: Bank of England Governor Mervyn King tells the Treasury Select Committee on monetary policy and financial stability:   “Last week we learned of the strong 1.1% estimate of GDP growth in the second quarter. On the face of it that’s encouraging. But we must be careful not to read too much into one number. The wider economic problems around the world underline the fact that we can’t be confident that the recovery and demand output and employment here in the UK will be sustained.” He also notes: “The debate is about the appropriate degree of stimulus, not about applying the brakes.” He adds: “I am arguing that we have room to use monetary policy in either direction. I don’t want to prejudge where it will need to go. Our view so far has been is that we have not need to move in either direction, but we are prepared to do so in either direction as seems appropriate.”

The National Institute for Economic and Social Research writes that Britain’s economic recovery will be slower than the government believes and consumer spending will not recover to its pre-recession peak until 2015. The NIESR  predicts that the economy will grow by 1.2% over 2010 as a whole, rising to 1.7% in 2011 and 2.2% in 2012 (compared with the governments forecasts for 2011/12 of 2.3% and 2.8% respectively.

New Zealand: The National Bank of New Zealand’s monthly business outlook showed a net 32.4% of companies expected their own business to improve in the next 12 months, compared with 38.5% in the June survey. The survey’s headline measure of sentiment fell for the third straight month, with a net 27.9% of respondents expecting the economy to improve over the next 12 months, sharply down compared with a net 40.2% a month earlier.

Comments

There can be little doubt that the last week and a half has seen some cheering news for the UK. Friday saw the ONS report that Q2 had seen  the largest q/q rise in GDP (1.1%) in four years while the y/y reading of 1.6% was the first positive result in two. Much of this was driven by the services sector enjoying its fastest growth in three years while construction increased at the fastest rate since 1963. A similarly positive story emerged yesterday when the CBI reported the strongest results from its monthly distributive trades survey in three years, supporting the ONS retail sales report published last Thursday. Even the CBI’s industrial trends survey provided reasons for optimism with the total order book balance for July rising to -16 in July from -23 in June (the highest level since August 2008).

Despite this, however, there still remains a distinctly unsettling backdrop of concerns for the UK economy and GBP. The same survey saw the CBI’s export order book balance fell to -12 from -2 (a slight issue if the UK is looking for an export led recovery) while on Monday Hometrack published its latest index of house prices showing an average fall of 0.1% m/m in July (the first fall since April 2009) as the y/y  rate slipped to 2.0% from 2.1% (the first reduction since March 2009). Perhaps of greater concern, however, was the report from the ONS that the public sector posted a record net cash requirement of GBP 20.905 Bn in June. This compared to GBP 20.213 Bn a year ago (and forecasts of a requirement of just GBP 15 Bn). As a result, total public sector net debt rose to 63.9% of GDP, the highest on record since this measure began in March 1993. This just serves to underline the scale of the job facing the Chancellor as he puts together his plan to reduce the scale of public spending (Cambridge Econometrics estimates that over the next decade the government share of economic output will fall back to roughly where it was in 2000 before the big spending increases under Labour).

At present the details the final spending decisions that the Chancellor will announce to Parliament on October 20th remain shrouded in mystery. What we do know, however, is that he has insisted that most “unprotected” departments should outline spending cuts of either 25% or 40%. Only health and overseas aid are fully protected from cuts, while education and defence ministers were told earlier this summer to draw up smaller  reductions of either 10% or 20%. As a result we see little reason to argue with estimates that more than 100,000 public sector jobs are likely to be cut as a result of the review. Following on from this, it seems reasonable to assume that consumer sentiment will start of fall sharply well before the cuts are actually announced in three months time as the full implications of the spending review become more apparent for those working in the public sector. Put another way, few will wish to make any significant purchases if they are aware that their job is under review.

We are not alone in feeling a degree of caution about the outlook for the months ahead. BOE MPC member Spencer Dale told The Independent last Thursday: “The near-term outlook for both growth and inflation has deteriorated over the past couple of months.” He added “ …there are some signs that growth may be softening, again partly reflecting the June Budget … [and] there’s also the greater question of how things develop as countries around the world accelerate their fiscal consolidation plans.” He argued that the economy would not return to normal “for an awfully long time.” The minutes from the latest meeting of the MPC show other members of the committee may well share Mr. Dale’s concerns. Although Andrew Sentance continued to lobby for a 25 bp rate hike, it was noticeable that easing was mentioned as a policy option at the meeting for the first time since February. This point was driven home this morning by BOE Governor Mervyn king’s comments to the Treasury Select Committee on monetary policy and financial stability. He warned investors and politicians not to read too much into the Q2 GDP data, arguing that he couldn’t be certain that the recovery in the UK economy will be sustained. He also noted that policy settings could move in either direction.

For the moment at least the currency markets prefer to take a Panglossian view of the outlook for GBP and the UK economy. As a result it seems unwise to try and fight the current strength of GBP head on. Nevertheless, we are once again reminded of the fact that GBP has a tendency to trade in very well defined patterns over the long term, something that is most clearly demonstrated in the performance of the GBP index over the past thirty years. We note that since the start of 2009 the index has become locked into a very clearly defined and narrowing range and that GBP is trading within 1% of the top of this range. Although it is perfectly possible that GBP could break out of the top of this range, this would go against a pattern of trading that has become well established over the past year and a half. Moreover, it would not only go against the trend of the past three years but also against the broader downtrend seen in GBP since January 1981 (it’s worth noting that the only significant rally seen in the index in the entire 30 year period came between August 1996 and March 1998 in the run up to and aftermath of the 1997 General Election). (simon.derrick@bnymellon.com)

Key Economic Data Releases

RBNZ policy decision (2200 BST)

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