Q2 saw a modest uptick in GDP growth, from 0.2% in Q1 to 0.3%, but in the broader scheme of things this still represented a sub-par outturn. Decent momentum in the monthly data suggests we may see a slightly firmer outturn for Q3, but the strength of the numerous headwinds facing the economy means that a material improvement in growth in H2 looks unlikely.
Confidence rises in June to a four-month high, underpinned by continued strength in labor market and business conditions. Consumers’ heightened optimism is in contrast to the recent slowing in consumer spending, but over time improved sentiment should reinvigorate spending.
We present our updated projections for the Federal Reserve's balance sheet normalization, based on its detailed plans and the increased likelihood that reserve balances will be $500 billion at normalization. The FOMC should reach balance sheet normalization in May 2021, with a System Open Market Account (SOMA) balance of $2.862 trillion.
We continue to expect the FOMC to keep the current system for controlling the Fed funds rate using a system of floor rates: the interest on excess reserves (IOER) and reverse repo programs (RRP).
A speech by Financial Policy Committee member Alex Brazier is the latest warning shot from policymakers on the risks arising from recent rapid growth in unsecured borrowing. But the dangers to the overall economy from this development still strike us as limited.
In comments delivered on 24 July, Mr Brazier warned that a sharp rise in unsecured loans alongside weak growth in household incomes could pose a threat to the economy. And UK banks were in danger of entering “a spiral of complacency”, by reacting to a period of reasonable economic growth and low interest and loan default rates by weakening credit standards.
Higher unsecured debt leaves individuals more vulnerable to income shocks. But households in aggregate are currently in a reasonable position to take on debt thanks to deleveraging since 2008 and record-low borrowing costs. The share of household incomes absorbed by interest costs has not been so low since records began.
And the balance sheet of UK households is historically strong. At the beginning of 2017, households’ net holdings of financial assets amounted to almost four times annual income, a near-record high. Moreover, 40% of households with consumer debt have savings bigger than their outstanding debt.
Historically, one of the biggest shocks to borrowers’ spending power has come from a steep rise in interest rates, with knock-on consequences for activity and employment. But with the current episode of elevated inflation likely to be nearing its peak and an absence of underlying price pressures in the economy, a hike in Bank Rate looks a far-distant prospect.
Finally, there is also cause for confidence on the supply side. UK banks are far better capitalised than in 2008. And bank's losses during the financial crisis were overwhelmingly driven by bad decisions overseas, not bad loans at home.
President Andrzej Duda’s veto of two of Poland’s controversial judicial bills suggests that the ruling Law and Justice (PiS) party is now scaling back some of its controversial legislation following pressure from civil society and the international community. But we are sceptical that PiS will abandon its drive to consolidate power and therefore see the political risk premium persisting in the near term.
In terms of market implications, we think Poland’s asset performance will continue to be driven by the solid macroeconomic momentum, which is unlikely to be dented by the latest political developments in the short term. In the medium to long term, however, we continue to see the adverse institutional developments as a downside risk to an otherwise solid structural growth story.
The business climate indicators for Germany and France showed further broad-based improvement in July. This contrasts with evidence from other recent surveys like the ZEW, Sentix and the PMIs, where sentiment seems to have turned down. The German manufacturing ifo even surpassed its last cyclical high (of February 2011), pointing to ongoing impetus from the global cycle; a stark contrast to the manufacturing PMI that fell to a 3-month low.
Short-term discrepancies between different survey measures are not unusual and are not a worry in an environment where some surveys have been overestimating the pace of economic growth. If anything, the strong national surveys suggest that growth in Q3 should remain robust and lend further support to our above consensus Eurozone growth forecast.