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Final GDP data confirmed German economic growth at 0.4% in Q2. Europe’s export powerhouse is alive and well, with growth primarily driven by a strong rise in exports.
Eurozone consumer confidence fell for a third consecutive month in August, and remains more affected by the Brexit vote than other survey indicators in the Eurozone which have shown surprising resilience. However, sentiment is still high by historical standards. Meanwhile, the ECB’s Cœuré once again warned that lack of reforms and fiscal action by national governments could force the ECB to apply further stimulus.
As we expected, the final GDP growth print for Q2 was slightly revised up to -0.2% q/q from the flash estimate of -0.3%. Retail and services expanded by 0.1% while primary and secondary activities fell by 0.3% and 1.5% respectively.
Economic activity expanded by 0.6% m/m in June, led by a sharp (6.3% m/m) recovery of the primary sector, while secondary and tertiary activities expanded by 0.1% m/m.
our August global macro chartbook, we summarise our asset views and key global themes. We also highlight the contributions of our recent research.
Germany continued its strong start to the year in Q2 and appears to have shrugged off the UK's Brexit decision, leaving it on track to outperform the Eurozone this year. Although monthly activity data painted a downbeat picture of growth prospects in Q2, the flash release showed that GDP rose 0.4% on the quarter, not much weaker than Q1's healthy 0.7% rise. The quarterly increase appears to have largely reflected a strong export performance.
For now, at least, there appears to be little evidence that the underlying pace of growth will weaken in H2. But we see Brexit and the impact of higher inflation on real incomes having some negative influence on the pace of growth. In H2, we expect GDP growth to average about 0.3% compared with 0.5-0.6% in H1. This would result in growth of 1.8% for 2016 as a whole, the best outturn since 2011. This is 0.4% points higher than our forecast last month, mainly reflecting the Q2 upside surprise.
August’s rise in the Eurozone composite PMI adds to the evidence that any near-term adverse effects of the UK Brexit decision on Eurozone activity in the region are likely to be small. Against this backdrop, speculation that the ECB will announce a further extension to QE, perhaps even in September, seems wide of the mark.
The Peruvian economy expanded by 3.7% y/y in Q2, marginally above our 3.6% forecast. The breakdown revealed a fairly weak picture, with quarterly growth largely dependent on private consumption and a fall in imports.However, with regard to H2 2016 and beyond, the new administration’s commitment to ease regulation and increase fiscal spending may prompt a much-needed rebound in private investment and government consumption. We continue to expect that the economy will expand by 3.7% in 2016 as a whole.
Despite the announcement by Banca Monte dei Paschi (MPS) of a “structural and definitive solution to the bad loan legacy” just before the release of the EBA stress tests results, the market is still pricing in a significant risk of default by MPS.
The success of the rescue package is not guaranteed as it is conditional on the sale of MPS’s non-performing loans (NPLs), which will be securitised. A consortium of banks led by JP Morgan has to find €5bn of fresh capital by the end of September to cover the negative impact on capital from the NPLs’ disposal.
If the plan fails, Italian retail customers will be the first to incur a loss. During the financial crisis, banks sold households (very risky) MPS’s juniorsubordinated bonds as a safe placement, paying a very low 2.4% coupon. (This compares with the 7% paid to institutional investors for less risky bonds.) Tax incentives were even provided to bolster the purchases of these bonds.
The political impact of failure will also be strong, with the ‘No’ campaign more likely to win the constitutional referendum in the autumn. Italy could then see a period of political gridlock.
Given the risk that investors may not rush to buy the senior tranche of the securitised NPLs – even with some state guarantee – the Italian government may either put pressure on local insurers and banks so that they increase their contribution to Atlante II (a fund arranged by the Italian government and financed by Italian banks, insurers and pension funds) or claim an exemption clause to the Bank Recovery and Resolution Directive (BRRD), in order to be able to inject public money in MPS.
The likelihood of the first safety net will depend on the potential losses of local financial institutions from their existing exposure to the Italian banking sector (mainly their additional Tier 2 capital), as AT2 bonds could be converted into equity and wiped out in the case of a bail-in. But local banks and insurers could also be reluctant to increase their exposure to Italian banks, given the perception of the sector as a “house of cards”.
The second safety net is the exemption clause (Article 32(4)(d)(iii)) in the EU BRRD, which would allow the government to provide “extraordinary public financial support” to MPS. This clause could be activated to “remedy a serious disturbance in the economy of a Member State and preserve financial stability”.
But it is not clear whether this way of avoiding a full bail-in will still mean some burden sharing by private investors. Whether the MPS junior creditors (Italian households) could avoid incurring losses will largely depend on Renzi’s ability to convince its European peers to interpret the EU Directive in a flexible way a few weeks before the constitutional referendum.
We attach a 15% probability to a scenario in which JP Morgan is not able to find the €5bn by the end of September, the Italian insurers and banks refuse to provide additional capital and the exceptional circumstances can’t be triggered and the government is unable to provide support to MPS. We would then expect strong contagion effects not only to Italian banks but also to the European banking sector.
Italian PM Renzi said that the next elections will not be before 2018, suggesting that he may be reconsidering his intention to quit if he loses the senate referendum. We still expect him to resign if the referendum does not pass, but this adds another scenario to the complicated political situation; if he resigns, the President can still ask him to form a new government.
Later today, Merkel, Hollande and Renzi meet to discuss post-Brexit EU reforms ahead of the September informal EU summit. As there are still some differences among the three, we do not expect any important decisions, just a signal of more flexible application of the current rules.
We explore two trends that worry policymakers and investors. The gap between rapid credit expansion and slowing GDP and, in particular, investment has two distinct causes with different implications. Meanwhile, the apparent divergence between strongly slowing private investment and soaring public investment is caused by data problems.
The appointment of Dr. Urjit Patel - the architect of the RBI’s inflation targeting framework - as the new Governor, should assure observers of policy continuity in India and assuage concerns regarding the central bank’s independence.
We expect Patel to share Rajan’s views on the importance of low and stable inflation for sustainable medium-term growth. Hence, we do not perceive any risk to our policy “pause” view from his appointment.
Growth accelerated to 5.2% in Q2, the fastest pace recorded since 2013. Growth was supported by a pick-up in government consumption and some improvement in private spending. Following the better than expected outturn in Q2, we have revised up our 2016 GDP growth forecast to 5.1% from 5% previously.
Bank Indonesia has moved to its new policy framework focusing on the 7-day reverse repo rate (currently set at 5.25%). Given the latest data and our view that domestic activity will improve in H2, we expect the central bank to maintain its policy stance unless there is evidence of a serious threat to the domestic recovery.
Growth in real activity continues to be robust, with the manufacturing and services PMIs both reporting a healthy expansion in July. Amid concerns about inflation expectations anchoring below target, the RBA cut interest rates in August to 1.5%. We expect one further 25bp cut in the easing cycle in November to support spending, put downward pressure on the currency, and boost inflation.
Retail sales volumes grew by 1.4% y/y in July, against consensus expectations of only a 0.1% increase. The rise was broad-based, with July’s relatively good weather boosting clothing and food sales.
The Claimant Count measure of unemployment saw a surprise 8,600 fall in the same month, the first drop since February. And the official LFS numbers for April to June pointed to resilience in the labour market in the run-up to the referendum.
Annual CPI inflation ticked up from 0.5% in June to 0.6% in July, largely as a consequence of higher fuel prices. Producer input prices rose for the first time since mid-2013, pointing to an acceleration in consumer price inflation in coming months.
Better-than-expected economic data supported a modest rally in sterling. The pound made gains against both the dollar and the euro. And borrowing costs for the Government and corporates declined further.
We judge the risk of recession to be unchanged from last week at 30%.
Spanish PM Mariano Rajoy announced yesterday that the confidence vote will take place on August 30. Rajoy has accepted Ciudadanos’ conditions and will start negotiations in order to ensure their support in the vote.
Nevertheless, the Socialist Party still holds the key to a possible PP government and has so far refused to budge, so there remains a substantial risk that Spain will go to the polls again. Given the Spanish electoral calendar, potential third elections would take place on Christmas Day.
Although July yielded a surplus in the public finances of £1bn, this was smaller than the surplus of £1.2bn recorded in the same month a year earlier. And July’s outturn did little to narrow the projected shortfall with the OBR’s full-year borrowing forecast.
However, dampening any Brexit-related slowdown and the opportunity presented by record low borrowing costs mean that deficit goals are set to play second fiddle to supporting the economy in the forthcoming Autumn Statement.
At an aggregate level, July trade data paint a subdued picture in both nominal and real terms, and contained fewer positive signs than June’s data. This supports our cautious outlook about both the pace and extent of improvement in global trade – which is expected to be patchy and mild, leading to only a modest recovery in the open economies that depend heavily on global and regional trade flows.
A referendum vote in favour of the new constitution means that military dominance of Thailand's government is set to persist. However, the debate was highly controlled, perhaps implying less voter support than appears at first sight. The detailed consequences have yet to be outlined, but suggest a continuing military presence guiding political developments.
This is another negative for the economy, adding to growing insecurity after the recent bombings. This could threaten tourism, the mainstay of the lacklustre economy. Elections in H2 2017 will prolong the uncertainty.
The Chilean economy expanded by 1.5% y/y in Q2, a notch above our 1.4% forecast and the markets’ 1.2%.Today’s numbers do not change our view that the economy will expand by 1.7% in 2016 as a whole. For H2, we expect mining activity to dampen overall growth while services will maintain a relatively solid pace. However, the risks remain to the downside.
A light day on the release front saw French unemployment falling into single digits for the first time since 2012. Consumer sentiment held steady in the Netherlands in August, offering further proof that – so far – the confidence shock from the Brexit vote has been limited in the Eurozone. Inflation in the Eurozone was confirmed at 0.2% in July, the highest in eight months.
Moving south, Spain remains stuck in political limbo as PM Rajoy is ignoring Ciudadanos’ demands in exchange for its potential support in an investiture vote. There is an increasing risk that Spain could be headed for a third election.
The Brexit debate has highlighted free movement of people as a source of destabilisation. Divergent mobility trends describe Eastern European citizens migrating to wealthier countries. But at the scale of the Eurozone, labour mobility has become an increasing source of stabilisation, highlighting the economic importance of free movement of people.
EU citizen mobility, the share of the population which moves across borders to live and work, is limited. In 2014, it only reached 0.4% compared with 2.3% in the US.
The 2004 enlargement set a movement from east to west in motion. While adding to the labour supply of western EU countries, Eastern European migrants have been a source of brain drain at home. As a result, the convergence process, a promise tied to EU accession, may have actually slowed.
Meanwhile, deeper EU integration with the common currency has reduced barriers to migration and with this spurred higher labour mobility.
With the euro crisis, Europeans from the south have moved north for work. This has increased the role of mobility as an economic stabiliser in the event of asymmetric shocks. Yet it is too limited to reduce the gap in unemployment rates in the Eurozone.
The refugee crisis has put a strain on the free movement of labour with some countries closing their borders. The EU-Turkey deal to limit refugee arrivals is looking shakier than ever, but EU member states are still likely to uphold it to avoid the political challenge of increased coordination in matters of asylum policies.
Meanwhile, the advent of Brexit will change EU labour mobility with net migration to the UK reduced by 1 million by 2040. Those migrants will move to other prosperous EU countries, especially Ireland and Germany, and where ties are strongest.
A very strong retail sales performance in July saw monthly growth in volumes of 1.4% run well ahead of expectations and confound fears that the outcome of the EU vote would stymie consumers’ appetite to spend.
Granted, it is early days and Brexit uncertainty may still make its presence felt in the consumer sector. But falling interest rates, relatively cheap oil and a banking sector in a position to supply plentiful credit offer some compensation.
Robust household consumption and investment pushed growth to 7% in Q2, despite the substantial drag from net exports. While we expect growth to slowdown in the second half, this poses upside risks to our full year growth forecast of 6.3%.
The July 26-27 FOMC minutes show a split amongst Fed officials consisting of the hawks who see economic conditions likely warranting a near-term rate hike versus the doves who prefer to wait for more data. The FOMC remains cautious as it considers raising rates again, however, there was more support for a rate hike among participants at July meeting than the 9-1 vote suggested.
Investors will be looking for Chair Yellen to weigh in on the near-term tightening prospects at her speech at the Fed's Jackson Hole Fed symposium on Aug. 26.
The hawks assert that the labor market is essentially back to full employment. A view that we share (see chart below).
The more hawkish members also said that "various benchmarks for assessing the appropriate stance of monetary policy supported" some removal of policy accommodation. They were concerned that inflation pressures could build and require more aggressive rate hikes as a result.
On the other hand, the more dovish members opined that there would be "ample time to react if inflation rose more quickly than they currently anticipated". They preferred to see more data that confirmed inflation is likely moving towards the 2% target.
These doves argued that a tighter labor market had not yet contributed to a higher rate of inflation. The reason may be that the natural rate of unemployment rate is lower than most current estimates.
There was an extensive discussion of international developments largely in the context of post-Brexit vote. While the "near-term risks to the outlook associated with Brexit had diminished over the intermeeting period, participants generally agreed that they should continue to closely monitor economic and financial developments abroad".
Real GDP was flat in Q2, following a 0.5% rise in Q1. Household spending fared better than expected and activity was supported by another large rise in public spending but the strong yen weighed on business investment and exports – both of which fell on the quarter.
We now expect the BoJ to increase asset purchases by only a further ¥10 trillion in September with interest rates to remain steady. Consequently the yen is forecast to remain elevated this year and only drift down to 112 by mid-2018. While this will certainly hurt exports and investment intentions, the newly approved fiscal package will provide a modest boost to household spending and infrastructure investment. On balance, we have raised our GDP growth forecast for this year to 0.4% (from 0.1% previously), and the outlook is for similarly sluggish growth in 2017.
Recent events, including the British vote to leave the EU, have increased the likelihood of central banks easing monetary policy further. The Bank of Japan and the Bank of England have already acted; both are poised to do more. The likelihood of at least one major central bank moving to helicopter money, while still small, has increased. The Bank of Japan is the most likely candidate; the Bank of England and the Federal Reserve are much less likely to follow suit – and then only if the outlook deteriorates substantially. By contrast, the ECB is unlikely to use this type of instrument.
Helicopter money involves increasing the money holdings of the non-bank private sector. This can be done in a number of ways. We would expect that – if undertaken – the BoJ would use cash transfers; the BoE would use asset purchases; and the Fed would aim for a repeat of the 2008 tax rebate. The ECB does have the option of engaging in ‘pure’ helicopter money, i.e. cash transfers, but is unlikely to do so.
There are a number of factors that would influence the success of a helicopter money program: savings and consumption patterns; demographics; leakage through imports; the size and composition of the tax burden; and the credibility of the monetary and fiscal authorities. Weak demographics imply that the impact would be less in Japan than in the USA, the UK or the EZ; but a low savings rate and relatively high tax burden argue the opposite. The US is better placed demographically, but its lower tax burden hints that any cash transfers would be less important. In the UK, the leakage of spending through imports would be higher than in the other major economies.
While we believe that helicopter money would be a powerful instrument, the impact could thus vary substantially from country to country.
Yesterday, the head of sovereign ratings at DBRS warned about a deterioration in the Portuguese economy. Avoiding a downgrade in October is essential for Portugal, as a rating cut could prevent the ECB from buying Portuguese sovereign debt.
The recovery that started in 2015 came to a temporary halt in Q2 this year, as the GDP flash release showed that the Italian economy stagnated in the quarter. While growth slowed across all the main Eurozone countries in Q2, the deterioration in Italy was more pronounced than in Spain and Germany. We do not have the breakdown of the national accounts yet but, with industrial production falling slightly on the quarter and net trade making a small positive contribution to growth, it seems likely that destocking was a negative development in Q2. And while this could go into reverse in the following quarter, the survey indicators published so far, such as the composite PMI, point to quarterly GDP growth of just 0.2% in Q3.
Following the weaker than expected outturn in Q2, we have slightly downgraded the outlook for 2017 and 2018. Overall, we see Italian GDP posting 0.8% growth in 2016 and 1% in 2017, down from 1% and 1.1% respectively last month.
Another solid set of labour market statistics, with a chunky rise in employment and a further fall in unemployment.
The more timely data on the claimant count and job vacancies suggest little impact from Brexit, although it is very early days with the labour market data likely to react to developments in the wider economy, rather than lead them.
After making a positive contribution to Q2 GDP growth, exports have started Q3 on a weak note with domestic oil and non-oil exports the primary drivers behind the fall in export volumes on the year. However, while we think the decline in oil exports is likely to prove temporary, the outlook for NODX is less certain. In particular, external demand remains sluggish and the boost from the pharmaceutical sector is already showing signs of fading.
The Alberta wildfires caused Canada's real GDP to contract 0.6% on a monthly basis in May, the largest decline in more than seven years. However, we think that the impact of the fires will be short-lived as oil production is already coming back online. More concerning is the pace of non-energy activity. Indeed, non-energy exports, expected to be a partial offset to the drag from low oil prices, were down in Q2.
Our analysis of the economy at the provincial level illustrates that there are other pockets of weakness in the economy, namely manufacturing. As a result, we have trimmed our real GDP growth forecast to 1.2% for 2016. Growth should firm to around 2% in 2017. In light of this adjustment, we have pushed back our expectations on the Bank of Canada hiking interest rates to Q1 2018 from Q4 2017 previously, as policy makers will look to be sure that the economy is on a sufficiently strong footing before tightening monetary policy.
Broad-based gains in manufacturing, mining and utilities rendered a larger
than expected July 0.7% gain in industrial production. Big gains in June and July automotive output, and weather related gains in June/July utility output should be reversed in months ahead.
July CPI unchanged, up 0.8% y/y. Core CPI up 0.1% for a y/y increase of 2.2%, an 8th consecutive month of above 2.0% readings. We expect that firmer inflation, reaching 2% y/y by year-end, will allow the Fed to raise rates this year (in September).
Housing starts increased 2.1% in July, while permits slipped. After detracting from second quarter growth, we expect residential investment to make a positive contribution to Q3 GDP.
The German ZEW economic sentiment index rose in August, recovering from a sharp post-Brexit plunge in July. This is another survey indicator pointing to the limited impact of the UK’s vote to leave the EU on the German economy. However, the August PMI and Ifo readings will be a better guide to Germany’s Q3 performance. Separately, the Eurozone trade surplus rose again in June, boosted by a sharp 5% fall in imports.
The Peruvian economy expanded by 3.6% y/y in June. Growth was driven by the mining sector, which grew by 15.8%.For the remainder of the year, growth should be supported by increased infrastructure spending and a pick-up in private investment. We have kept our 2016 GDP growth forecast unchanged at 3.8%.
Inflation nudged up in July as last year’s steep falls in food and petrol prices were not repeated.
These base effects will become increasingly important as the year progresses, while the impact of the recent plunge in the value of the pound will also continue to feed through. We expect the 2% target to be breached in early-2017, but muted core pressures should limit the extent to which inflation accelerates.
Net financial outflows rose in July to US$39bn, but FX reserves remained broadly stable because of China’s current account surplus.
Against the background of rising US Fed interest rates and some loss of domestic growth momentum in H2, we expect the CNY to weaken some more in the coming months, and capital outflow pressures to remain, but not to escalate.
There are some signs that the improvement in sentiment and in asset prices seen in the past few months is now translating into increasing economic activity. Notwithstanding this, we still expect the recovery to be slow, hampered by public and private deleveraging, as well as by sluggish world trade. As a result, GDP growth in 2017 is only likely to be marginally positive.
That said, ultra-low interest rates in advanced economies have made investors more willing to accept risk, spurring another rally in Brazilian assets. Accordingly, we have revised our forecast for the exchange rate and now expect the Brazilian real to close 2016 at 3.35 per USD, and 2017 at 3.55.
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