Rates Rise ... Sterling Falls ...

Rates up, Sterling falls, the Bank hikes UK rates to 0.75%, Markets had expected a rate rise this week. The unanimous decision to increase base rate was a surprise to many. The concerns of group think in Threadneedle Street are enhanced. 

So what prompted the move this week? According to the Governor, employment is at a record high, there is limited spare capacity, real wages are picking up. Domestic inflation pressures are increasing. The prospect of excess demand is emerging. Earnings may have increased to 1.75% around the middle of this year.

UK growth is estimated to have rebounded in the second quarter. An underlying trend is emerging following the weather affected performance in the first quarter. The Bank expects growth of 1.5% this year.

"With domestically generated inflation building and the prospect of excess demand emerging, a modest tightening of monetary policy is now appropriate to return inflation to the 2% target and keep it there."

Is this the right decision? Well probably but for the wrong reasons. Growth in the second quarter is unlikely to have accelerated much in Q2. This according to the short term GDP trackers from the ONS and NIESR. The Governor may cite a recovery in construction output in May but monthly building data is incredibly volatile and subject to revision.

Danny Blanchflower has condemned the move. "Raising rates is a big mistake. The decision is made on the basis wage growth is about to skyrocket. It isn't. The decision will have to be reversed."

Is it really about wages? The Bank is concerned about the rising possibility of a "no deal" Brexit and a shock to output. The Banking system is "mission ready" with adequate liquidity to absorb a Brexit setback. The Central Bank would like to be in a position to cut rates to ease pressures within the economy in the event of a Brexit shock. It has to put rates up first before it can bring them down again.

It is what one might call the "Grand Old Duke of York" Strategy. "March rates up to the top of the hill and march them down again". They won't get very far up the hill before there may be a need to act! The bank is suggesting one rate rise per annum over the next decade. Rates would cap out at just over 3% by the end of the next decade. Forward guidance returns, now with a much longer perspective.

The Governor's bearish statements on a hard Brexit pushed sterling to $1.29 against the Dollar before a pullback about the $1.30 floor by end of week.

Jacob Rees-Mogg was unimpressed. "Mark Carney has long been the high priest of project fear. His reputation for inaccurate and politically motivated forecasting has damaged the reputation of the Bank of England". Ouch!  Some Brexiteers, so tough to please ...

Trade wars escalate ...
Over in the USA, The White House is considering increasing the proposed tariffs on $200 billion of Chinese goods to 25% from the current 10% initially proposed.

China has responded with a threat to increase tariffs on $60 billion of US imports into China. The import taxes would range from 5% to 25% applied to four categories from agriculture to metals and chemicals.

Beijing has made it clear, any threat of trade wars or blackmail, will only lead to intensification of conflicts and damage to the interests of all parties. The White House has called on China to address the longstanding concerns about unfair trading practices.

According to CNBC there is "Zero Engagement" between the Trump administration as the tensions rise between the two super powers. It's a stand off but who will blink first? China markets wilted this week on the threat of trade wars. The threat to growth will push China to accede to Trump demands is the theory.

The political reality suggests otherwise. US business hates a trade war. The tariffs will increase inflationary pressure, lower real demand and damage profits. The White House is realigning.

Trump is creating warm overtures to Europe suggesting a free trade deal across the Atlantic. A Mexican stand off is near settlement opening up the prospects of a NAFTA agreement encompassing once again a deal with Canada and the Southern state.

The Republican party would like to avoid a trade war on any front. The harsh rhetoric between Beijing and Washington must continue until the mid term elections this year.

Trump's base audience loves the tough talk with China. America First the claim. Trump cannot abandon the aggressive trade platform completely. His core base cannot be denied the dogma in the run up to the election. The GOP may lose control of the House in November? It could be a close call. Either way, once the votes are in, an accommodation with Beijing will be sought.

The trade deficit is increasing as growth accelerates in the USA. Debt levels are rising as spending plans and tax cuts take effect. Tax cuts of $1.2 trillion and military spending increases of $800 billion will compound the underlying weakness of Trump's grand plan. A $22 trillion deficit will need the "Kindness of Strangers" to avoid a funding crisis and a run on the Dollar in the medium term.

Don't Miss Our Monday Morning Markets ...
In July, we launched our Monday Morning Markets. The update is released every Monday Morning at around 8:00am.

We look at key stock markets, bond markets, interest rates and currencies every week and monitor trends and direction in key areas. It's just for fun.

Last week our "Empires of the Cloud" fund took a bath on Facebook. Wiping out our gains for the month as a whole. This week, we backed up the Facebook position and moved in on Twitter. The Apple results boosted share prices, The NASDAQ and the DOW moved up. We are back in the black and 40% invested. Don't miss the updates. It's just for fun. Like the tennis scores.

That's all for this week, we will be back next week, with more economics. Need more information? Check out the Monthly Round Up on the Saturday Economist Web Site. Here we provide more detail on monthly data.

Have a great weekend, John