Will Rates Rise Next week ...
The Monetary Policy Committee is set to meet next week. Tom Knowles, Economics Correspondent in the Times today, thinks rates are almost certain to rise when they do meet.
Silvana Tenreyro [Photo] is Professor in Economics at the London School of Economics and an external member of the Monetary Policy Committee. Silvana has been a member of the MPC since July last year. Silvana is considered to be a dove.
If rates do rise next week to 0.75% from 0.5%, it will for just the second time since 2007. Ten year gilt yields jumped five basis points this week from 1.23% to 1.28%. Markets are attaching a high probability to the rate rise. It is hard to see why exactly.
Unemployment is steady at 4.2%. Inflation remains above target and is likely to remain so for the rest of the year. Earnings growth fell back to 2.5% in the latest data for May. Oil prices are unlikely to rise much further as we explained on our note this week. Food prices may escalate as a result of the severe weather impact on crop performance but the overall performance of the UK economy is muted. We expect growth of 1.2% in the first quarter of the year, to be echoed in the second quarter.
The Bank should be moving to 'normalise" rates. The old norm of 4.5% base rates and ten year gilts appears as a complete anachronism. 1.5% is the new "normal now" for base rates or so it would seem. For Andrew Sentance, writing in the Times today, it's hard to avoid the conclusion the Bank has left it too late already.
"ECB rates on hold until September ..."
The ECB made clear this week, EU rates are on hold. September next year is considered to be the earliest possible date for a rate increase. Governor Carney is anxious to ensure rate hikes do not damage prospects for growth, before his tenure ends in June next year. There is no real reason why the Bank should move next week. Opportunities have been missed in the past. They may well be missed again next week ...
Eyes on the Fed ...
Over in the USA, all eyes are on the Fed. Ten year bond rates closed up ten basis points this week at just under 3%. The Fed has begun the process of normalisation. At least two rate rises are expected before the end of the year with at least three more penciled in for 2019.
Rate hikes are expected in September and November. The Fed is not expected to change rates next week. Don't be too surprised in the move is made. US base rates will range within the 2.25% and 2.50% by the end of the year.
The Fed blue dot markets expect rates to rise to over 3.5% within a two year period. The pressure will remain on Dollar strength at the expense of the Euro, Yen, Yuan and Sterling. Further weakness in Sterling against the Dollar is inevitable as short and long rate spreads widen.
"US Economy grew by 4.1% in Second Quarter"
The Federal Reserve will be emboldened to act with the release of the latest US GDP data for Q2. The US economy grew by over 4% in the second quarter of the year. Consumer spending, exports and business investment all assisted in the powerful performance. Government spending helped as did the $1.2 trillion tax cut. Trump hailed the performance as "Amazing" a result of his policies on tax, spending and trade.
"Once again we are the envy of the entire world" Trump declared outside the South Portico of the White House. "We have accomplished an economic turnaround of historic proportions" he added.
Well not quite, the economy has been in a growth phase over the past nine years. The fiscal boost and government spending boom will accelerate growth along with government borrowing and the trade deficit. Stock markets are boosted by strong prospects for earnings and stock buy backs.
In the first three months, following the change in taxation policy, some $300 billion of overseas earnings were repatriated into the USA. A further $2 trillion dollars may flow back to Uncle Sam within the next two years. Stock buy backs rather than investment may be the priority for the cash boost. Concerns continue about the prospects for trade wars with China and the rest of the world.
Eyes on the Fed ... Trump is watching ...
The US economy grew by 2.8% year on year in the second quarter, following growth of 2.6% in the first three months of the year. Nominal GDP increased by over 5.4% in the second quarter. We expect US growth of over 3% this year. Nominal growth will be over 5.5%.
The export surge in the second quarter is an anomaly. An element of front running soya beans ahead of the tariffs to follow. The IMF forecast growth of over 6.5% for China, with a minimal impact from a trade war with Trump.
This week Venezuela warned of an inflation rate of one million per cent per annum. Egocentric dictators with little grasp of fundamental economics lay the ground work for hyper inflation in South America. It is not a confined regional phenomenon.
Uncle Sam is a strong "buy" over the next eighteen months but US rates may have to rise beyond the "Blue Dot" horizon if double digit inflation is to be avoided in the years ahead.
"Rates may have to rise beyond the Blue Dot Horizon"
Jerome Powell head of the Fed has warned of the dangers of the trade wars and the need for rates to rise. As we mentioned last week, Trump is displeased and has moved on the Fed with his latest pointers on how to run monetary policy. "I am not thrilled" "I am not happy about it".
So will the Fed move next week ... the odds have increased following the GDP data and the Trump advice. August or September it really doesn't make much difference in the short term. Focus on the growth data, the real comparisons year on year. Real growth of 3% and nominal growth approaching 6% suggest rates will continue to rise on a steady path pushing ten year bond rates back to 4.5% where they belong ...
Don't Miss Our Monday Morning Markets ...
Earlier this month 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. We are not licensed for the giving of investment advice.
This week our "Empires of the Cloud" fund took a bath on Facebook. Wiping out our gains for the month as a whole. What next do we take the hit or average in at the new low? The move on Twitter has opened up the "Buy" target. Don't miss this week's edition.
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.
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