US
The main event in the coming week is the FOMC meeting on 16-17 September. The meeting will provide updated economic projections as well as a press conference with Chair Yellen. The US economy has made significant progress over the past year, in particular on the labour market. As full employment has virtually been reached in the U.S. economy, the Fed will soon raise interest rates.
But will it act as soon as the meeting next Thursday?
It looks like this will be a close call. If the US central bank honours its word, it is on balance likely to sit tight. In its statement after its last meeting at the end of July, the Fed stated the conditions for an initial interest rate hike are:
The labour market must show “some further improvement”: The labour market criterion ought to be fulfilled; 245,000 more jobs were created in July and 173,000 in August.
The central bank must expect the inflation rate to rise to the 2% target: The latest market turmoil, particularly in the Emerging Markets, and the oil price slide, have added a question mark to the Fed’s outlook and there are no indications so far of how this is affecting the US economy.
The Fed therefore has to weigh up whether the new risks justify waiting before hiking rates.
The Bureau of Economic Analysis’ advance estimate of June quarter GDP growth was significantly revised upwards last month. This reflected upwards revisions to business investment and public demand in particular, as well as residential investment, net exports, consumption and inventories.
The strong June quarter result needs to be read together with the weak March quarter outcome, with GDP growing at a moderate annualized rate of 2.2% over this period. Moreover, the higher estimate for inventories is unfavorable for the September quarter, as it increases the likelihood of an inventory correction.
In terms of data, retail sales data for August will be made available. Another solid increase is expected in the core retail sales measure (ex. autos, gasoline and building materials) as consumption is getting a boost from lower gasoline prices and solid job growth.
Headline retail sales will be dragged down by falling gasoline sales (driven by lower prices). CPI figures will also be watched closely and another solid increase in core is to be expected. August manufacturing production will be important as well. Global manufacturing production has been weak lately and the drop in the ISM manufacturing survey suggests some slowdown in the US as well.
EU
In the Eurozone (euro area) the focus of attention will continue to be on any negative sentiment effect from the weakness in the Chinese economy and related to this a decline is expected in the German ZEW. The indicator has a reputation of only describing developments in the stock market, but it has been good at predicting turning points in the IFO expectations which are more closely related to the economic development.
In terms of hard economic data, industrial production and trade balance figures for July are due for release. German exports for July did not show signs of weakness from China, but in monthly terms it increased at the highest rate since December. Industrial production will in our view only increase very moderately because of headwind from weak French production.
Employment growth and labour costs for Q2 will also be released. The Eurozone recovery is making inroads into the labour market slack that ballooned during painful double dip recessions. The harmonized unemployment rate for the region slipped to 10.9% in July, down from 11.6 in the same month last year and from a peak of 12.1%. While the ongoing cyclical recovery in the region is far from spectacular by international standards, it has clearly been sufficient to kick start job creation – employment has risen by 1.45 million over the past 12 months, or 1%. These effects are amplified in the Eurozone, with poor demographics meaning that the working age population is already shrinking slightly, although at present this is being offset by higher participation (an interesting contrast to developments in the US).
Survey data suggest that this momentum will continue, or accelerate, with employment expectations in both the Purchasing Manager’s Index and EC Economic Sentiment Survey having strengthened over recent months. There is a risk that the recent market turmoil will make firms more cautious with regards to recruitment. However, barring any interruption, the trends in employment provide encouragement that the recovery will prove sustainable.
UK
The Bank of England surprised no one by leaving its bank rate unchanged at 0.5%. One MPC member voted for a hike for the second consecutive time but was out-gunned by an 8 to 1 margin. The simultaneously released meeting minutes stuck to a relatively upbeat tone by noting that international risks are to be “weighed against the prospects for a continued health domestic expansion. Global developments do not as yet appear sufficient to alter materially the central outlook” that was outlined in the recent Inflation Report.
NIESR estimates of GDP suggest that output grew by 0.5 per cent in the three months ending in August, after growth of 0.6 per cent in the three months ending in July 2015. Despite the slight softening, growth remains close to the estimated long-run potential of the economy, but below the average rate of growth (0.7 per cent per quarter) observed since the start of 2013.
There are several important releases next week. As the Bank of England’s focus has moved to inflation, CPI inflation in August will attract most attention. The timing of price changes in summer 2014 was unusual and is still affecting headline inflation in August. The fall in headline inflation is due to lower non-energy industrial goods inflation and services inflation while changes in energy and food prices are not expected to contribute to either higher or lower inflation. Core inflation surprised on the upside in July.
The trend registered in unemployment and labour supply suggest they will provide support for wages. If productivity has finally turned a corner then this will support earnings over the coming years, without stoking inflationary pressures. The decline in labour market slack should also boost wages, as firms increasingly have to compete for labour. There has been a clear pick up in the movement of employees between jobs, reflecting a greater churn in the labour market. This type of wage pressure will feed through to inflation as unit labour costs increase. The Bank of England’s current forecast is for wage growth to outpace productivity going forward; helping the Bank hit its inflation target two years ahead. However, there is considerable uncertainty over the estimates. Productivity could be weaker/stronger than expected, while the transmission of narrowing labour market slack to wage growth is difficult to predict. How pay packets evolve will go a long way to determining the monetary policy outlook.
China
Chinese CPI inflation accelerated again last month and is running at its hottest in a year. The overnight print came in at 2% y/y versus 1.8% consensus and 1.6% the prior month. Food prices were the culprit with a 3.7% y/y rise, while nonfood prices are climbing at a more tepid 1.1% pace. Pork prices and some vegetables were the culprits behind rising food prices. Will rising inflation derail expectations for additional stimulus? Not likely and for several reasons:
Inflation remains well below the government’s 3% target.
CPI inflation is being driven by a relative price shock to some food prices as upside pressure on headline CPI lacks breadth.
Falling producer prices suggest economy-wide price pressures in a broader GDP deflator sense are muted. Producer prices fell 5.9% y/y in August and were also released overnight. That is the steepest pace of decline since 2009.
The weakness in producer prices has considerable breadth to it as prices in the mining, raw materials, manufacturing and consumer goods categories are all falling. Local analysts emphasize the negative impact on company profit margins as producer prices are falling but CPI increases impact wage expectations.
Chinese Premier Li Keqiang’s speech at the World Economic Forum is noteworthy as he made the following interesting points:
He announced that foreign central banks will be allowed to trade yuan in the domestic foreign exchange market. This is a further step along the path toward securing reserve currency status and inclusion in the IMF’s Special Drawing Rights group of currencies.
This is part of an ongoing broader move to liberalize capital account flows within an overall set of financial reforms.
He reinforced the notion that the government will strike a balance between supporting growth and further enactment of reforms.
He went on to note that “we have sufficient capability to respond” to downside risks and “we have plenty of tools at our disposal.”
Sources: Scotiabank, Commerzbank, Danske Bank, Handelsbanken, Standard Life Investments. The Financial Times
