Economic Overview
The global economic landscape continues to face challenges, with the Eurozone and the United States grappling with their own unique set of circumstances. In the Eurozone, rising debt levels across the 20 countries of the currency area reached 88.7% of GDP in the first quarter, while the overall deficit shrank to 3.2% of GDP. The European Central Bank left interest rates unchanged in July but maintained a stance open to further policy easing due to weak economic growth and easing price pressures.
Meanwhile, in the United States, Federal Reserve Chair Jerome Powell emphasised the need for more robust data to support the case for interest rate cuts, acknowledging that the U.S. is no longer an overheated economy. The U.S. employment market remains robust, with job openings holding steady and employers adding jobs above expectations in June. However, economic activity in the manufacturing sector contracted for the third consecutive month, and consumer spending, which accounts for more than two-thirds of U.S. economic activity, saw only a marginal uptick in May.
Financial markets always react poorly to instability. In the immediate aftermath of the shooting of Donald Trump, safe-haven assets such as gold, US Treasuries, and the US dollar experienced increased demand. The "Trump Trade" (market movements driven by the anticipation of Trump's business-friendly policies) were then partially offset by Biden's surprise announcement and the anointing of VP Kamala Harris as his successor.
Financial analysts were quick to complain that Harris's entry into the equation made the US Presidency a "whole new race," adding another layer of complexity for investors to navigate.
Back across the Pond, the sudden and dramatic parliamentary elections in France, have left the country facing a prolonged period of instability as three opposing political blocs, with competing ideas and agendas, attempt to form new working relationships and find common ground. This raises concerns about the new NPF government's ability to pass key, lasting reforms, including measures to reduce France's substantial government debt pile, which stood at 110.6% of GDP at the end of last year, and its budget deficit, which reached 5.5% of GDP last year. France’s debt now exceeds the European Union's Stability and Growth Pact limit, prompting corrective action from the European Commission via the Excessive Deficit Procedure. Yet the governing coalition has already made sweeping spending commitments, including a substantial increase to the minimum wage and a freeze on prices for many essential goods.
Spreads on French sovereign bonds (OATs) pushed up to 80 basis points above German Bunds as a result, the widest level since the European sovereign debt crisis of 2010. While spreads later narrowed slightly to around 65 basis points, they are likely to remain volatile in the medium term. Business sentiment in Europe is also on the move – finance executives are now rethinking the decision to expand in Europe given increasingly strict labour laws and new, aggressive taxation measures proposed by hard-left politicians.
The S&P Credit Conditions Europe Q3 2024 report highlighted a mixed picture for credit availability and risks across the continent. While their base case view remained unchanged (expectations of gradually improving growth, ongoing disinflation, and the ECB returning to a neutral policy stance by Q3 2025) several factors continue to impact credit conditions. Geopolitical risks, particularly potential spillovers from the wars in Ukraine and Gaza, represent the main systemic risk for Europe, while de-risking from China also carries its own perils. Macro tail risks - according to the ratings agency - include a prolonged period of slow growth or interest rates remaining higher than expected for longer. Despite balanced ratings performance overall, pockets of risk persist, especially for overleveraged borrowers with maturing fixed-rate debt, typically in the 'CCC' category.
Against this all-rather-too-exciting backdrop, the UK economic data and election in July painted a welcome and comparatively tranquil picture.
- The Consumer Prices Index (CPI) rose by 2.0% in the 12 months to June 2024, the same rate as in the 12 months to May 2024. This is well below the recent peak of 11.1% in October 2022. The largest upward contribution came from restaurants and hotels, while the largest downward contribution came from clothing and footwear.
- Core CPI inflation (excluding energy, food, alcohol and tobacco) remained steady at 3.5% in the 12 months to June 2024, unchanged from May. The CPI services annual rate ticked up slightly from 5.7% to 5.8%, while the CPI goods annual rate fell from negative 1.3% to negative 1.4%.
- The unemployment rate held steady at 4.4% but rose slightly in absolute terms as economic inactivity fell. Private sector ex-bonus pay growth slowed to 5.6% year-over-year in May from 5.9% in April, suggesting only small upside risks to the MPC's Q2 forecast.
- Public sector net borrowing (PSNB) excluding public sector banks is forecast at £11.0 billion for June, £0.6 billion below the OBR's projection. While investment spending should rebound, strong wage growth is expected to support tax receipts.
- Ongoing tensions in the Middle East continue to put upward pressure on oil and shipping costs, contributing to inflation. Domestically, potential minimum wage reforms proposed by the Labour party could add upward pressure to inflation.
"Against this all-rather-too-exciting backdrop, the UK economic data and election in July painted a welcome and comparatively tranquil picture."
The June 2024 CPI figures confirm inflation remains on a gradual downward path back towards the Bank of England's 2% target, though services inflation remains elevated. The steady core inflation and strong services rates suggest underlying upside inflationary pressures are still present in the economy, a factor which will likely weigh heavily on the MPC's thinking at their August meeting.
Forecasts for CPI have as a result become more bearish, with Pantheon Macroeconomics now expecting inflation to rise to 2.2% in July and as high as 2.9% in November, given that services inflation continues to slow only gradually, and goods disinflation appears to have peaked.
Recovering job growth may give the MPC pause. The situation is being compounded by uncertainty over the accuracy of ONS Labour Market data, the impact on CPI of temporary factors like music concerts, the EURO 2024 football tournament and the weaknesses in the BoE’s own forecasting abilities highlighted by the Bernanke review.
Weak wage growth could put an August cut back on the table, but for now most commentators expect the MPC to cut rates in September and December, provided services inflation cools in July &//or August.
SEB SAYS: "Across the board most major nations have reported similar macro trends as the UK, but with varying degrees of certainty and confidence in the underlying inflation data.
It isn’t entirely unreasonable to expect the Bank of England to follow the decisions of the ECB, Switzerland & Canada in the short-term, but any August or September rate cut appears heavily linked to the personal interpretation of the direction & reliability of individual datapoints by each MPC member.
One or two cuts going into Q4 are still possible but with an expected 'dead-cat bounce' in CPI towards the end of the year, I think we are unlikely to see base rates below 4.5% until well into H1 2025."