MacroScope

The week kicks off with a G8 leaders’ summit in Northern Ireland. Syria will dominate the gathering and the British agenda on tax avoidance is likely to be long on rhetoric, short on specifics. But for the markets, this meeting could still yield some big news. For a start, Japanese prime minister Abe is there – the man who has launched one of the most aggressive stimulus drives in history yet has already seen the yen climb back to the level it held before he started. Abe will also speak in London and Warsaw during the week.

The financial backdrop could hardly be more volatile with emerging markets selling off dramatically since the Federal Reserve warned the pace of its dollar creation could be slowed. Berlin has said the G8 leaders are likely to discuss the role of central banks and monetary policy, and Angela Merkel will hold bilateral talks with Abe during the summit. President Barack Obama travels to Berlin after the summit for talks with Merkel.

The central banks of Turkey, Switzerland and Norway all have monetary policy decisions to make in the coming week and may have some interesting things to say about the revival of market turmoil after months of calm. The Norwegians have said interest rates are likely to stay at 1.5 percent for months to come and the Swiss National Bank is unlikely to loosen its cap on the Swiss franc which has served it so well, particularly given markets are now back in flux and traders are starting to talk about flight-to-safety moves again. The elephant in the room is the Federal Reserve’s latest policy decision on Wednesday, followed by a Ben Bernanke press conference.

The Turks are the hottest story of the moment on our patch with Prime Minister Tayyip Erdogan first saying his patience had run out after almost two weeks of anti-government protests, and then sounding more conciliatory, holding talks with protest leaders. How this ends will go a long way to dictating the investor view of Turkey and how its markets recover (if at all) from a drubbing inspired by a perfect storm of domestic and international factors – about $8 billion had fled Turkish markets from the beginning of May to last Wednesday and a gaping current account deficit doesn’t help.
The central bank has already come in to defend the lira and while it said it saw no need to raise the upper band of its interest rate corridor who knows what the next few days will bring. At its May meeting, it cut all its key rates by 50 basis points, but with the lira under huge pressure you can rule out a repeat of that. Indonesia was first out of the blocks in recent days, becoming the first central bank in Asia to raise rates since 2011. It’s early days but a repeat of the capital outflows that marked the Asian financial crisis of the late 1990s is an unpleasant reminder of the damage that can be wrought.

The euro zone bears watching as always, now we’re back into turbulent times.

Spain, France and Germany all hold bond auctions during the week with the benevolent bond market conditions of the first five months of the year now gone. Italian and Spanish borrowing costs fell for 10 months after European Central Bank chief Mario Draghi pledged to do whatever it takes to save the euro but have begun creeping up since Bernanke’s intervention. Both countries have frontloaded their funding for this year, so some of the pressure is off. Germany could start to benefit from safe haven status again so maybe France is the most interesting. Its economy is flatlining, the government is railing against exhortations from Berlin and Brussels to raise the pace of structural reform and yet it can still borrow for 10 years at not much more than two percent.

With little sign of economic recovery in Europe and governments incrementally loosening their austerity drives (Britain being the exception) the focus turns to the big central banks on our patch and what more they might be able to do to foster some recovery.

With the European Central Bank meeting on Thursday, President Mario Draghi is in Shanghai saying the euro zone is on track for only a “very gradual recovery”. It’s hard to tell at a glance whether that is a rhetorical downgrade of the existing forecast for a pick-up in the second half of the year with downside risks attached. Either way, the pressure on the ECB to act again is growing.

However, don’t expect anything at its monthly meeting on Thursday, although a further interest rate cut could come this year and there is still talk of cutting the deposit rate – the return banks get for parking funds at the ECB – into negative territory to try and get them to lend. The big question is would that achieve much? Despite being in a world awash with central bank money, there is clearly a reluctance among banks to push money into the real economy. The latest data showed bank loans to euro zone businesses and households contracted for the 12th month in a row in April.

Even if they can’t agree how much Britain’s Help to Buy mortgage guarantee scheme will boost the housing market, analysts in the latest Reuters poll are united by an understanding of its dangers.

The government’s Help to Buy programme, unveiled in its March budget, is designed to boost mortgage lending and help buyers with small deposits get on the property ladder.

The poll predicts Britain’s house prices will rise at their fastest pace in four years in 2013, and data from Hometrack show London property was snapped up in April more quickly than at any time since October 2007 – adding to concerns Help to Buy might start a new house price bubble.

The British government faces another potentially thorny day with the International Monetary Fund delivering its annual review of the UK economy. If David Cameron has a consistent policy, it’s that the only way to get Britain back on its feet is to cut spending and debt. Trouble is, we know the IMF doesn’t agree and advocates a more growth-fostering approach. Finance minister George Osborne has changed rhetorical tack in response but is walking a tightrope as a result.

This comes at a time when there are distinct signs that Cameron’s Conservative party is unraveling and not just over Europe. Unless he gets a grip soon, who knows what further concessions may be made on an EU referendum which could push Britain further towards the exit door. It remains unlikely that the coalition government will fall apart before 2015 elections, not least because the junior, pro-EU Liberal Democrat partners face electoral evisceration according to the polls. It’s even less likely that Cameron will be toppled by fractious members of his party. But it’s no longer impossible.

Britain’s LibDem deputy prime minister will take the unusual step of holding a news conference to say the coalition will hold together until 2015. Another big flashpoint looms this summer with the government’s spending review where hardline Conservatives will push for big welfare cuts and the LibDems will resist. Former foreign secretary Geoffrey Howe, the man who did more than anyone else to end Margaret Thatcher’s reign, says Cameron is losing control of his party. From the other side of the political divide, Peter Mandelson says he has to lead not follow. Hard to argue with either of them.

In his valedictory Quarterly Inflation Report, Bank of England Governor Mervyn King shone a ray of light on the British economy, saying it should grow 0.5 percent in the current quarter.

But according to the latest Reuters poll of more than 30 economists, published on Tuesday, that might be too optimistic.

The consensus showed gross domestic product would only expand 0.2 percent, weaker than the 0.3 percent expansion seen in the first quarter when the country missed sinking into an unprecedented triple-dip recession.

Britain’s David Cameron began the day on Monday gently slapping down two Cabinet colleagues who said if they had a vote today, they would opt to leave the EU. It was senseless, he said, to throw in the towel before he had had a chance to renegotiate Britain’s relationship with Europe. He ended it by caving into rebels in his Conservative party who are demanding legislation now to commit to an in/out referendum before the next election.

The 25 year history of the Conservatives and Europe – internecine warfare and successive election defeats as they obsessed about something which figures low on most Britons’ priority list – suggests no good can come of this and if Cameron wins the 2015 election it moves Britain incrementally closer to the EU exit door. The more immediate question is whether Cameron has lanced the boil. Again, history suggests that if you give ground to the eurosceptics they merely demand more. And what the PM’s pro-EU Liberal Democrat coalition partners make of this isn’t hard to imagine which means he might not even have the numbers to get the bill through parliament. One of the leading rebels seized on that point, saying the move could well fail.

The anti-EU fringe party UKIP, which could well not win a single seat at the next election but has seriously spooked the Conservatives with strong showings in recent local elections, must be laughing all the way to the bank. If it can remake the Conservative party in its own image, its job will be done. But just as likely is a split party. The irony of Cameron doing all this while in Washington to bang the drum for an EU/U.S. trade deal is hard to ignore. President Obama pointedly said the British premier should fix its relationship with the EU.  If Cameron believes Britain should remain part of its main trading bloc, as he says he does, he is going to have to start explaining why and that is difficult to imagine.

* Updated to show Scotland’s composite PMI has bettered the UK equivalent for seven straight months now, after Monday’s data.

For the first time in a long while, Scotland’s economic performance has caught up with the UK average– and there is at least some evidence to suggest it’s doing slightly better than the British baseline.

In general, the Scottish economy has come second-best behind the poor UK average, at least since the full onslaught of the global financial crisis hit in September 2008 with the collapse of Lehman Brothers.

It’s European Central Bank day and we have it on very good authority that a quarter-point interest rate cut is on the cards, which will take rates to a record low 0.5 percent. A plunge in euro zone inflation to 1.2 percent, way below the target of close to but below 2 percent, has cemented the case for action.

In terms of reviving the euro zone economy this is pea shooter and elephant territory. The ECB has consistently diagnosed the key problem that already ultra-low interest rates are not transmitted to high debt corners of the euro zone, where lending rates are much higher and credit restricted. A rate cut won’t change that. It also illuminates the gulf in approach with the Bank of Japan and Federal Reserve who continue to print money at a furious rate.

The Fed said on Wednesday it would continue buying $85 billion in bonds with new money each month and added it would step up purchases if needed to protect the economy, dousing recent suggestions that the programme could be wound up in the months ahead. Nonetheless, a euro rate cut will help at the margins.

First quarter UK GDP figures will show whether Britain has succumbed to an unprecedented “triple dip” recession. Economically, the difference between 0.2 percent growth or contraction doesn’t amount to much, and the first GDP reading is nearly always revised at a later date. But politically it’s huge.

Finance minister George Osborne has already suffered the ignominy of downgrades by two ratings agencies – something he once vowed would not happen on his watch. And even more uncomfortably, he is looking increasingly isolated as the flag bearer for austerity. The IMF is urging a change of tack (and will deliver its annual report on the UK soon) and even euro zone policymakers are starting to talk that talk. It was very much the consensus at last week’s G20 meeting.

The government can argue that it hasn’t actually cut that hard – successive deficit targets have been missed – and that it does have pro-growth measures such as for the housing market and bank lending. But the inescapable political fact is that Osborne and his boss, David Cameron, have spent three years arguing that they would cut their way back to growth and that to borrow your way out of a debt crisis is madness. In fact, it’s arguably perfectly economically sane, given that if you get growth going, tax revenues rise and will eat away at the national debt pile.

There’s been a lot of noise surrounding the rhetorical shift away from austerity in the euro zone in recent days, the notable exception being Germany. It is now widely acknowledged that monetary policy alone cannot turn economies around. But of course it has a vital part to play.

That puts the focus on the European Central Bank and growing expectations that it will cut interest rates to a new record low next month. Yesterday’s poor German PMI could have been the tipping point. On three of the four times the survey reading has fallen below 50 since the collapse of Lehman Brothers a rate cut followed the month after. Germany’s PMI duly slipped into contractionary territory yesterday.

In all this, we shouldn’t lose sight of the fact that a quarter-point rate cut may move markets but will have only a small impact on the euro zone economy. It’s also true that the ECB has shown no signs of wanting debt-cutting drives to be mothballed. Its reaction to any shift in that direction remains to be seen.