MacroScope

Weak UK inflation casts doubt on interest rate hike this year

 

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Bank of England Governor Mark Carney shocked markets last week, saying interest rates could rise sooner than expected.

At first glance, the latest UK inflation data suggest they might not.

Inflation has nearly halved to 1.5 percent in May from 2.9 percent last June. And wage inflation is much lower.

While still well above the euro zone, where inflation has tumbled to 0.5 percent, keeping alive the real risk of deflation, the latest UK inflation rate fell below even the lowest forecast in a Reuters poll.

And inflation is now 0.2 percentage point below where the BOE thought it would be in its own forecasts made one month ago.

So by all accounts, inflation is running behind where it should be to justify what was interpreted — and spun by Carney — as a very dovish set of BOE forecasts in May.

Common cause for Washington and Tehran in Iraq?

Iraq is going up in flames and there appears to be no question of the West putting boots back on the ground in contrast to 2003 when the United States and Britain invaded to topple Saddam Hussein and set in train a decade of chaos that has now exploded again.

Iraq’s most senior Shi’ite Muslim cleric has urged his followers to take up arms against a full-blown Sunni militant insurgency to topple Shi’ite Prime Minister Nuri al-Maliki. The chances of ISIL militants taking heavily armed Baghdad are slim but that doesn’t mean conflict will not continue and, with Iraqi Kurdish forces seizing control the oil hub of Kirkuk just outside their autonomous enclave in the north, the prospect of the country splitting along sectarian lines is real.

Over the weekend, ISIL’s advance on Baghdad slowed but spread northwest, with Sunni militants seizing Tal Afar, a town close to the Syrian border.

UK rate rise this year? Possible, but not certain yet

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“It could happen sooner than markets currently expect.”

That was the bomb of a headline Bank of England Mark Carney dropped in a speech on Thursday that suggested a significant change in tone at the bank.

So far, Carney has seemed comfortable with keeping rates at a record low of 0.5 percent for another year. That has been the forward guidance markets have been following.

But are many now convinced that Bank Rate will go up earlier?

Not yet, but some.

Given that Carney’s remarks come only a month after he outlined a dovish outlook for rates in the May Inflation Report, he took many by surprise, sending sterling to just under $1.70 and rallying to less than 80 pence per euro.

Better U.S. growth and just muddling along both point to low rates for longer

UFaith that the U.S. economy may finally be at a turning point for the better appears to be on the rise, as many ramp up expectations for a better Q2 and second half of the year.

But that does not mean that interest rates are likely to rise any sooner.

Goldman Sachs’s Jan Hatzius, one of the most dovish economists on when the Federal Reserve will eventually raise rates, has lifted his growth outlook but stuck to the view that the first interest rate rise off the near-zero floor won’t come for nearly two years, in early 2016.

The latest Reuters poll of Wall Street dealers on Friday still points to the second half of next year at least before the Fed, which is still printing tens of billions of dollars monthly as it winds down the third installment of its QE program, will start raising rates from 0-0.25 percent.

ECB aftermath; how firm is opposition to QE?

After the European Central Bank opened its toolbox and deployed pretty much everything it had left, bar printing money, the question is if and when QE becomes a live possibility.

ECB chief Mario Draghi pointedly said at his monthly news conference that all policy options had not been exhausted.
German resistance to such a move will remain, however, and Draghi’s deputy, Vitor Constancio, has already intimated that it will take until late this year to judge whether the latest gambits have made a difference before moving onto the next stage.

Bundesbank chief Jens Weidmann is already out today saying the ECB has ventured onto new ground and that governments need to treat the move as a wake-up call to continue with economic reforms. He added that there was a risk that long-term inflation expectations could be de-anchored – ECB speak for deflation.

Euro zone inflation data to set seal on ECB action

Euro zone inflation – due at 0900 GMT – is forecast to hold at a paltry 0.7 percent in May, in what European Central Bank President Mario Draghi has labelled the danger zone below 1.0 percent for the eighth successive month.

After German inflation fell to just 0.6 percent on the EU measure on Monday, well below forecasts, the bloc-wide figure could also undercut. We already know the Spanish and Italian inflation rates were just 0.2 and 0.4 percent respectively last month. If that comes to pass, any doubts about ECB action on Thursday, which are thin on the ground anyway, must surely be banished.

A clutch of senior sources have told Reuters the ECB was preparing a package of policy options for its meeting on Thursday, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms (SMEs).

Signs of European dash for growth

The ripples of EU election results are being felt, no more so than in France where the National Front topped the poll.

The day after the results, Prime Minister Manuel Valls promised further tax cuts for French households. The government is already committed to a 30 billion euros cut in labour taxes to help business but insists all this can be done while meeting its EU deficit commitments.

Brussels has already given Paris an extra two years to get its deficit down to three percent of GDP. Today, the European Commission will produce updated country recommendations.

Evening of reckoning

EU heads of government and state dine in Brussels this evening to discuss their response to a big slap in the face from the bloc’s electorates.

Italy’s Matteo Renzi, who bucked the trend by winning handsomely as an incumbent prime minister, has the wind in his sails and has pledged to change Europe’s focus towards growth and job creation after years of fiscal austerity in response to the euro zone’s debt crisis.

A French official said President Francois Hollande would back Renzi’s call for more pro-growth policies and tell fellow EU leaders that Europe had reached “the alarm level”. Even Germany’s Angela Merkel – the one who really counts – is talking about Europe’s people not caring about treaty change but job security and prosperity.

PMIs next signpost for ECB

Following a mixed bag of euro zone GDP data last week which showed Germany charging on and Spain holding its own but France stagnating and Italy, Portugal and the Netherlands slipping back into contraction, flash PMI surveys for the euro zone, Germany and France certainly have the power to jolt the markets today.

As things stand, there seems little to dissuade the European Central Bank from loosening policy next month. Five senior sources told us it was  preparing a package of policy options for its early June meeting, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms.

Bundesbank chief Jens Weidman speaks later. He told a German newspaper it was not yet certain that action would be taken in June. The three PMI readings are not expected to move much from April with the French numbers lagging those of the euro zone and Germany.

Elusive China gas deal

Vladimir Putin is well into his second and final day of a trip to China during which he was hoping to sign a long-sought gas deal with Beijing. There’s no sign of white smoke so far and if the Russian president leaves empty handed it would be a serious blow.

Gazprom has repeatedly said negotiations are in their final stages but it seems there has been no agreement yet on price and Moscow may have to lower its sights given the prospect of it losing business in Europe, which has been spooked into considering how to secure its energy needs elsewhere in future, has rather strengthened Beijing’s negotiating hand.

There has been a lot of talk in Russia about a pivot to the east but some analysts say that could never fully compensate for lost business with the West and if the China gas deal which could be worth $400 billion or more does not come to pass the strategy will look hollow. Late on Tuesday, a Putin spokesman said negotiators from both countries have been unable to bridge differences on price.