15 November 2018
Brexodus heaps pressure on May

A slew of ministerial resignations and the probability that enough of her MPs will look to trigger a no-confidence vote leave PM Theresa May’s Brexit plan in tatters. The biggest loser is the UK economy

PM May’s proposed EU exit deal was never likely to please everyone and in the end, it pleased no-one. Minsters queued up to hand in their resignation and Conservative Brexit hardliners vocally rallied to the cause of ousting Theresa May as Prime Minister. They have since been joined by some remainers who have lost faith in the Prime Minister’s leadership. As such it looks increasingly likely that the threshold of 48 MPs (15% of total Conservative MPs) writing letters of no-confidence in the PM will be achieved today. This then will trigger a full no- confidence vote in a secret ballot of all Conservative MPs.

ECB: Auto pilot with a slight dovish bias

In one of his rare public speeches, ECB president Mario Draghi just confirmed the bank's determination to end quantitative easing, but opened the door for a long period of low interest rates

When ECB President Maro Draghi gives a speech four weeks ahead of a crucial policy meeting, it is always worthwhile listening closely. In his speech at the Frankfurt European Banking Congress, Draghi gave his view on the current discussion on whether the eurozone economy was in a soft patch or already at the start of a new downswing. Not surprisingly, he confirmed the ECB’s previous take, arguing in favour of a soft patch and pointing to several one-off factors. At the same time, however, Draghi stressed that some temporary factors could become long-lasting, ie trade tensions and external uncertainty. In sum, Draghi is still betting on domestic demand, the strong labour market and investment, to support the eurozone recovery in the coming months.

Turning to inflation, Draghi pointed to satisfying wage growth but emphasised that the pass-through from higher wages to higher inflation was still hardly visible and that uncertainties surrounding the medium-term outlook had increased.

Against all of the above, Draghi slightly changed the well-known ECB communication. While there is still a strong determination to end the net-QE purchases by the end of the year, Draghi opened the door for changes to the forward guidance in the course of 2019. This is the key paragraph from the speech: “The nature of this forward guidance is contingent on economic developments and therefore acts as an automatic stabiliser. If financial or liquidity conditions should tighten unduly or if the inflation outlook should deteriorate, our reaction function is well defined. This should, in turn, be reflected in an adjustment in the expected path of future interest rates.”

It is too early to read any real changes in the ECB’s anticipated path for monetary policy beyond the end of the net-QE purchases. However, Draghi at least just sent a clear signal of the ECB’s willingness to err on the side of caution when it comes to the first rate hike. The risk that Draghi could go down in European history books as the first ECB president who never hikes rate is increasing.

GBP: Rocked by Brexit resignations, sterling could fall another 3 to 4%

The resignation of the British Brexit Secretary, Dominic Raab, has increased the chances of a leadership challenge to Theresa May and a 'no-deal' Brexit.  Investors can demand greater risk premia of UK assets, which could mean another 3 to 4% fall for sterling

Raab rocks GBP

After rallying on a brief period of optimism on the scope for a soft Brexit, GBP has today been hit hard by the resignation of Dominic Raab, the Brexit secretary. His resignation letter referenced two key concerns of the Withdrawal Agreement recently negotiated between London and Brussels, namely: i) the threat to the integrity of the UK posed by the proposed regulatory regime for N.Ireland and ii) the EU holding a veto over the UK’s ability to exit the back-stop of a customs union.

For the Brexiteers, the withdrawal deal offers too many concessions to Brussels. For the Remainers, they reject the proposition that it is a question of this (bad) deal or no deal at all. They would prefer another referendum or at least a delay in Article 50 to allow more time to negotiate a better deal.

Investors must weigh up two key challenges

International investors now have to weigh up the chances of a leadership challenge against the Prime Minister, Theresa May, in addition to the (seemingly declining) chances of the withdrawal deal being approved by UK parliament in December. On the former, the news cycle will be focusing on whether sufficient names are backing a no-confidence vote in May, which could potentially take place in the next few days.

For reference, our Chief International Economist, James Knightley and our UK economist, James Smith, both think that we won’t see a leadership challenge, arguing that one would merely delay negotiations and make an Article 50 extension and a Brexit delay more likely. So let’s see what happens within Conservative ranks over the next few days.

Eurozone: a dismal third quarter confirmed

GDP growth in the Eurozone was confirmed at just 0.2% in Q3. Industrial production saw a decline in September. While a small recovery of GDP is expected for Q4, growth momentum has clearly been lost in 2018

The second estimate, GDP growth was confirmed at just 0.2% QoQ and 1.7% YoY. The main culprit was Germany, the Eurozone’s stronghold throughout the 2010s, which saw its economy shrink by -0.2% in Q3. Disruptions in the car industry were an important driver of the first negative quarter since 2015 and the slow quarter in the Eurozone, but it seems that the worries about growth are broader than that.

Exports are weaker thanks to global problems related to trade wars and emerging markets, and consumption was dampened by the higher oil prices seen in Q3. The stagnation in Italy’s economy adds to worries around the Italian budget. The confrontation with Brussels has not been resolved as the ball now returns to the European Commission’s court that now has to decide whether to put Italy in an excessive deficit procedure.

Industrial production in the Eurozone posted a very small decline in Q3, adding to the slow growth performance. Production in September dropped by -0.3% MoM. On the year, growth is just 0.9% for industry and production is still well below the November peak. 2018, therefore, seems to have become the year of one-off excuses for a severe weakening of growth. The question is whether this explains the whole picture or whether these are excuses along the lines of “the dog ate my GDP” and something more structural is happening. While a small recovery of growth in Q4 is in the making, it seems evident that the growth cycle for the Eurozone already peaked last year.

Germany: Wake-up call

First it was politics, now it is the economy. The worst economic performance since 1Q 2013 is another wake-up call for the eurozone’s largest economy to take action 

The swan songs and obituaries on the golden decade of the German economy were already waiting in the wings (and devastating headlines had already been prepared). Monthly data over the last few months was simply too bad not to expect a disappointing 3Q performance of the German economy. The just-released first estimate of 3Q GDP confirms the negative gut feeling.

According to the first release of the statistical agency, the German economy had its worst performance in 3Q since the first quarter of 2013, shrinking by 0.2 % quarter-on-quarter. The first quarterly drop since the 1Q 2015. On the year, the economy still grew by 1.1%. The GDP components will only be released at the end of the month but available monthly data suggests that net exports were the main drag on growth, while investments and the construction sector were growth-supportive. Private consumption declined.

A mix of one-offs and more worrying structural factors

The disappointing performance of the German economy in the third quarter can be explained by several one-off factors but also some more worrying structural developments. Problems with the emission norms created severe production problems in the automotive industry, higher energy prices completely erased previous wage increases and also don’t underestimate the negative confidence effect from the World Cup. We don’t dare to predict the performance of the national football team but at least the automotive sector should rebound in the coming months and somewhat lower energy prices should revamp private consumption. However, the poor export performance, despite a weak euro exchange rate, suggests that trade tensions and weaknesses in emerging markets could continue to weigh on Germany's growth performance.

Wake-up call

Looking ahead, the late-cycle economy is likely to fluctuate between hopeful and worrying news and developments. Low interest rates, a weak euro and some fiscal stimulus, as well as the reversal of adverse one-off factors, are strong arguments in favour of a growth rebound in the coming quarters. At the same time, however, dropping capacity utilisation and increasing external risks put a lid on any upside potential.

In sum, the outlook for the German economy is still positive and swan songs will have a short shelf-life but the reputation of the invincible strong man (or woman) of Europe has received some scratches. After the latest political developments, today’s disappointing growth data is yet another wake-up call that political stability and strong growth are by no means a given.

The Eurozone economy: Between optimism and pessimism

There is currently a lot of speculation about the future path of the global economy. Is the best behind us and are fears about an imminent and protracted slowdown justified? For the Eurozone, an old saying by Ben Bernanke rings a bell: recoveries don’t die of old age. However, they can definitely lose momentum

The discussion between optimists and pessimists is getting fiercer. Recent developments have sparked uncertainty about the length of the expansion in the Eurozone as confidence among businesses and consumers has been hit by concerns about a trade war, Brexit, higher oil prices and emerging market turmoil. 

This does not necessarily mean that the economy is set for a severe decline. The investment environment remains favourable with low borrowing rates, eased credit standards and high levels of capacity utilisation. Consumption continues to profit from lower levels of unemployment and cautious increases in wage growth. 

Business cycles show Eurozone recoveries don’t die of old age - instead, they always need a special trigger. This can either be the central bank hitting the interest rates brakes too early and too strongly or an external event, like an oil crisis or a financial one

Still, with lower confidence, capacity constraints and slowing demand from outside of the Eurozone curbing growth at the moment, the economic cycle does seem to have peaked in 2017. According to our latest forecasts, growth will slow markedly this year, dropping from 2.4% in 2017 to 2.0% this year. As output gaps have closed faster than initially expected by the IMF, it looks like the Eurozone economy is currently set for a loss of momentum and not for an upcoming recession. 

Empirical evidence of previous business cycles shows that recoveries in the Eurozone indeed don’t die of old age. Instead, it always needs a special trigger. This can either be the central bank hitting the interest rates brake too early and too strongly or an external event, like an oil crisis or a financial one. 

At the current juncture, it looks highly unlikely that the European Central Bank could do anything that would harm the economic expansion. However, a slowing of the US and Chinese economies, additional weakness in emerging markets, trade tensions or a new existential crisis of the Eurozone could obviously trigger a new recession. Or at least lead to a severe slowdown. 

Our base case is that the Eurozone expansion is losing some momentum but not on its last legs yet. However, it would be naïve to exclude the possibility of a recession in the short-run

If one or more of the ample downside risks were to materialise, the policy response would likely be very weak. At every recent ECB press conference, President Mario Draghi has called for more structural reform and fiscal responsibility of the Eurozone economies and a comprehensive capital markets and banking union. 

But looking at Draghi’s call from the perspective of a next possible recession reveals that the ECB may not be able to fight the next crisis all by itself again.

Forecasting is fallible, yet necessary

Economic forecasters are caught out by shocks so often that one might reasonably ask why they bother. The short answer is that they have no choice, writes ING chief economist Mark Cliffe for Project Syndicate

In a complex and uncertain world, making predictions is a fraught business, not least for economists, whose forecasts are notoriously inaccurate. Even worse, economic forecasts tend to let you down just when you need them most. The Nobel laureate economist Paul Samuelson once quipped that “the stock market has called nine of the last five recessions,” which seems forgivable when compared with economic forecasters who rarely predict any.

People simply cannot live without predictions

Given that economic forecasters are so often caught out by shocks, one might ask why they bother. The short answer is that they have no choice. Even when they are well aware of the fallibility of their analyses. People simply cannot live without predictions. Because all decisions – in business, politics, or even one’s personal life – are based on some idea of what the future holds, demand for forecasts is insatiable. People want to be able to justify decisions that they would have made anyway for other reasons. And when things go wrong, they can always blame the “experts.”

Reading time around 12 minutes

In case you missed it: Peak uncertainty

After a week of high drama in the UK and low growth in the eurozone, levels of uncertainty appear to be reaching a crescendo. It's all very far from ideal. The question is, will the situation get worse and could it even lead us into recession?  

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