8 February 2019
Italy: Falling deeper

Poor December industrial production data adds to the risk of another GDP contraction in 1Q19, and pushes our average GDP growth forecast for 2019 down to a miserable 0.1%

Industrial production weaker then expected in December

Industrial production data for December 2018, released earlier today by Istat, came in well below consensus, confirming that the soft patch of Italian manufacturing activity continued without any relief until the end of 2018. The seasonally adjusted measure was down 0.8% month on month (from -1.7% MoM revised in November), posting the fourth consecutive monthly contraction. The working day adjusted measure, better suited to follow the trend, turned out a disappointingly weak -5.5% year on year (from -2.6% YoY in November), the steepest yearly fall since March 2013.

A quick look at big aggregates shows that the monthly contraction was marked in consumer goods (-2.9% MoM) and in energy (-1.5% MoM); production was flat on the month for investment goods and marginally positive (+0.1% MoM) in intermediate goods.

Canada: What wage growth concerns?

When it comes to the story of sluggish wage growth, the Groundhog Day we've been seeing since June last year has finally changed its tune. January saw wage growth finally pick-up for full-time workers, and we don't expect this to just be a temporary relief

After the hiring blitz in November (+94,000), there was a much slower pace of job gains in December (+9,300), but Canada is back on track in January creating 67,000 jobs. The unemployment rate ticked back up to 5.8% after sitting at a four-decade low of 5.6% for two months as more people entered the labour market. That said this is still a relatively low unemployment rate and jobs are still being created, so on face value, the picture is pretty positive and won’t be too much of a concern for the Bank of Canada (BoC). 

Riksbank preview: February blues

We expect little change from the Riksbank next week, but the outlook has clearly taken a turn for the worse and a further dovish shift in the policy stance at the next meeting in April looks increasingly likely

Worsening outlook

We expect the Riksbank's February meeting to be largely a non-event. The central bank is unlikely to shift policy meaningfully so soon after the December meeting when the policy rate increased to -0.25% but the interest rate forecast was revised down (a very dovish hike), and forecasts for growth and inflation were revised down (again).

We expect the Riksbank's February meeting to be largely a non-event

Since then, the outlook for the Swedish economy has worsened further, both due to domestic factors and a now clearly a slowing global economy. Survey data points to a marked loss of momentum in the domestic economy, both due to the export sector suffering from lower growth in trading partners and the housing market slowdown in Sweden. The manufacturing PMI has fallen to 51.5, and the ratio of orders to inventory suggests we are likely to see the PMI fall below 50 in coming months, indicating a contraction in the manufacturing sector.

House prices have also started falling again, and a large amount of outstanding supply suggests risks remain to the downside. There are also increasing signs that the housing market troubles are affecting households, with consumption in 4Q18 likely to come in lower than 4Q17 as consumers tighten their belts.

Bank of England slashes forecasts amid Brexit uncertainty

There’s plenty of short-term negativity in the Bank of England’s latest predictions, but there is still the subtlest of hints that they’d still like to tighten policy further if they can. That says to us that a 2019 rate hike shouldn’t be ruled out just yet, although as ever it all depends on Brexit

A big cut to 2019 growth forecasts

With just 50 days left until Brexit, it shouldn’t come as much of a surprise that the Bank of England has taken a more dovish stance amid all the uncertainty. Policymakers unanimously opted to keep rates unchanged, and the statement is littered with references to intensified uncertainty.

That said, the extent of the downgrade to 2019 growth – from 1.7% to 1.2% – is much sharper than we had expected. The Bank now looks for just 0.2% in both the first and second quarter of 2019 and only a marginal improvement in the third.

This partly reflects the weaker global backdrop, but we suspect it may also reflect the growing risk that the Brexit deadline could need to be extended, prolonging the uncertainty well beyond March. We agree that there is a real risk that business investment stays subdued for some time, as firms remain awake to the ‘no deal’ risk.

A hike still seems some way off, but it's too early to rule it out this year

The upshot is that the Bank is highly unlikely to tighten policy again through the first half of this year, and indeed the chances of a rate hike at all in 2019 have receded – although we think it’s too early to write one off completely.

Despite all the caution in the February report, we still get the sense that the Bank has a preference to tighten policy at some point if it can. Wage growth has been particularly strong recently and the Bank continues to see this rising at a rate close to 4% in 2021. This has been central to the Bank’s previous rationale for hiking rates, and policymakers gave the subtlest of hints again that It thinks rates may eventually need to rise further than markets expect.

A lot depends on Brexit

Of course, all of that relies heavily on Brexit. Most paths now lead to an extension of the article 50 negotiating period, but if (and it's still a big if) the government can secure a cross-party consensus for a particular deal – for instance one that commits to a permanent customs union – then this may well be followed up with a Bank of England rate hike relatively swiftly.

A lot depends on the global outlook too, and some are questioning whether the Bank of England would still opt to hike rates at a time where the Fed is easing off and the ECB is moving only very gradually. However, it's important to remember that the Bank of England is much further away from a neutral stance than the Fed. So with the economy running close to full capacity, policymakers may still conclude that some catch up is required.

India: RBI’s surprise rate cut appears premature

The Reserve Bank of India (RBI) has ignored the inflationary consequences of the fiscal splurge and eased policy in support of the government’s drive to boost growth before the elections. We think the markets will view such a policy move as premature and the rupee will be the main victim  

An RBI rate cut with neutral policy stance

The RBI Monetary Policy Committee voted 4-2 to cut the key policy rate by 25 basis points, taking the repurchase rate to 6.25% and the reverse repo rate to 6.00%. The decision was surprising in that very few, only eight out of 38 participants in the Bloomberg survey anticipated it. As widely expected, there was no change to the banks’ reserve requirement rate of 4.00%. The MPC also switched its policy stance to ‘neutral’ from ‘calibrated tightening’, which was a unanimous decision by all members.

What’s more amazing though is the sharp swing in the policy perception within the MPC. Until late 2018, all but one member expressed caution on inflation and advocated a tighter stance with stable rates, whereas all favoured a neutral stance and the majority voted for a rate cut today.

US State of the Union: Building walls, not bridges

The President’s State of the Union address spoke about bi-partisanship, but the government shutdown and a lack of policy thrust highlight the problems he faces with a divided government

A hint of an olive branch...

President Trump’s 82 minute speech to Congress spoke of a need for the Republicans and Democrats to come together for the good of the American people. He talked of efforts to reduce drug prices and repeated his calls for bi-partisan cooperation on infrastructure investment, although there was next to no detail on what that may involve. The President also repeated calls for support for the border security wall with Mexico, but stopped short of saying he would declare a national emergency and get it built himself should that support not come. Obviously the potential for such action remains firmly on the table.

He was even more vague on US-China trade policy, merely stating that “I have great respect for President Xi, and we are now working on a new trade deal with China. But it must include real, structural change to end unfair trade practices, reduce our chronic trade deficit, and protect American jobs.”  

However, in a warning shot to Europe and their car exports to America, he made the plea to Congress, “I am also asking you to pass the United States Reciprocal Trade Act, so that if another country places an unfair tariff on an American product, we can charge them the exact same tariff on the exact same product that they sell to us.” Europe charges a 10% tariff on American made cars while America charges only a 2.5% tariff on EU made car imports. On this front, we are focused on the US Commerce Department’s report (due 17 February) on whether the import of cars is a threat to US national security, which could trigger a stepping up of US-EU tensions.

Reading time around 8 minutes

In case you missed it: Trade truce withering away

Will the trade truce between the US and China give way to renewed conflict, peace or drawn out simmering tension? February could be the turning point. And with a dovish Bank of England slashing growth forecasts amidst the uncertainty, next week will be another week, another vote in Brexit Britain

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