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Macro Watch: will the Bank of England cut interest rates?

Your guide to this week's big economic events 

Key points

  • The Federal Reserve (Fed) and Bank of England (BoE) meet
  • Despite mixed data, the US economy appears to be holding up
  • European economic growth is showing tentative signs of improvement

The Fed meets, but the BoE should steal the limelight

The Fed is expected to keep policies unchanged, as recent economic developments vindicate its dovish turn last year. Manufacturing remains in the doldrums, but a strong labour market is supporting consumption, while external demand has risen and the US-China trade deal has improved the outlook. Policy support should remain for the time being, as trade tensions will likely linger and inflation is contained. The Fed will probably also continue to buy roughly $60bn-worth of Treasury bills a month – despite stressing this is not quantitative easing. Across the pond, it is unclear whether the BoE will cut rates by 25bps or stay on hold. Negative Q4 data for GDP, consumption and inflation, combined with dovish comments from BOE officials, have fuelled expectations of a rate cut. But forward-looking surveys recently pointed to a modest rebound in activity and at the time of writing the OIS market is pricing in a 50% chance of a rate cut. It probably makes more sense for the BoE to stay on hold and see how the economy performs after the withdrawal agreement is approved. The bank may need its scarce ammunitions for later in the year when negotiations with the European Union could turn sour – the biggest threat to the outlook.

Figure 1. Central-bank balance sheets should expand this year 

Source: Refinitiv, based on national sources, as at January 2020

The US economy: a mixed picture, but holding up overall

Recent data continue to show a dichotomy between healthy consumers and struggling manufacturing. GDP is expected to increase by about 2% at a quarterly annualised rate in Q4, in line with Q3 – although consumption growth likely slowed in the fourth quarter. Going forward, growth should be affected by a large aircraft manufacturer’s decision to suspend production of one its main products. Meanwhile, regional manufacturing surveys have shown some signs of improvement and the Richmond Federal Reserve Survey this week should paint a similar picture. Consumer confidence is also expected to hold up, with both the Conference Board and University of Michigan surveys running comfortably above their long-term averages. Finally, inflation should stay contained: the personal-consumption expenditures metric should rise from 1.5% to 1.7% – mainly due to energy prices – while the core measure should be unchanged at 1.6%. And wage inflation, measured by the employment cost index, should be unchanged at 2.9% – in line with the message from the December payrolls.

Figure 2. US wage inflation is well contained 

Source: Refinitiv, based on the Bureau of Labour Statistics, as at January 2020

Europe’s economy makes headway

At its recent meeting the European Central Bank acknowledged that the manufacturing sector is still under severe strain, but also highlighted that economic conditions have tentatively improved due to improved external demand and receding trade tensions. GDP growth probably stabilised in Q4: consensus estimates expect output to expand by 0.2% quarter-on-quarter, in line with growth in Q3. Forward-looking economic indicators should also point to a brighter picture. M1 money supply leads GDP by a year and should confirm that economic activity has bottomed out, while the European Commission Economic Sentiment Index should edge up from 101.5 to 102 in January, following two consecutive months of improvement. Meanwhile, the Harmonised Index of Consumer Prices should rise from 1.3% to 1.4% (again, a reflection of energy prices) while the core component should ease from 1.3% to 1.2%. Attention will be also on German releases – the IFO business-climate survey, GfK consumer confidence index and the unemployment rate – which should show whether growth has risen from recent lows.

Figure 3. Eurozone growth about to turn a corner?

Source: Refinitiv, Eurostat, European Commission, European Central Bank, as at January 2020. 

Other events we're watching 

  • China’s National Bureau of Statistics Purchasing Managers’ Index (PMI). The official composite PMI has improved in the last couple of months, mainly reflecting encouraging developments in the manufacturing sector.
  • Brexit Day: the UK will leave the European Union on 31 January.

What we're reading right now

The International Monetary Fund’s (IMF’s) World Economic Outlook, a high-conviction approach to credit investing and the strength of the US consumer are among some of the interesting reads you may have missed.

IMF World Economic Outlook, January 2020

The IMF predicts that world economic growth will accelerate from 2.9% in 2019 to 3.3% this year. This is at a slightly weaker pace than previously anticipated, due to trade-related uncertainty and tensions in the Middle East.

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The strength of consumers is overstated

There seems to be a consensus that the US consumer is healthy enough to boost economic growth, despite the fact that manufacturing is struggling. But retail sales are declining, and strong(ish) consumption may not be enough to stave off a downturn.

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