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Macro Watch: how has the UK economy weathered prolonged uncertainty?

Your guide to this week's big economic events 

Key points

  • The UK election result will determine its future relationship with the European Union (EU)
  • New European Central Bank (ECB) President Christine Lagarde chairs her first policy meeting
  • The Federal Reserve (Fed) should keep policies on hold after three rate cuts earlier this year

UK election: an uncertain outlook

The UK votes this week at its third general election in four years. Polls suggest that Boris Johnson is on course to win a majority, although a hung parliament cannot be ruled out. Even if the Conservative Party takes office and follows through on its promise to exit the EU, progress is unlikely to be plain sailing. A withdrawal bill will only cover the divorce aspects of Brexit and the future relationship with the EU will take years to negotiate. As we discussed in our latest edition of Ahead of the curve, sustained uncertainty has already taken its toll on the UK economy. This should be reflected in the October GDP figures released this week. Output expanded by 0.3% quarter-on-quarter in Q3, reversing a 0.2% decline the previous quarter. But growth was only 1% on a year-on-year basis, the lowest rate since the start of 2010.

Figure 1. The UK economy is in the doldrums 

Source: Office for National Statistics, as at Deccember 2019. 

ECB meeting: a depleted toolbox

Christine Lagarde presides over her first ECB meeting as President this week. Her predecessor Mario Draghi unleashed some controversial easing measures over his tenure, which were questioned by some members of the ECB’s Governing Council. As a former politician, Lagarde is likely take a more collegiate approach to decision making. Interest rates should be left on hold at this meeting, following September’s package of easing measures which included the resumption of quantitative easing and cutting deposit rates further into negative territory. But economic data continues to deteriorate and GDP is set to expand by only 1.2% this year, compared to 1.8% last year and 2.4% in 2017. Inflation also remains stubbornly below the ECB’s 2% target and long-term inflation expectations have declined for the past year. A change in policy stance may be on the horizon: Lagarde has promised a review of the ECB’s strategy and called for an increase in public investment to ease the burden on monetary policy.

Figure 2. Eurozone inflation expectations are heading south

Source: European Central Bank, Federal Reserve Bank of St Louis, as at December 2019.

Fed meeting: on hold for now

The Fed meets this week and is expected to keep interest rates on hold, following three cuts earlier this year. The minutes from the October meeting emphasised that the Fed thinks the cuts are enough to support the economy for the moment, despite the manufacturing slowdown. The Institute for Supply Management’s manufacturing Purchasing Managers’ Index declined to 48.1 in November, which indicates that activity is contracting. But the labour market is strong, as is consumption, which accounts for 70% of the economy. Retail-sales data are also released this week, which should shed more light on whether consumers have stayed cheery. But downside risks prevail, most notably the US-China trade war. Although there was hope a phase-one trade deal could be reached, the long-term outlook remains uncertain. All eyes will be on the US to see whether it imposes tariffs on $156bn-worth of Chinese goods this Sunday. It remains to be seen how long the Fed will leave rates unchanged: the futures market has priced in another cut for 2020.

Figure 3. US interest rates should remain unchanged

Source: Federal Reserve Bank of St Louis, as at December 2019. 

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Fiscal policy cannot save the ECB

There have recently been renewed calls from policymakers for fiscal easing to support looser monetary policy. However, research shows that a very large fiscal deficit would be needed to have even a modest effect on inflation or interest rates.

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In the second instalment of our two-part paper, we discuss our approach to capturing the illiquidity premium in a multi-asset credit framework, assessing how observations about the illiquidity premium can affect asset allocation, relative-value analysis and portfolio-management decisions.

The adaptive age

Kristalina Georgieva, managing director of the International Monetary Fund, argues that central banks need to adapt regulatory frameworks in order to address climate-related risks. In turn, this should help capital flow towards low-carbon investments.  

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