Market Bulletin (12/08/2015)
For markets that remain ‘data-dependent’ – jittering in response to any and every signal of the health of the global economy – the end of the week offered the chance of some definite answers to the questions of when the US and UK would start raising interest rates. As it turned out, the Bank of England’s deluge of data, released on what was dubbed ‘Super Thursday’, quashed any expectations of an imminent rise and signalled that the Monetary Policy Committee (MPC) does not anticipate rates changing before spring 2016.
The minutes of the MPC’s August interest rate meeting revealed that the strong pound (which has appreciated 3.5% since May), further falls in commodity prices and uncertainty over how the labour market is evolving provided the reasons for policymakers to wait in the short term. Only one member of the nine-strong committee voted in favour of a rate increase; the first time since December that the vote has not been unanimous. However, markets were surprised by the unexpectedly cautious stance, as the Bank’s quarterly inflation report confirmed an upgrade in its growth forecasts and depicted a more broadly balanced recovery in which productivity is improving and consumer and business confidence is rising, thanks to low interest rates and rising wages.
Stephanie Flanders of J.P. Morgan Asset Management said that the MPC’s assessment that productivity was improving was a key judgement. “If the MPC is right, wages can grow faster without necessarily squeezing profitability for UK companies and the Bank need not rush to tighten policy; but we have seen so many disappointments on this score in the years since the financial crisis, the MPC is surely right not to take this as a given.”
The MPC revised down its forecast for CPI inflation over the next 12 months, expecting it to remain at zero in July and August and rise to around 0.5% by December and to 1% in February. Indeed, Mr Carney raised the possibility that UK inflation could again turn negative in the coming months given recent oil-price falls and changes to utility prices. The committee expects inflation to only just return to its 2% target at the two-year policy horizon.
The prospect of UK rates staying lower for longer helped UK equities outperform their peers, with the FTSE 100 Index rising 0.33% over the week, despite a knock on Friday from a 3.4% fall for ITV on the back of a sell-off in the US media sector.
Eyes on the Fed
Economic data from the US came in the form of eagerly awaited payroll figures, which confirmed a healthy 215,000 jobs were added in July, broadly in line with the consensus forecast, while the unemployment rate remained unchanged at 5.3%. Wall Street economists said the numbers satisfied the criteria set out by the Federal Reserve that it must see “some further improvement” in the labour market before increasing rates.
The report increased traders’ confidence that the Fed is likely to begin raising interest rates when its Open Market Committee next meets in September, but failed to offer overwhelming support for those expecting a move. Nagging doubts remain about the lack of inflationary pressures in the economy. The dollar’s dramatic rise – up 9.2% for the year – makes US goods less competitive abroad and reduces the price of imports, attacking the inflationary risk that a rate rise would be combating. Added to this, the falling oil price has curtailed new investment in the US shale industry, on which most of the growth in recent years has been based; and the expected consumer boost from US drivers spending the money they have saved on petrol has not materialised. Further falls in oil would be highly deflationary.
The price of Brent crude has fallen 24% since the beginning of July and finished the week at a six-month low of $48.61 due to a combination of concerns over Chinese demand and increased supply from Iran.
Markets were in a ‘risk-off’ mood in advance of the Fed report and reaction afterwards was muted. The S&P 500 index lost 1.25% over the week. Elsewhere in the world, Chinese equities ended the week in a calmer mood after the release of weak manufacturing data early in the week heightened worries. The Shanghai Composite registered a weekly gain of 2.2%.
On the European stage, equity markets took their cue from Wall Street’s poor performance and some disappointing German economic figures. The FTSEurofirst 300 Index eeked out a gain of 0.13% over the week.
Meanwhile, it was reported on Friday that Greece is on track to complete a draft deal on Tuesday to secure a third bailout of €86 billion to stave off economic collapse and stay in the eurozone. Prime Minister Alexis Tsipras has tried to force the pace of the talks to receive an initial payment by 20 August, in time to make a bond payment to the European Central Bank. To do so, Greece will need to enact another package of reform legislation before then.
EU officials expressed satisfaction with the progress of talks and the co-operation of the Greek side, but signs of a potential rift between France and Germany emerged as German finance minister Wolfgang Schäuble expressed concern that negotiations should not be rushed. Schäuble has repeatedly demanded assurances that Greece can implement a series of tough creditor conditions, and Berlin is said to favour providing to Greece another bridging loan of €5 billion to buy time to extend talks – a politically sensitive step that the European Commission is keen to avoid. This position is at odds with that of French President Françoise Hollande, who agreed at a meeting with Tsipras on Thursday that a new deal should be concluded by 15 August.
Rate rise ramifications
Figures from the Halifax suggest that the post-election surge in house prices has lost pace as the residential property market enters the summer lull. The average house price fell 0.6% in July – the first drop in value since February – and experts fear that, despite tighter lending, the market is still vulnerable to ‘boom and bust’, with eventual interest rises only likely to add to the potential upheaval.
House prices are still being inflated in the long run by cash buyers, often subsidised by the ‘Bank of Mum and Dad’ to make up the growing gap between price rises and wage increases. As one expert commented, “We have reached the bonkers situation where kids are borrowing money from their parents to be able to afford the prices that their parents’ generation are asking.”
There were also warnings to buy-to-let landlords that rising interest rates could see a wave of repossessions. The Council of Mortgage Lenders forecasts there will be 16,500 repossessions next year, of which Citizens Advice estimates around a third are likely to be buy-to-let properties.
In a further blow to savers, credit ratings agency Moody’s forecasts that only borrowers are likely to notice the difference when the Bank of England begins to slowly increase interest rates. Moody’s believes that savers will not benefit from any rise, as banks will hold down rates to improve margins and boost profitability. If so, it means hard-pressed savers will have to wait even longer for relief from the rock-bottom deposit rates they have endured since the Bank cut rates to 0.5% in 2009.
There is the potential for increased volatility in equity markets as the first US interest rate rise nears, but investors should continue to look beyond short-term fluctuations and remain focused on the long-term prospects for income and growth through investment in real assets.
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