Market Bulletin (23/08/2016)
The curtain came down on the Rio Olympics, and Team GB basked in the glory of its best-ever medals tally; but events at home were somewhat less inspiring, as markets digested a raft of data and news on interest rates, inflation, retail sales, employment and the likely direction of the UK economy.
Since the Bank of England (BoE) announced its measures to stimulate the UK economy at the beginning of August, the FTSE 100 Index has risen by almost 4%, and hit a 14-month high on Monday. But stronger-than-expected inflation, renewed concerns over the impact of Brexit, and lower oil prices combined to send the benchmark index down 0.82% by the end of the week. Rumours swirled that Theresa May could trigger the clause that will begin formal EU exit negotiations as early as next April.
The ratings agency Moody’s predicts that the UK economy will slow, but avoid recession as the shock of the Brexit vote recedes. It forecasts growth of 1.5% this year and 1.2% in 2017, buoyed by weak sterling and increased government spending, while acknowledging that the uncertainty of life outside the common market will continue to dampen business investment and consumer spending.
The likelihood of employers becoming more cautious about hiring new staff following the vote to leave the EU was supported in a new report from the Chartered Institute of Personnel and Development (CIPD). The proportion of employers expecting to increase staff over the next three months dropped from 40% ahead of the vote to 36% after it, with a significantly sharper fall among private sector firms. “There are signs that some organisations, particularly in the private sector, are preparing to batten down the hatches,” commented CIPD chief economist Ian Brinkley.
For now though, data released on Wednesday showed that the labour market was strong prior to the referendum and that the Leave vote doesn’t appear to have caused any immediate damage. The number of those on benefits fell by 8,600 in July, while the unemployment rate held steady at an 11-year low of 4.9%, although that figure was based on data covering only the three months before the referendum.
The jobs and benefits data added to the mixed signals on how the EU vote has affected the economy. Economists remain wary that heightened uncertainty will take a toll on the labour market over the coming months. An upward drift in unemployment should, though, contain further rises in earnings growth, giving the Monetary Policy Committee a freer hand to follow through with more monetary easing.
Although Moody’s forecasts that consumers will postpone large spending decisions, July’s official retail sales figures suggest that consumers haven’t yet been ruffled by the Leave vote. The Office for National Statistics (ONS) reported that retail sales grew by 5.9% compared with July last year, and were 1.4% up on June, boosted by the warmer weather and overseas visitors taking advantage of the weaker pound to splash out on watches and jewellery, sales of which showed their biggest jump in nearly two years.
However, Samuel Tombs of Pantheon Macroeconomics cautioned against reading too much into the figures. “Consumers’ blissful ignorance won’t last long. The real test for consumer spending lies in 2017 when jobs cuts will kick in and inflation will erode spending power.”
Ups and downs
Figures from the ONS confirmed that CPI inflation continued its upward path in July, increasing to 0.6% from 0.5% in June – its biggest rise since November 2014. As the effects of sterling’s post-referendum fall take time to feed through to prices on the high street, and the impact of previous falls in food and energy prices continues to wane, it is forecast that CPI inflation should break through the 2% target level in the second quarter of 2017, and approach 3% by the end of that year.
When it unleashed its stimulus package, the BoE also said there was scope to cut the base rate further if the economy worsens. Based on the after-effects of sterling’s depreciation in 2008, the drop in the pound is unlikely to have a permanent upward impact on inflation expectations or wages growth, and is therefore another factor unlikely to prevent the MPC from pressing ahead with further monetary policy loosening later in the year. Markets are pricing in a one-in-three chance that benchmark rates will be cut again before 2016 is over. Capital Economics currently forecasts a cut to 0.10% in November.
Saga Investment Services neatly summarised the dilemma, and a potential solution, for savers suffering from the combined impact of rising inflation and even lower interest rates. “A steady transition from cash to stocks and shares has the potential to transform the returns that can be achieved. Many savers may be reluctant to put their capital at risk, but sticking steadfastly to cash in the current environment could do them a great deal of harm.”
US stocks continued their ascent to record highs on Monday as oil prices reached one-month peaks and expectations mounted for further accommodative action from the world’s central banks. But as the week progressed, anxiety about the release of the minutes of the Federal Reserve’s last meeting dragged down stocks.
The minutes revealed that the committee was divided over when the next rate rise should come. The US central bank is widely expected to raise interest rates before the end of the year, but with the timing of the November meeting thought to be too close to the US election, that leaves September or December as the remaining opportunities. There was general agreement among members that some of the uncertainties over the US economy had diminished, but while some said an increase would “soon be warranted”, others preferred to wait for more evidence that inflation would rise to 2% on a sustained basis.
A retreat for oil prices on Friday unsettled Wall Street and the S&P 500 index ended the week down fractionally by 0.03%, but still within striking distance of record highs. Japan’s Nikkei 225 index ended down 2.21% on news that the country’s growth in the second quarter was weaker than expected. The FTSEurofirst 300 Index also came under pressure, falling 1.69%.
Under the mattress
Despite Mark Carney, the BoE governor, ruling out negative interest rates, there came news at the end of the week that RBS will start to charge some large corporate customers for holding their cash – the first signs that UK banks are being forced to follow the path of European lenders, where this most radical form of monetary stimulus has already been implemented by the ECB. The levy charged to private sector banks on the funds held with the eurozone’s 10 central banks has cost them around €2.4 billion since the policy was introduced in 2014.
But just as the policy is viewed as extreme, so too are measures reported to have been considered by some banks to avoid the charges, such as turning the electronic money kept at central banks into hard cash to be stored elsewhere. Such a practice would create big problems. Banks would not be as affected by further interest rate cuts if they are not paying central bank interest charges, so would not be incentivised to lend money, which is the whole purpose of the policy. However, aside from the threat of bank robbers, earthquakes and other unforeseen disasters is the challenge of where to store it. Banks are presumably not taking too seriously the fact that the €2.075 trillion in circulation and held by banks would fill 298 removal vans or the space under 22,985 double beds.
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