Brazil GDP tanks as UK remains resilient...

Week Commencing Monday 31st August 2015

Overriding Market Themes

This week we are concentrating on global GDP growth levels, where Brazil has entered recession in the second quarter. Once coined as a global success story, its economy contracted 1.9 percent on the quarter and is not 2.6 percent smaller than a year ago. Diving into the figures, there are a couple of key points to note which have contributed to this sharp decline. Firstly, Brazil’s exports to China have exploded over the past decade, however now that China’s economy is slowing, it requires fewer imports from the South American economy. Secondly and perhaps most crucially, prices for all of Brazil’s key commodities have collapsed. Finally, there are a number of corruption scandals which are rocking the ruling party, including a money laundering scandal hitting the state run oil company Petrobras. All this has led to its currency plummeting, unemployment rising and its stock market down by 20 percent from a year ago. Its president, Dilma Rousseff, has an 8 percent approval rating, which is the lowest since 1992 when Brazil's president was impeached. Although maybe not too important in a Sterling-centric view of the world, one thing which is scaring markets is the slowdown in the BRICS. As the chief driver of global growth, this slowdown will without doubt impact the developed world and make our recovery even harder.

Keeping with the growth story and back on home soil, in contrast to Brazil the UK economy grew by 0.7 percent in the quarter. The main drivers were led by the all-dominant services sector and a jump in export and business investment. The initial figure released in July were also boosted by a sharp rise in oil and gas production, after tax breaks for the beleaguered North Sea oil and gas industry helped the production sector to its strongest performance for four and a half years. Unfortunately for the markets however, this growth figure is unlikely to alter expectation over the timing of Mark Carney’s first rate hike in interest rates. The UK GDP confirmation comes at the same time that the CBI said accountancy, law and marketing firms have recorded their best performance in 17 years as Britain's dominant services sector bounced back after a weak start to the year. How long will this growth last with all the troubles in the developing world, who knows! One thing is clear, current levels are very impressive and are only currently been outstripped, albeit marginally, by the US. Long may it continue!

 

GBP This Week

We have a reasonably quiet week for the UK with the highlights being the PMIs. UK Manufacturing has already been confirmed lower at 51.5, while the all-important services should be confirm in at a healthy 57.6. Finally, Construction PMI should be welcomed in at 57.5 versus a 57.1 print last month, signalling a modest expansion in the UK building industry.

We continue to think that the Bank of England remains uncomfortable with recent Sterling strength, however with bank rate so close to zero there is little they can do. As such, we continue to expect some very modest outperformance by GBP versus the EUR, with some significant support levels in place from the single currency. The USD should be more robust, with a material depreciation of Cable most likely.

USD This Week

Manufacturing and Services ISM should continue to support the general view that the US economy is recovering. We expect a print of 52.0 on Manufacturing and a 57.5 print for Services. The focus then shifts to Friday’s employment report, where we expect Non-farms to increase to 225k, while the unemployment rate should fall to 5.2 percent. These positive readings from the employment report should reaffirm our belief that USD strength will be the trend moving forward into September, especially as the country continues to lead the western world in both GBP and labour market growth.

EUR This Week

Thursday’s much-anticipated ECB meeting will likely ensure that policymakers remain an important driver of FX markets. Following all the turmoil in financial markets surrounding China, we now believe that central bankers will have little choice but to expand on their current monetary policy arrangements. Given this, we expect Mario Draghi to at least signal his willingness to ease further should markets continue to tighten.

In terms of data, we believe euro area HCIP inflation should decline by 0.1 percent to 0.1 percent in August, while core inflation should ease to 0.9 percent on the year. Finally, Euro area manufacturing and services PMI out on Tuesday and Thursday respectively should be confirmed in line with consensus at 52.4 and 54.3.

 

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