Deflation fears leave Draghi with little room to move ... Anyone for a dose of QE?

Week commencing Monday 31st March 2014


This week in Short



  • In the UK we have the usual PMI releases for the economy, with construction set to increase further while both manufacturing and services are set to come in relatively flat. We also have the Bank of England monthly MPC meeting, although we doubt there will be any announcements of note.

  • In the US we have ADP non-farms, non-farms and unemployment, all of which are expected to come in relatively positively for the world’s largest economy.  Unemployment is likely to be the event of the week for the Dollar, with forecasts pointing to a 0.1% drop to a new short term low of 6.6%.

  • In Europe we have EZ CPI followed by the usual monthly ECB monetary policy meeting. CPI will be an important release with the figure likely to form the basis for the committee meeting on Thursday, which incidentally is likely to be the event of the week.


Overriding Market Themes


The UK’s current account deficit was much higher than expected in the fourth quarter of 2013, with households running down savings to keep up spending. The current account deficit in the October-December period was GBP 22.4 billion, or 5.4% of gross domestic product, down only slightly from a record of 5.6% in the third quarter, official data from the ONS showed. The current account shortfall was driven largely by an increase in foreign investment earnings leaving the country and a drop in income on British investments abroad, heightened by a rise in sterling. The Office for National Statistics also confirmed the economy grew 0.7% in October-December last year compared with the previous quarter and was 2.7% bigger than in the fourth quarter of 2012. Despite the UK’s stronger than expected recovery, total output in the fourth quarter was still 1.4% below the pre-financial crisis peak in 2008. With most major industrialised economies already larger than their pre-crisis levels, the UK still has some way to go to get back on track.


Sticking with the UK, a fall in petrol prices pushed the inflation rate to a new four-year low of 1.7% last month, figures from the Bank of England show. It is the second consecutive month that the Consumer Prices Index rate has been below the Bank of England's 2% target, having stood at 1.9% in January. Total pay in the private sector rose by 1.7% in the year to January. Finance and business services earnings actually dropped by 0.2% during the year, but construction, manufacturing and retail earnings all swelled by more than 3% in the same period. CPI peaked at 5.2% following the crisis in September 2011, and hit a 2013 high of 2.9% in June. Since then it has moderated, slipping back to the Bank of England’s 2% target in December.


Moving to the far east, Japanese core CPI rose 1.3% from a year earlier in February, gaining for a ninth month amid an aggressive easing program by the BoJ to overcome more than a decade of deflation. A separate release revealed that Japan's jobless rate fell to 3.6% - the lowest rate in six years. The figures have fuelled speculation about whether or not the BoJ will step in with further stimulus measures should the tax increase have an adverse impact. Already, analysts have been surprised by falling consumer spending, defying the central banks expectations that the planned tax increase would lead to a rush of shopping before its implementation.


Finally back in Europe, The IMF is close to agreement with Ukraine on financial assistance worth potentially over £10 billion over the next 2 years. The agreement is intended to help Ukraine meet debt payments looming this year after months of anti-government protests that culminated in the overthrow of President Yanukovych and a standoff with Moscow in which Russia annexed the Crimea region. Kiev has said it desperately needs cash to cover expenses and avert a possible debt default. The country's finance minister has predicted the economy will contract by 3% this year, weakened by years of mismanagement and political turmoil. Ukraine's new leaders announced a radical 50% increase in the price of domestic gas on Wednesday with effect from 1 May, meeting an unpopular IMF condition that Yanukovych had refused.


GBP This Week


We have a busy week ahead for the UK with the usual swath of PMI releases due this week. We start with manufacturing PMI, which is due out on Tuesday morning. Given that all the UK PMI releases are growing at a relatively strong place, and minor slowdown in this indicator is unlikely to create any significant Sterling selling. That said, any significant drop could be viewed as a shift in direction for the sector at large, and therefore markets may pay more attention. With this in mind, anything below 56.0 would probably grab the markets somewhat. However, forecasts are looking for this figure to come in flat at 56.9 which would likely make little market impact.


Moving to Wednesday, the construction PMI figure is due to be released following the substantial pullback seen in the February figure. From a currency shifting perspective, the construction PMI typically requires a big move away from expectations to see a substantial shift in price action. Market expectations point towards a rise to 63.0 from the February figure of 62.6.


Finally we have the all-important services PMI release on Thursday. This figure follows a majorly disappointing figure last month, albeit the current rate of 58.2 remains historically strong. The expectations are that the recent downturn in this figure are going to be subdued, posting a steady figure of 58.2. However, this does set us up for a possibly notable miss in either direction, so expect this to be the major Sterling event of the week.


USD This Week


In the US we have the all-important ADP non-farm payrolls, alongside the non-farms and unemployment rate. We start with the ADP, market forecasters point towards a substantial rise back towards the 195k level, following a figure of 139k last month. This would put the indicators closer to the figures we were seeing prior to the severe weather that took hold of the country from December, however with the previous 2 releases missing expectations, it will be interesting to see if it can buck the trend and post a positive.


Moving to Friday’s headline non-farm payrolls, market forecasters are looking for a move higher in payrolls, with a figure closer to 196k expected following the February number of 175k. We would suspect that if we see a figure anywhere above 190k, further tapering should be on the cards come the April meeting of the FOMC.


Finally we await the release of the official unemployment rate on Friday, where expectations point towards a fall back to 6.6% following the February rate of 6.7%. This remains one of the Feds key policy indicators, especially since Ben Bernanke gave the 6.5% threshold before interest rate hikes could be considered. However, with Yellen now deciding to follow Mark Carney’s lead in issuing additional forward guidance statements last month, the impact of this figure should make less of a difference in terms of the perception with regards to interest rate expectations than previously thought.


EUR This Week


Over in Europe we look forward to the flash CPI estimates followed by the ECB monetary policy decision on Thursday. Starting with CPI, market expectations are pointing towards a reduction to 0.6%, which would represent the lowest rate since October 2009. Should this occur, it would almost certainly spark some sort of reaction from the ECB on Thursday as markets continue to worry about deflation.


Moving to Thursday, the ECB monetary policy meeting could well be the most important event of the week, both for the zone and internationally. With the rate currently at 0.25%, there is very little room left to alter policy, especially as recent experience has shown that rate cuts have little impact in relation to inflation. That being said, it does appears to be the favoured policy from many within the ECB, with a number of members mentioning negative rates as the most appropriate measure available. Should we not see a cut in base rate, we could very well see the implementation of the quantitative easing program. Much of this will depend on the results of CPI earlier in the week, but either way some serious action is required at this meeting, an no doubt it will move markets accordingly.

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