I’m sure the manager of our positive impact portfolios will be thrilled to know that I refused to eat any candy floss (the sugar content is horrific!) over the weekend, having had the pleasure to visit a very charming circus on Saturday evening. Enthralled by the physical stamina and acrobatic ability of the performers, my view on the circus as being filled with creepy clowns has changed and I look forward to going again in future!
As if swinging on a trapeze from one side of the stage to the other, emerging market equities pared last week’s strong gains as investor sentiment around the impending trade war continues to oscillate. Asset class returns in sterling and local currency are below; most notable is the relatively large negative move in UK gilts as yields rose following the decision by the Bank of England to raise interest rates to the highest level since 2009.
Table 1: GBP total returns
Table 2: Local CCY total returns
Members of the Bank of England’s Monetary Policy Committee voted unanimously for a 25 basis point (0.25%) rise in interest rates, bringing the UK’s benchmark rate to 0.75%. Now officially following the US Federal Reserve with the implementation of tighter monetary policy, the two Anglospheric central banks are on a path towards normalisation which is increasingly disparate from the policy of European and Japanese counterparts. Many investors are now beginning to grapple the realising prospect of “Quantitative Tightening” – the reverse of Quantitative Easing – in which markets are likely to see rising bond yields and the subsequent consequences.
Chart 1: UK and US interest rates have begun rising from historic lows, while European and Japanese remain low
Source: Bloomberg, US Federal Reserve, Bank of England, European Central Bank, Bank of Japan
By unanimously voting to raise rates the MPC underlined its view that the UK’s first quarter slowdown in economic activity (just 0.2% for the quarter, revised up from initial estimates of just 0.1%) was just a temporary blip. However, the Bank’s forecasts reflect a view that current levels of economic growth are set to remain below historic averages. This is in part due to the collapse in the UK’s productivity growth – coined the “productivity puzzle” – which has meant more muted increases in average earnings than pre-crisis levels. Unfortunately, the struggle for the domestic economy doesn’t stop there. With CPI inflation at 2.4% driven primarily by rising energy prices, and average earnings growth at 2.5%, real wage growth has remained subdued though at least positive in real-terms.
Interestingly, for the first time the BOE revealed details around its methodology for the largely unmentioned “R-star rate” which represents the Bank’s estimate of the level of interest rate at which inflation and growth will remain stable when the economy is running at full capacity (e.g. full employment and capacity utilisation). Based on statements by BOE policymakers and analysis of forecasts, estimates from economists at banks such as HSBC and JP Morgan have estimated this figure to stand around 1.5%. Incidentally, this is also the level of interest rate at which the Bank has said it would consider running down its balance sheet through the sale of government bonds. By keeping the UK’s interest rate below this figure, the Bank is effectively in expansionary territory while pushing above this rate is contractionary. Therefore, the Bank has indicated just how much further it sees UK interest rates rising in the longer term.
Chart 2: Though the UK has historically been one of the fastest growing economies in the G7, it is currently lagging the pack as Brexit uncertainty weighs
Source: Bloomberg, OECD
The rate decision has also stirred the Brexit pot, with pro-Remain and pro-Leave groups battling over the context of the hike. While groups on the Remain side have challenged the Bank for acting too brashly in the face of Brexit related uncertainty, the Bank’s Governor, Mark Carney, has rebuffed this criticism, stating that it would be a mistake to hold off for “perfect certainty”. Meanwhile, Leave groups have claimed this decision as the latest in a string of positive data releases for the UK which signal the nation’s underlying economic resilience. Again, however, the tone set by Mr Carney sought to dispel speculation by not only tempering expectations over future rate rises but also expressing that the risk of a “no-deal” Brexit remains uncomfortably high.
THE WEEK AHEAD
Monday: Indonesia Q2 GDP, Germany Factory Orders, Germany Construction PMI
Tuesday: Germany Balance of Trade, Germany Industrial Production
Wednesday: China Balance of Trade
Thursday: China Inflation Rate
Friday: Japan Q2 GDP, UK Balance of Trade, UK June GDP, UK Q2 GDP, UK Industrial Production, Canada Unemployment Rate, US Inflation Rate, Russia Q2 GDP
STAT OF THE WEEK: 92% and 72% – the percentage of people who believe there is such a thing as human rights in Turkey and the UK respectively. (Statista, Ipsos MORI)
Data correct as at 03/08/18.