It has been a busy week of central bank meetings with most of the headlines made by the US Federal Reserve (Fed). As expected, the Fed kept rates on hold and signalled that the rate would remain near zero through 2023, with quantitative easing (QE) maintained at its current rate of $120 billion a month. The committee expects to maintain an “accommodative stance” of monetary policy until it achieves inflation averaging 2% over time and longer-term inflation expectations remain anchored at 2%. Indeed, the Fed said they would not tighten until inflation is higher than 2% “for some time”. The Fed estimates that the US economy will only return to levels seen in Q4 2019 by the end of 2021, stating that further fiscal stimulus would be needed to support the economy. What appeared to be a reasonably dovish outlook was well telegraphed in advance and the market reaction implied a little disappointment that the Fed had not gone even further, with a lack of additional information on the makeup of future asset purchases blamed for the poor market reaction to the Fed meeting. However, the reality is that the Feds target of an average of 2% inflation and maximum employment (which per the Fed is an unemployment rate of about 4.1%) represents something of an economic utopia that has been rarely achieved. Bloomberg analysis shows that in the past 60 years there have only been three occasions when the US economy has seen inflation at 2% and unemployment at such low levels, in 1966, 2000 and 2018. So, for the Fed to tell markets that rates will basically stay at zero until the economy is in such a state certainly suggests the Fed is very much in lower for longer mode and it will take quite a lot to take them off this path.
Moving on to the Bank of Japan, whose meeting concluded yesterday, there were no surprises, with policy on hold and the bank saying that the economy had started to pick up with economic activity resuming gradually. The Bank of England sent sterling lower after their meeting yesterday, the minutes of which highlighted that policymakers have made plans to take rates below zero if the economy warrants it. Sterling dropped by 0.79% against the US dollar, and by 0.4% against the euro, after news that the monetary policy committee “had been briefed on the central banks plans to explore how a negative bank rate could be implemented effectively, should the outlook for inflation and output warrant it at some point”. While the Bank does not appear on the brink of taking rates below zero, with an uncertain economic outlook, concerns over Brexit outcomes and the potential for a tough winter of higher unemployment and ongoing issues with the pandemic, it makes sense for the Monetary Policy Committee to be exploring this additional policy tool. Consensus remains that we will see additional QE before the Bank introduces negative rates.
In terms of economic data, China continues to look strong relative to the Western recovery. Chinese retail sales continued to recover and saw year on year growth of 0.5% in August. Industrial production climbed by 5.6%. In the UK, the inflation data fell to the lowest level since 2015, climbing only 0.2% in August, driven lower by falls in air fares and particularly by lower restaurant prices as a result of the government’s ‘eat out to help out’ scheme. Unemployment in the UK climbed slightly 4.1%, in line with expectations though the numbers remain skewed by over 5 million people being recorded as temporarily away from work, many of whom remain furloughed. As furlough comes to an end in the next six weeks, we will begin to see a truer picture of the employment backdrop.
In politics this week the Japanese Liberal Democratic party voted Yoshihide Suga as their new leader and subsequently Suga was approved as the new Prime Minister of Japan. Expectations that Suga would be the continuity candidate were confirmed by the re-appointment of many cabinet members that served under former Prime Minister Shinzo Abe. Suga also boosted sentiment by saying that he does not see the need for another sales tax hike within the next decade. The sales tax has represented a speed bump for the Japanese economy over the recent years with two hikes causing recessions each time.
Closer to home, the UK government saw their controversial internal markets bill passed through Parliament to a second reading with a majority of 77 despite a small rebellion of 20 Conservative MPs. The European Commission continued to suggest that there was limited time to remove the offending clauses in the bill that contradicted the withdrawal agreement and progress on other areas of negotiations would be impossible without resolving this issue. As the week draws to a close it does appear that the UK government may be changing tack and indeed there is some talk that the scrutiny of the bill through the House of Lords may actually get pushed back until later in the year. This leaves the question of why the government has chosen this tactic which appears to have caused significant irritation in Brussels. Despite the clear frustration amongst EU members, the Commission President Ursula von der Leyen said yesterday that she is “convinced” a trade deal with the UK is still possible despite the “distraction” caused by the UK’s move to violate the Withdrawal Agreement.
In terms of the coronavirus pandemic and the political response, we still await concrete news on any new fiscal stimulus in the US. Congressional leaders met earlier in the week and a compromise package of $1.5 trillion was proposed by a bipartisan group in the House of Representatives. This package gained support from the White House, but there still appears to be pushback from Senate Republicans concerned at yet more deficit fuelled spending. The timetable remains tight to push through new stimulus before the Presidential election but the recent easing in US retail sales data added to elevated unemployment and COVID-19 cases in the US levelling off but at an very high level, shows that there appears to still be a need for significant fiscal support to ensure that the nascent economic recovery can be sustained. The coronavirus numbers globally continue to climb, although do not yet appear to be causing any concerns in financial markets. All the same, it is clear the rising numbers of cases across Western Europe and indeed in the UK highlight that government restrictions on activity will persist and are likely to become more aggressive as winter approaches and will likely weigh on economic activity, particularly in the leisure and service sectors.
The benign backdrop of extremely low interest rates, as the Fed reminded us this week, for a long period of time, means monetary accommodation will be with us for some time to come. Combined with much looser fiscal policy than we have seen for many years, this is an environment that without the coronavirus pandemic would be very supportive for economic growth and financial assets. We have already seen significant recovery in financial assets from the low in March and certainly in the short term there were significant questions over whether that economic growth can be sustained not least when it is very clear that this pandemic will act as a brake on the service based economy until we have a vaccine and probably beyond. We heard a good quote this week “vaccines don't end a pandemic, vaccinations do” and while there is still confidence in financial markets that we will see a vaccine in the next six months, the roll out of this vaccine will take a significant amount of time and until then we will continue to have to live with this virus and suffer the economic disruptions as a consequence.