The Blog

Are We Reaching Escape Velocity?

Evidence seems to be mounting that global economic activity seems finally to be accelerating, maybe even creating a more classically rapid recovery, as opposed to the rather anaemic variety we have so far enjoyed.

Evidence seems to be mounting that global economic activity seems finally to be accelerating, maybe even creating a more classically rapid recovery, as opposed to the rather anaemic variety we have so far enjoyed.

Take the U.S., for instance, forty nine months after the start of the economic recovery, GDP is only 9 percent higher than it was when the recovery officially began, in June 2009. In the average post-World War II recovery, GDP is 17 percent higher at this point. An untold amount of effort has been expended in the search for the explanation for this, but we probably don't need to go any further than a) in the West we had become massively over-indebted, both privately and publicly, and this, combined with the worst banking crisis ever, means that the process of de-leveraging and re-leveraging for recovery are taking longer than ever and b) in emerging markets, especially China, growth had become unbalanced; dominated by investment, property development, and exports, with far too little consumption - this is now being addressed - which has a downside for near-term growth and is a very slow process.

Although Chinese retail sales growth slowed to 11.3% year on year in July in real terms from 11.7% in June, unemployment is stable and Beijing knows that slowing private consumption was the primary reason for the economic slowdown in H1 so, as predicted in this blog, Beijing has become more supportive of growth. For example, China Daily yesterday noted that Beijing authorities are aiming to boost the consumption of information products and services and make the sector a new engine for boosting domestic demand. China's consumption of information products and services is expected to grow at an annual pace of at least 20% to reach CNY3.2 trillion ($518 billion) by the end of 2015, according to a guideline released by the State Council yesterday. There are other tentatively positive signs, China's industrial power usage rose to a one-year high in July. According to official data, power usage by companies in the mining, manufacturing and construction sectors rose 8.1% year on year to 366.6bn kilowatt-hours.

Returning to the US, the July unemployment report may have been a tad disappointing, but forward-looking indicators such as the ISM surveys, (both Manufacturing and Non-manufacturing), have recently exceeded expectations, retail sales look healthy, and the latest jobless claims figures were very good news.

UK economic data is already on a roll, with significant recent positive surprises; employment and weekly earnings, PMI's, (Manufacturing, Construction and Services), Industrial Production, the Trade Balance, Housing Indicators, need I go on?

Even the poor old Eurozone has managed to crawl out of recession, and Angela Merkel's re-election as the Euro's best friend, combined with Draghi's ingenuity, suggest that we may finally be casting off the shadow of Euro disintegration that has also held back global recovery. We will steadily see more and more from Germany, once the elections are safely out of the way, with a gradual move towards true fiscal and banking unions.

Returning to the UK, the minutes of his first MPC meeting reveal that the urbane Governor Carney in fact had quite a baptism of fire, having to preside over a meeting riven by dissent which, on several matters, was very significant, tending to suggest that the MPC's commitment to keep rates 'low, for longer', is weaker than first thought.

There was a bombshell line in the minutes, revealing some sympathy with market rate hike expectations. Governor Carney had previously tried to persuade the market to flatten the yield curve, labelling the market's expectations for the quantum and timing for rate rises as "unwarranted", but we now discover that this view was by no means unanimous on the committee - "But UK short-term market interest rates remained higher than at the time of the May Inflation Report; and while some rise since May might be justified, most members judged that the extent of the increase remained greater than could be reconciled with the improvement in the economic outlook. Other members did not think market interest rates were obviously out of line with their view of the outlook."

Yet more dissent came from MPC member Weale, who objected to the 18 to 24 months horizon embodied in knockout 1, feeling that 18 to 24 months was too long, i.e. the Bank will be prepared to ignore a blip in inflation if it thinks it'll be back below 2.5% within two years, (oh yes, the Bank's inflation target has effectively now surreptitiously risen to 2.5%, rather than 2%), to quote the minutes, "One member, while accepting the principles of forward guidance, saw a particularly compelling need to do more to manage the risk that forward guidance could lead to an increase in medium-term inflation expectations, by setting an even shorter time horizon; that would make clear that the forward guidance was fully compatible with the Committee's commitment to meeting the 2% inflation target in the medium term."

Finally, QE in the UK is dead. It now seems highly unlikely that we will see any further QE in the UK. Not only do some members have palpable doubts over its efficacy, the pace of the UK's recovery should render any discussion of more QE unnecessary anyway.

All of the above means that bond markets are set to remain on the ropes, testing and pushing through recent highs in yields, returning to the sort of standard risk premiums that normally determine the levels of long-term rates, as opposed to the search for safe-havens which has driven markets since the crisis broke.

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