FX DAILY: Carney’s admission of a hollow UK recovery

15th May 2014

  • Chancellor George Osborne told UK lawmakers Wednesday that if Scotland voted for independence and decided to continue using sterling, it would be without the BoE’s authority and Edinburgh would no longer be able to print notes and would have to hold sterling. (The FT)
  • Japan’s Amari said any drop in demand after April sales tax hike would be only temporary and can expect FY14 economic recovery on solid domestic demand.He explained that sluggish exports were due to weak economies and said a “careful” decision would be made on 2015 sales tax hike. (MNI Market News)
  • BoJ’s Kuroda noted the central bank will be paying attention to low bank lending growth and we can expect base wages to start rising gradually. (MNI Market News)
  • China reiterated they will keep yuan stable around a reasonably balanced level and increase two-way FX movements.
  • China’s State Council issued guidelines on supporting trade, saying the trade situation is “complicated and severe”. (MNI Market News)
  • RBA’s head of financial stability Luci Ellis noted there is an ongoing Senate inquiry about offshore buying in the Australian housing market, noting that there is a large number of Australian residents who come from Greater China.
  • Ellis also noted that house prices are likely to cycle around slower trend than in the past and there is little room for 2003-type exuberance.
  • Japan’s Q1 GDP Annualised rose sharply to 5.9%, beating expectations of 4.2%. The report did downgrade Q4 GDP to 0.3% from 0.7%.
  • Japan GDP Deflator was flat on the first quarter, against expectations for -0.1% and a previous reading of -0.4%.
  • French Q1 GDP was flat on the quarter, against expectations for 0.1% growth and a previous downgraded reading of 0.2%.
  • Germany’s Q1 GDP beat expectations at 0.8% growth on the quarter, versus 0.7% expected and 0.4% previous.

Sterling-dollar was knocked off its pedestal yesterday, falling all the way from $1.6875 to end the day at $1.6767. The reason was two-fold. First came the labour statistics data. The unemployment rate dropped one tenth of a percent to 6.8% and employment growth over the three months to March was at its highest level on record. However the market zoned in on lacklustre wage growth at just 1.7% annually for the three month period. Sluggish pay growth is symptomatic of a bigger problem in the UK labour market, as the BoE would call it the country’s hidden spare capacity. Workers are being forced to start their own business or accept part-time positions because they can’t find full time employment. Of the record 283K jobs created in the three months to March, the increase was driven by a 4.3% increase in the self-employed, 1.34% in part-timers and only 0.33% in the full-time employeed. As full-time employees are the only ones with relative bargaining power, wage growth will continue to be weak until we see some reversal in these worrying employment trends.

This weak employment data was an excellent prelude to Carney’s Bank of England QIR press conference. As expected Carney pushed back against eagerly priced in expectations not only of earlier rate rises but faster hikes once the first tightening move comes. It was the usual culprit of spare capacity behind the BoE dragging their feet on tightening policy. The Governor didn’t mention the controversial housing market until near the end of his opening statement. The head of the MPC said that close co-ordination with the FPC would allow the central bank to maintain extraordinary stimulus for as long as necessary. This was the Bank of England officially handing over responsibility for a bubbling housing market to the FPC to deal with using macro-prudential measures.

There was an interesting glimpse of honesty in Carney’s statement and following Q&A yesterday. Carney admitted that the current recovery was supported by household spending and could only be sustained on a rebalancing to investment. He further intimated that the expansion would not endure on consumption alone and the UK would need to see some recovery in net exports. A new evolving risk to an export rebalancing is the stronger currency, in fact sterling’s strength was listed a downside risk to growth for the UK. Carney knows that this recovery was never the result of hard won economic reforms like our neighbours in the Eurozone and the US. While we have seen some rebalancing beneath all the hot money slushing around the system, it is not enough to sustain the recovery once stimulus is removed. The UK economy is like a full bath tube, with hot money slushing around to fill it up. Once Carney takes the first rate hike, pulls out the bathplug, all that stimulus and growth will drain away leaving nothing but a hollow old bath tube with all the same cracks it had before.

The timing of rate hikes, Carney said, would depend on the evolution of the economy but once they came further increases would be “gradual and limited”. There is some irony to be found in this contradiction. The first time hike will be left to the fate of economic evolution but Carney does know that once it comes further increases will be slow in coming. The underlying admission is that monetary policy could be kept easier than the economy needs it to be. Spare capacity and economic imbalances are some of the reasons but another is what’s happening to the UK’s east. With the UK’s biggest export market looking to ease policy, needing a weaker currency, the Bank of England will be hesitant to tightening policy with the ECB ready to ease. We maintain the Bank won’t hike rates until the first half of 2014, most likely in Q2.