Q2 Economic Outlook

23rd April 2015 By: Ranko Berich

Say what you like about the theoretical soundness of quantitative easing, its legality, or the role of fiscal policy. Recent events have shown that Mario Draghi’s QE does exactly what it says on the tin.

Asset yields are falling, lending is increasing, inflation expectations are picking up and business confidence is improving-and that’s mostly based on data collected before the programme even started. And the euro, of course, has been destroyed. No other word comes close to describing the fall the euro has experienced, a fall now comparable to the depreciation seen in 2012, when the actual future of the euro itself was in question. Political wrangling over the Greek debt crisis continues, and although a good basis exists for a deal between Greece and its creditors, negotiations remain antagonistic. A messy, unintentional Greek exit from the euro remains a risk as cash-strapped Greece struggles to meet its obligations.

In the meantime, the United States is coming off the back of a period of strong job creation which, combined with low oil prices, has triggered a bout of dollar strength. The labour market is indeed rampant and investment is strong. The voracious appetite of the US consumer lies dormant, waiting for increases in wages. However, the latest economic data, including the March jobs report, has fallen short of expectations, suggesting that growth may have cooled slightly in Q1. The Fed is dragging its toes, ever so cautiously, towards the rate hikes that will signal a true end to memories of the recession. The ubiquitous USD-long trade still seems a safe bet over the medium term, but with towering expectations comes the possibility of a multi-storey fall.

The UK’s general election has the potential to create some extraordinary volatility, as it did in 2010, but sterling’s future still hinges on economic developments. Despite election campaigning to the contrary, the two leading parties’ fiscal plans are too similar to deduce a durable effect on sterling from the election’s outcome. Instead, sterling’s longer-term future depends specifically on wage growth: should earnings pick up rapidly the Bank of England will quickly change its cautious tone and sterling will appreciate. Recall that GBPUSD broke through 1.70 when markets were assuming the BoE would begin to tighten policy. The opposite is also true: should wages fail to recover the BoE will continue to appear hesitant, creating uncertainty that will weigh on sterling.

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