In the UK the market-implied probability of a quarterly rate increase in August increased to 80% this week, as GDP figures suggested the economy is regaining momentum. Despite GDP growth remaining unimpressive, the latest data would suggest that the UK economy is on track to meet the 0.4% target that is expected to be sufficient to justify further monetary tightening. Readers would be right to be sceptical given Mark Carney’s reputation as an ‘unreliable boyfriend’, seeming reluctant to follow through on his own forward guidance, but labour market and inflation data released this week will strengthen the case for tightening action.
On Tuesday, labour market data will provide a mixed bag of results. Whilst growth in the labour market is expected to continue, it will likely be slightly lower than the impressive 146,000 jobs created in the three months to April, meaning that the unemployment level should remain at 4.2%. Despite a tightening labour market, average earnings growth appears to have settled at 2.8% for the three months to May. However, hopes of sustained real wage growth might be temporarily dented by inflation data released on Wednesday, in particular June’s CPI figures which is expected to be 2.6% having been 2.4% in May. This 0.2% increase appears to be largely driven by imported inflation, something supported by Wednesday’s producer prices data, following the recent increase in oil prices and the depreciation of the pound – both of which could reasonably be expected to be reversed in the coming months.
Political uncertainty following the resignation of the foreign secretary, Boris Johnson, dampened any bounce in the pound that would have been the market’s most likely response to signs of a softer Brexit. Whilst the UK’s white paper on the post-Brexit relationship is likely to be rejected by negotiators on the continent, its commitment to frictionless trade for goods has been welcomed by the markets who now see a no-deal scenario as extremely unlikely. Of particular concern to observers, though, might be the lack of clarity on the post-Brexit relationship that the service industry will be afforded. This has led to fears that the trade in goods is being prioritised over services. By the chancellor’s own recognition, “time is tight” and a “…pragmatic solution to preserve the mutual benefits of integrated markets” is needed. Fears about regulatory discrepancies are not limited to the UK with the European Securities and Markets Authority (ESMA) warning that financial areas in the Eurozone might be left at a disadvantage to London. In response they have opened a consultation paper proposing amendments to the recently introduced MIFID II legislation.
In an otherwise quiet week, the ECB released the minutes from their June meeting last week with analysts looking for greater clarity on policy maker’s appetite to increase rates. They will have been disappointed as the language remained deliberately vague, giving only a commitment for interest rates to stay on hold “…at least through the summer of 2019”. With core-inflation continuing to hover at c. 1% there remains little immediate pressure other than the lingering temptation to return interest rates to positive territory for sheer normality’s sake. Instead the ECB is, in the near term, likely to focus on tapering its balance sheet.
On a separate note, market regulators fired a warning shot this week as they become increasingly concerned at the lack of activity by financial firms in moving away from Libor to a risk-free reference rate. As speculation mounted that a number of banks would seek an extension to Libor’s publication, it was confirmed that none would be forthcoming and that Libor, which remains the most sizable and liquid market for interest rate derivatives, would be abandoned in 2021.
Given the enormity of these changes on the market, it remains important that borrowers work with the relevant trade bodies to ensure symmetry is maintained between existing derivatives and underlying debt terms they are there to hedge.