Minutes of the ECB meetings are a bit like a tin of Cadbury’s Roses sweets – there’s something for everyone inside. At first glance, there was nothing terribly exciting about the minutes of the ECB’s April 2017 meeting, released last week. But we know that it’s often the nuances of a phrase or the way something is reported that gives the biggest hints as to how the debate evolved or how Governing Council (GC) members are thinking. So a phrase like “due consideration would need to be given to adjusting the present formulation of the GC’s forward guidance” is really just saying that the ECB is likely to remove the easing bias in their language at the June 2017 meeting. Pretty much all of the discussion during the meeting was about the growth and inflation outlook. A key passage in the minutes noted that the ECB staff forecast are expecting a “relatively steep” increase in wage growth in order for the staff forecasts for inflation to be realised. We would read that phrase as being the equivalent of the ECB raising a sceptical eyebrow about the staff forecasts for wages, particularly as another report in the ECB Bulletin referenced potentially greater slack in the labour force than shown in the official numbers (and which we wrote about in last week’s blog). A failure of wage growth to increase was seen as a downside risk to the ECB’s inflation forecast. Indeed, the minutes even mentioned the possibility that “a downward revision to the inflation outlook in June cannot be ruled out”. Remember ECB President Mario Draghi has pointed to four conditions that must be met to consider a sustained pick-up in inflation, and we are not, in our opinion, close to those four conditions being met. Also of interest is a difference in opinion between Council members Peter Praet and Benoit Coeure – the latter warning that “too much gradualism in monetary policy bears the risk of larger market adjustments when the decision is eventually taken”, whilst the former is arguing that extreme caution is needed given the lack of clear evidence that wage inflation is re-accelerating. We continue to expect that small language changes will be made in June, but perhaps we might have to wait a bit longer for tapering to occur.
2. UK Wage Data and Inflation – A Lost Decade
Last week’s blog discussed the UK Inflation Report, and last week we also got confirmation of the upward trend in UK inflation. The April Consumer Price Index rose to 2.7% from last month’s 2.3%, and beat the market expectations of 2.6%. Then a day later labour force data showed that the UK’s unemployment rate fell to 4.6% in March, its lowest level since 1975. The Bank of England’s (BoE) estimate of the level of unemployment that causes wage pressures to emerge is 4.5%, so to all intents and purposes the UK is at full employment. But wages are still stubbornly low, with average weekly earnings only increasing at a pace of 2.4%. (Pre the Global Financial Crisis, the average for this measure was around 4% per annum). That means in real terms (i.e. after subtracting inflation) UK workers are suffering pay decreases. It’s the first time in two and a half years that this has happened, and with inflation expected to continue to pick up towards 3% later this year, the trend is only going to get worse. The two questions that should be asked are why are wages not picking up and what will falling real wages mean for the UK consumer? In terms of wages, it could be argued that there is more slack in the labour force than official figures show (as is being suggested in Europe). But productivity growth in the UK is also weak, falling 0.5% in the first quarter of 2017. BoE Governor Mark Carney addressed this issue in a speech entitled “The Spectre of Monetarism” at Liverpool John Moores University in December 2016, where he noted that over the past decade real earnings have grown at the slowest rate since the mid-19th century.
The outlook for the UK consumer is difficult. We feel the consumer is unlikely to continue spending as freely as they have done recently – April retail sales increased 2% vs an expected increase of 1%, but with negative wage growth, most of this spending is being financed by consumer debt. We continue to believe that the UK economy could slow as the year progresses and consumers reduce their spending.
3. Chinese Renminbi – Stealth Devaluation
There hasn’t been much noise about the Chinese Renminbi in recent months – since mid-March it’s been trading between 6.88 and 6.90 against the U.S. Dollar. Instead, the focus has shifted to the level of Chinese bond yields, with 5-year domestic yields starting 2017 at a level of 2.35% before jumping to their present levels of around 4%. So why have Chinese yields increased when other global yields are actually lower than where they started the year? It’s mainly because Chinese President Xi Jinping ordered a crackdown on financial leverage, with a consequent tightening of liquidity conditions and a rise in interest rates. The reduction in leverage has had its intended consequences, with stock markets falling and bond yields rising. However, Chinese authorities are walking a tightrope between reducing leverage and trying to avoid a market meltdown that could spill over into lower economic growth. Having introduced tighter capital controls to stem outflows, the Chinese Central Bank is also massaging the level of the currency to keep the currency relatively steady and sooth investors’ concerns. Whilst most market participants will watch the Renminbi exchange rate against the U.S. Dollar, it’s also instructive to keep an eye on the China Foreign Exchange Trade Survey (CFETS) Renminbi (RMB) Index. This index has been slowly weakening since the start of the year. The general weakness in the U.S. Dollar has allowed the Chinese authorities to maintain the USD/CNY rate, thus giving the illusion of stability, but the CFETS RMB Index paints a different story. We still maintain a bearish view on the Renminbi in the medium-term.