Economic Highlights

The UK economy barely expanded in February –and that’s before the energy and food price squeeze becomes really apparent. GDP grew by 0.1% month-on-month, much weaker than January’s +0.8% and the +0.3% consensus forecast. Overall, the economy is 1.3% bigger than pre-Covid, at least. Features included a 23% rise in accommodation output and a 33.1% gain for travel agency and tour operators. Falling vaccination activity led to a 5.1% fall in health output. Manufacturing dropped 0.4%, with Industrial Production -0.6% month-on-month, which leaves industrial sector output still below pre-Covid levels. There is no hint yet from the market, though, to suggest that the Bank of England will back off from raising the base rate by another 0.25% to 1% in May.

The minutes from the latest Federal Reserve meeting indicated that officials broadly supported increasing the pace at which it will reduce its asset holdings. Members broadly agreed on monthly caps of about $60bn for Treasuries and $35bn for agency Mortgage-Backed Securities, phased in over three months, or “modestly longer if market conditions warrant”. That amounts to asset reductions of just under $1tn a year from the $9tn balance sheet. The minutes showed that the Fed wants to shrink its balance sheet quickly and much more swiftly than the previous attempt to shed assets in 2017. Back then, the Fed capped the monthly reduction in its balance sheet at $50bn and took a year to reach that pace. LaelBrainard, the Fed’s proposed next vice-chair, said that the reduction would be “rapid” and could commence as soon as its next policy meeting in May. Minutes from the March meeting also showed officials were open to more aggressive rate rises this year. The current level of anticipated US monetary tightening is the most aggressive in decades. The implied US interest rate from Fed funds futures at the end of this year is 2.5%, implying a further 2% in interest rate rises over the next six meetings. Separately, Bill Dudley, the outspoken President of the New York Fed, said in relation to the Fed’s attempt to tighten financial conditions: "If stocks don't fall, the Fed needs to force them. In contrast to many other countries, the U.S. economy doesn't respond directly to the level of short-term interest rates… financial conditions need to tighten. If this doesn't happen on its own, the Fed will have to shock markets to achieve the desired response". Is that as close as a Fed member could come to saying they are trying to make equities go down?

The European Central Bank’s Governing Council's 9-10 March meeting showed a number of divisions across members on the action to take, whether the prevailing surge in inflation was temporary or permanent and what the appropriate policy response was. A large number of members backed the immediate further normalisation of measures, such as scaling back the remaining asset purchases. Furthermore 'some members' wanted to set an end date for the remaining QE purchases, which the Governing Council (GC) planned to scale back to €20bn per month in June. Instead it was agreed that the QE timetable for purchases over Q3 would be data dependent. Also, a hawkish contingent on the GC argued that preserving optionality on QE was 'not without cost', suggesting that a path should be cleared for a possible increase in interest rates during Q3. In the end the GC agreed that 'prevailing uncertainties called for the Governing Council to maintain maximum optionality and flexibility' in setting policy. The most obvious impression from the Account is the division across the GC, but one could argue that the overall feel of the discussions was a touch less hawkish than it might have been. There is another meeting this week, but no policy changes are expected just yet.

The latest inflation data from China was a little higher than forecast. The headline Consumer Price Index for March came in at +1.5% year-on-year vs an expected +1.4%, although core inflation was lower at +1.1%. The numbers are still massively influenced by pork prices, which are -41% year-on-year as the market normalises following last year’s swine flu outbreak and the mass culling of pigs. The Producer Price Index (input prices) fell back a little to +8.3%, but was still ahead of the expected +8.1%. CPI is expected to continue to rise from its current low levels. Covid-related shutdowns remain a problem for the economy. There are lots of stories of backed-up supply chains in and around Shanghai and there are reports of more stringent measures being introduced in Guangzhou. It has been suggested that China will not lift its zero-Covid policy until President Xi has been safely installed for his third term at the Party Congress in the autumn. Apparently, he is more fearful of the threat to social stability from rampant Covid than from tighter restrictions and a weak economy.