Economic Highlights

The Bank of England's Monetary Policy Committee (MPC) voted to maintain policy. Bank Rate remains 0.10%, and the targeted stock of asset purchases at £895bn. This time the vote on the continuation of quantitative easing (QE) dropped to 7-2 (vs 8-1). The central bank revised down its Q3 GDP growth forecast from August by 0.8% to 2.1% owing to more persistent supply constraints limiting output, while the inflation outlook was revised upwards, with CPI now expected to rise to slightly above 4% by the end of 2021. In light of the surge in gas prices, the committee acknowledged that there could be a ‘significant upside risk’ to the inflation projections from April 2022, where we are likely to see a further increase in the energy price cap. The minutes signalled that the MPC had opened the door for members to vote for an increase in Bank Rate, even before the end of the existing QE programme in December. We deem this to be highly unlikely, even though the committee seems to be concerned that the current period of higher inflation could be stickier. Interest rate futures markets reacted by moving expectations for a rate rise forward to Q1’21 from mid-year.

The Federal Open Market Committee (FOMC) minutes strongly hinted that the Fed would begin tapering asset purchases after the next meeting in early November. While this was expected by some, it is a little sooner than the consensus had anticipated. The other major development was the interest rate forecast “dots,” which saw the committee evenly divided (9-9) as to whether they anticipated any hikes next year, so the 12/22 dot moved up from 0.125% in June to 0.25%. The 2023 median went from 0.625% to 1.0%, and the first look at 2024 indicated a median expectation of 1.75%. This will depend on “labor market conditions consistent with maximum employment,” but there was an admission that there are conflicting signs as to how far we are from meeting that test. Markets saw bond yields rise while shorter tenor breakeven inflation rates fell, suggesting that investors perceive a reduction in shorter-term inflationary risks, while at the same time maintaining the longer-term transitory narrative.

The latest round of Markit PMI data saw an almost inevitable reduction in activity, with all readings undershooting expectations. Manufacturing slipped from 61.4 to 58.7; Services from 59.0 to 56.3; and the Composite measure from 59.0 to 56.1. But these readings are all still consistent with a growing economy – just not quite as fast as it was.

We await further developments at Evergrande, the highly indebted real estate group. The company disclosed payments to onshore bondholders, leaving offshore investors in the dark. There are sufficient signs of activity behind the scenes to suggest that the company will not be allowed to fall into a disruptive state of bankruptcy that will bring down the rest of the sector and economy – i.e., it is not China’s “Lehman Moment”. The PBOC has also been pumping liquidity into the financial system to support it. Even so, the country’s speculative “borrow-and-build” strategy is under review, and there will almost certainly be downward pressure on growth in the future. Cue further monetary policy loosening, perhaps? China is moving in a different direction compared with the rest of the world.