06 Jul 2018

Chequers retreat a potential pivot for pound

Today’s main event is likely to be the widely heralded UK Cabinet summit at Chequers.

Theresa May has managed to maintain support from her deeply divided party to date by promising satisfactory outcomes to all, without divulging details that might upset one side of her party or the other. However today’s meeting, which has the aim of agreeing the government’s White Paper on its future arrangements with the EU will force May to reveal her position. The summit is set to begin at 10am, with various reports suggesting PM May is set to face a difficult set of discussions. Attendees have already been grumbling at being given just a few hours to digest the 120 page outline of May’s proposal last night. Also notable is the fact that seven members of the Cabinet including David Davis and Michael Gove met in Boris Johnson’s office last night to discuss their position on what the Brexit Secretary has already called an unworkable plan. PM May also appeared to get a cool reception in Germany, where she was visiting Angela Merkel yesterday, with German officials calling the UK government’s proposals on customs arrangements unworkable.
 

If the PM successfully gains approval for a plan that is acceptable to the EU (especially one leaning towards a softer Brexit), we could see a major turning point for the pound today. However a challenge to May’s leadership and prolonged uncertainty remains a threat, and could come to a head during today’s events.
 

More good UK data
 

The US Federal Reserve published its minutes from its last FOMC meeting overnight. The minutes noted that almost all participants thought the hike enacted at June’s meeting was appropriate (the Fed increased the Fed Funds Target Rate Range to 1.75-2.00%). Looking forward committee members saw a gradual path of rate hikes being needed, amid what they saw as a ‘very strong’ economy. Indeed the assessment of the economy presented a solid outlook, however they did also note the risks from a trade war had intensified, as well as noting risks from emerging markets. A number of Fed officials were also concerned about the shape of the yield curve and the risk of an inversion (a notorious predictor of recessions in the US), where the current 2-10yr spread currently stands at just 28bp. However, some officials also noted that there were risks of allowing the economy to run above potential, which they believed could fuel inflation and cause financial imbalances. There was also a suggestion from some officials, that if the economy continued on its current trajectory it could be possible that the Fed Funds rate could rise above what they deem to be neutral in 2019: the Fed’s current median estimate of the long term rate is 2.9%. It is notable that June’s meeting saw the announcement that the Fed would hold press conferences after all eight meetings, given them the flexibility to change the pace of rate hikes if required. Overall there was little to change our view that the Fed will enact another two hikes in 2018 and two more in 2019.
 

Payroll Friday
 

Non-farm payrolls rose by 223k in May, up from April’s figure of +159k. The three month average of the increase in jobs remains in a 175k-225k range, where it has been all year so far, signifying that the US economy continues to post decent growth. GDP growth in Q1 was recorded at 2.0% on a seasonally adjusted annualised rate, while Q2 is likely to witness a faster pace of growth. Moreover various survey based indicators of the labour market, such as the Philly and Empire State Fed indices, have signalled that labour market conditions continued to tighten in June, without yielding more specific clues to this month’s payroll numbers. Our forecast for June’s reading is for a rise of 185k. This view is consistent with the unemployment rate dropping gently, on the premise that this is not offset by an increase in the participation rate. As such we expect the unemployment rate for June to hold at 3.8% (no change from May).
 

Irish banks: CBI to lift CCyB from zero to 1.0% from July 2019
 

The Central Bank of Ireland (CBI) has announced the implementation of its countercyclical capital buffer (CCyB), lifting it from the current zero level to 1.0%, effective from July 2019, and applying to Irish RWA exposures. This is the first use of the CCyB by the CBI since its creation in 2015. We find the decision to lift the CCyB at this juncture, and by a full 100bps, to be a curious one, given the CBI’s own data which shows a still significant negative credit gap (the difference between credit-to-GNI vs trend credit-to-GNI) existing in the Irish economy (c.-80% as at Q417). This metric is supposed to be a key determinant when setting the CCyB, and would, in isolation, indicate that any increase in the CCyB was not required at this point. However, the move is not a complete surprise given recent suggestions that the CBI had expressed a preference for an early implementation of the CCyB, particularly given the 12 month notice period required on implementation, and also when other quantitative and qualitative metrics that the CBI has referenced other than the credit gap are taken into consideration. The CBI’s rationale for this move include the strengthening of a range of credit indicators, the rapid growth in the domestic economy, the highly volatile nature of the Irish economy and its vulnerability to external risks, and vulnerabilities in the financial system, including high levels of household indebtedness and the still-high stock of non-performing loans, which compound cyclical risks. The CBI has been keen to stress the need to improve the “resiliency” of the Irish banking system as one of the reasons for their decision to raise the CCyB. While we are sympathetic to these risks and this viewpoint, there are already signs of stabilisation or continued moderation in many of them (GDP growth, mortgage lending growth, household indebtedness, level of NPLs). Additionally, the Irish banking system can already point to evidence of “resiliency” in terms of the excess capital all of the banks currently operate under with regard to minimum regulatory requirements (although perhaps that made the decision to increase the CCyB an easier one). The change increases the risk that the Irish banks may need to operate under higher CET1 assumptions in the medium term than they have currently guided for (AIBG and BIRG both 13%, PTSB 11%).
 

Economic releases
 

13.30 US Non-farm Payrolls

13.30 US Unemployment rate

         UK Chequers summit