Foreign Currency
Sterling is circa ¾% lower against the euro and the US dollar. Yesterday’s data was supportive of the US currency. The US trade deficit narrowed to $57 billion in June versus a previously reported $60 billion deficit. The improvement reflected a significant upturn in US exports, in part due to the second quarter decline in the dollar’s value which improved the US competitive position. The UK competitive position is at risk of being eroded by inflation. CPI rose by 0.6% pa to 4.4% per annum – well over double the government’s inflation target. Headline inflation, RPI, rose by 0.4% pa to 5.0% per annum. The one positive aspect of the data was the 0.2% fall in core inflation (excluding food and energy). It is, however, the food and energy components which are driving CPI and RPI towards the levels of the early 1990’s. There was a weather related aspect in the food component, but the overall picture was one of inflationary pressure in many sectors of the economy. CPI is now likely to peak in early autumn at a level just below 5% per annum. To date, the rise in inflation has not been reflected in a rise in average earnings.
Interest Rates
Period rates are, on average, 0.05% lower ahead of this morning’s employment report when the focus will return to the slowdown in the economy and the lack of cost pressures in the labour market. Unemployment is expected to rise by 0.1% to 5.3%, the start of a very gradual upward trend in the unemployment rate. We expect the actual unemployment rate to peak at a level just under 6% in the winter months – the official figure may be lower due to a wide range of factors. Underlying average earnings are expected to remain in a 3.5% -4.0% range for several months. Today also sees publication of the Bank of England Quarterly Inflation Report. The Report’s inflation and economic growth projections will have an important bearing on the financial markets expectations of the future path of base rate.
Equities
FTSE 100 was in consolidation mode yesterday, closing above 5500. There was a more negative tone in other equity markets, reflecting a sharp downturn in the rate of Japanese growth and a very substantial write down at J P Morgan, one of world’s strongest banks. The underlying trend in world equities is currently slightly bullish. If the international credit crunch were to exhibit a third round impact, then sentiment would quickly change. Our central scenario is that equity market downside will be limited by the prospect of stronger global growth in 2009 and 2010.
Oil and other commodities
Brent crude (1 month forward) has fallen to around $111/ barrel, despite the precautionary closure of major oil pipelines in Georgia. The downturn in Japanese growth could have a significant impact on world crude oil demand.