UK GDP data reinforces rate cut prospects

GBP: October GDP contracts

Next week will be the final full trading week of the year and as is often the case, it will be a busy one. The BoE, the ECB (Thursday) and the BoJ (Friday) will all meet with market pricing quite clear – the ECB is set to maintain its policy rate at 2.00% with the monetary stance “in a good place” while the BoJ is expected to raise its key policy rate by 25bps – the OIS pricing implies a 92% probability of a hike and a Bloomberg survey of 50 economists revealed all responses predict a hike.

In contrast to the BoJ, the BoE is set to cut by 25bps and that is priced only marginally less than the BoJ pricing and the data released this morning will certainly help reinforce those expectations. Real GDP contracted by 0.1% in October, which followed a similar contraction in September. The economy has certainly taken a hit with three contractions in the last four months and the last month of expansion coming in June. Of course the government will likely get the blame here with budget uncertainty cited as a factor causing a pull-back in activity in October ahead of the budget. If the budget is a key factor then the November GDP is likely to be poor as well. It was the services that was the primary factor in dragging the economy down in October with services activity contracting by 0.3%. Construction activity contracted by 0.6% while there was a partial offset in manufacturing with a 1.1% increase.

BoE MPC members have cited in recent public comments that there has been greater evidence of disinflation in the services sector and the GDP data will only reinforce that view and strengthens the prospect of a BoE rate cut next week. The vote at the November meeting was 5-4 favouring no change so Bailey switching to join the dissenters in November would be enough for a majority favouring a cut next week. The GDP data could help swing one other MPC member in favour of a cut, possibly Huw Pill. Megan Greene, Clare Lombardelli and Catherine Mann look less likely to join the vote for a cut. So a 5-4 or 6-3 vote looks most likely now.

The pound is little changed in response to today’s data which is understandable given a rate cut is close to fully priced. The pound has gained versus the dollar following the broad-based dollar sell-off but has weakened versus the euro. We would expect that pattern to continue with the pound underperforming within the G10 space. While the Gilt market has given the budget a cautionary thumbs up, the political consequences may have further to play out with the potential of a leadership challenge for Kier Starmer to deal with next year.

The lack of move in GBP also reflects the other big event risk next week – the NFP data releases for both October and November. Fed Chair Powell was clear in his press conference this week that the reason for the Fed cutting with inflation above target was the weakening labour market. If the data confirms that again next week, further dollar selling into year-end seems very likely. Further labour market weakness is a core assumption of our dollar bearish view ahead. 

UK GDP CONTINUES TO LAG BEHIND KEY G10 ECONOMIES – ONLY JAPAN HAS PERFORMED WORSE RELATIVE TO PRE-COVID

Source: Bloomberg, Macrobond & MUFG GMR

CNY: USD/CNY drop would add fuel to broader drop

Upward pressure on CNY continues to build and there is certainly scope for CNY to continue advancing to breach and trade below the 7.000-level. China’s trade surplus is grabbing more attention and is leading to increased accusations that China continues to rely on external demand for overall economic growth. The trade surplus is now through the USD 1 trillion level and the larger the surplus becomes the more these surpluses will seep into strengthening CNY as companies inevitably increase conversion rates out of the US dollar.

The IMF this week warned China that its dependence on manufacturing and exporting abroad risked raising tensions with trading partners and that China needed to be more assertive in its attempts to boost domestic demand. China yesterday responded following the conclusion of the Central Economic Work Conference, when policies for the following year are laid out, by confirming the focus would be on boosting domestic demand through “moderately loose” monetary policy and “a more proactive fiscal policy”. The commitments are quite similar to a year ago but these goals may be pursued more aggressively given the risks of global trade tensions escalating.

On Wednesday Senators in Mexico voted in favour of implementing tariffs ranging from 5% to 50% against Asian countries with no trade agreement – including China. Imports from China will be most impacted. Other countries could follow and hence China will be on increased pressure to show it is not redirecting exports to other markets in part through using a weaker CNY.

The CFETS RMB Index fell nearly 7% in the first half of the year and has since rebounded by around 2.5%. If the US dollar is going to take another leg lower (our view) then USD/CNY moves may need to more closely match the broader drop than during the first half of the year. A stronger currency would also be consistent with the policy focused laid out this week as a strong currency helps provide scope for additional monetary easing. Quarter-to-date, CNY is now the third best performing major currency in Asia and further adjustment stronger looks likely. The IMF pointed the finger at currency weakness for the sheer scale of China’s trade surplus and this accusation is likely to prompt further strengthening ahead assuming broader US dollar depreciation from here.

SPOT USD/CNY NOW TRADING BELOW PBOC DAILY FIX

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com