The unrelenting movement of glaciers

Today's news headlines:

‘Boris Johnson loses second attempt to hold snap general election’. Yesterday, MPs blocked Boris Johnson’s second attempt to hold a snap general election in a bid to break the Brexit impasse. Now, an election can’t take place until November at the earliest, leaving Boris Johnson stuck in Downing Street hoping to secure a revised Brexit deal in the meantime. Johnson accused Labour’s Jeremy Corbyn of ‘preposterous cowardice’ and signalled he might defy any law forcing him to seek a delay to Brexit if no deal is reached. (Financial Times)
‘US retailers accelerate shift away from Chinese suppliers’. US firms seeking to avoid rising costs from Trump’s trade tariffs are choosing to source products from Vietnam, Cambodia, and Thailand instead of China. The push to re-engineer supply chains has become more urgent now that Trump has introduced new tariffs on $112bn worth of Chinese goods. While many fashion companies are moving production away from China, other countries often lack the necessary skills to handle more complex products. Meanwhile, American and Chinese officials have agreed to resume face-to-face talks in the coming weeks. (Financial Times)

To tier or not to tier

Let’s be candid; the fact that European Central Bank (ECB) is winding up for more monetary policy easing—irrespective of the policy tools it employs—represents a failure of member country government organisation and doesn’t bode well for the deteriorating economic position of the bloc.

Any way you look at it, there is a good deal of deceleration in the EU. Rewind the tape as far back as you like, economic releases are grinding gradually lower. It’s not a dramatic plummet, it’s more like the unrelenting movement of glaciers; contrast the pace of growth versus a year ago, and you’ll notice a marked difference. Despite a record level of government surplus in Germany—the government is spending much less than income; year-on-year government spending has only nudged up a bit from last year’s low.

In this circumstance, the central bank has little choice but to ease monetary policy to account for the deteriorating backdrop and member government inaction. This Thursday’s European Central Bank meeting is expected to result in a 0.10% decline in the deposit rate (to -0.5%) and the introduction of tiering of bank collateral. This works by exempting a certain amount of excess reserves from the lower deposit rate and lessening the impact on the banks, who are critical if we require the lower policy rate to result in more lending. Less likely is the return of quantitative easing, or central asset purchases.

Either way, the policy step is logical and, in the case of tiering, not particularly revolutionary. The problem is that this iterative step in policy is likely to result in some positive uptick in economic performance, but more importantly, to encourage moral hazard among member economies. Finance Ministers get to avoid making decisions, knowing that the ECB will step in and grant a reprieve. This is not good news, just more of the same.

Bottom line: The implementation of tiering is likely to help EU bank stocks, by cosseting them from further policy easing, but it doesn’t remedy the overarching, systematic problems in the EU. Consequently, any positivity is likely to be short-lived. The Euro Index is sitting at the bottom of two-year lows and appears likely to tip into the lower range of the 2015 – 2017 period, plumbing depths circa 8% lower than the current level.

Official German economic data

Source: Bloomberg, Deutsche Bundesbank

GBP/USD

Sterling maintained its post-GDP data gains but failed to progress through 1.2385 against the Dollar, returning instead to around the 1.2350 mark. With Parliament prorogued until October 14th, the focus will shift towards today’s upcoming UK labour data. We now see support for the Pound at the 1.23 handle, and a break below could be met with little resistance. On a positive note, the pair is comfortably positioned above the 50-day moving average leaving the near-term outlook relatively bullish.

GBP/EUR

The pair’s upward trend continued yesterday as the Pound climbed above the 1.12 mark for the first time since late July. This morning, we’ve seen a pullback to the mid-range of July and the next challenge will be if Sterling can find enough momentum for a meaningful break above the 100-day moving average. The pullback was aided by reports that Germany could boost fiscal stimulus by creating a ‘shadow budget’ to boost public investment above official debt limits.

EUR/USD

The currency pair continues to trade in a tight range, struggling for direction, in the lead-up to this week’s European Central Bank meeting. The Euro has found consolidation in the mid-1.10’s following the broad Dollar sell-off that looks to have run out of steam. Continued uncertainty over the growth outlook for the bloc may limit further Euro upside.