The following is an excerpt from a Capital Daily report by London-based research provider Capital Economics.

-    China’s focus on government debt is encouraging

-    GDP in Sweden probably contracted 0.3% in Q2 (08.30 BST)

-    Reserve Bank of India may keep interest rates on hold (06.30 BST)

Key Market Themes

The dollar touched a one-month low against the yen on Monday. However, we do not expect the weakness of the US currency to be sustained. We still see the dollar ending the year at 105 against the yen, at 1.25 to the euro and at 1.50 to the pound, consistent with small gains against all three from present levels.

Reassuring comments from Fed officials that the monetary policy stance in the US will remain accommodative for a long period even as the central bank starts to wind down its bond-buying programme have weighed on the dollar.

However, the fact remains that the Fed is likely to become less accommodative well before the other major central banks. Indeed, those banks are actually likely to become more accommodative in the coming months: we think the ECB will its key rate again by the end of the year even if, as we expect, there is no change on Thursday. Meanwhile, we suspect that the Bank of England will introduce formal Fed-style “forward guidance” to keep rate expectations low on 7th August, alongside the publication of the next Inflation Report.

Finally, we would not be surprised to see the Bank of Japan step up its own bold easing, as the planned doubling of the monetary base may not be enough to achieve the desired amount of inflation.

In addition, the dollar is likely to gain some support from the relative strength of the US economy. Although we expect Q2 GDP data on Wednesday to be disappointing, this will probably have been due to headwinds that should soon fade. Recent survey data suggest a better Q3, while the improvements in housing and labour markets and in the availability of credit are also encouraging. The better news should extend into next year, when we expect the US economy to grow by 2.5% compared to a contraction of 1.0% in the euro-zone and growth of just 1.5% and 1.2% in the UK and Japan, respectively. (Jessica Hinds)

What to watch for today: US

After rising sharply in each of the previous three months, we anticipate that the Conference Board measure of consumer confidence in the US (15.00 BST) increased more modestly in July, to around 83.0 from 81.4 in June. Equity prices have staged impressive gains in July and, despite the recent rebound, gasoline prices are still below June’s average. At the same time, both the housing and labour markets have continued to strengthen. Other measures of confidence, however, suggest that any further rise in sentiment in July was small. (Amna Asaf)

Continental Europe

GDP in Sweden (08.30 BST) probably contracted in Q2 for the first time since Q4 2011. At face value, the industrial and service production indices suggest that a fall in excess of 1% is possible. But these data tend not to be a particularly reliable guide to the actual rate of GDP growth. What’s more, the retail sales and trade are a bit more positive and the PMI survey points to a rather smaller drop in GDP. Accordingly, we have pencilled in a quarterly fall of 0.3% in Q2, which would reduce the annual growth rate to 0.8%. But a larger decline should not be ruled out. (Ben May)

We expect the EC’s Economic Sentiment Indicator (ESI) (10.00 BST) to rise for the third month running in July, adding to evidence that economic conditions in the euro-zone are very gradually starting to improve. We forecast a moderate rise to about 92.5, which would leave it pointing to annual falls in GDP of about 0.5% – better than Q1’s 1.1% contraction. (Jennifer McKeown)

Japan

We will be particularly interested in small business confidence (06.00 BST), which is the first survey data for July. The Economy Watchers Survey (EWS), which tends to lead small business confidence by a month or so, has now fallen for three consecutive months. We therefore expect small business confidence to drop back in July, although the index should still be at a relatively high level. Industrial production (00.50 BST) should fall back in June as well, but this needs to be seen in the context of the forecasts which will be published for July and August.

Meanwhile, news reports show that there is a heated debate within the government on whether to go ahead with the planned consumption tax hike. While finance minister Aso seems adamant that it must be implemented, cabinet adviser Hamada has proposed a number of conditions that would certainly delay the hike. According to unconfirmed press reports, the government has asked for the evaluation of four different options, including a delay in the hike as well as a more gradual increase of 1% per year. We still believe that the tax will be raised as the economic case is overwhelming and not doing so would deal a severe blow to the government's credibility. However, either a delay or a more gradual increase is possible.

Retail sales figures for June (published on Monday) suggest that consumer spending will have given a solid boost to GDP growth in Q2. However, sales in June were lower than a month before, and surveys suggest consumer spending is already slowing. (Marcel Thieliant)

China

China’s National Audit Office announced on Sunday that it is conducting a comprehensive review of all government debt, just one month after audit results on the debt of 36 local governments were released. The announcement has revived concern about the health of the Chinese government’s balance sheet although, of course, the problem is not a new one. Indeed, we are encouraged by the fact that the government is focusing on the issue.

Current concerns are rooted in the stimulus spending of 2009 which produced a big increase in the liabilities of local government financing vehicles. These vehicles have since continued to finance projects through various forms of finance, including a recent surge in corporate bonds. The new audit should help both policymakers and investors to understand the actual position. Our estimate suggests that the outstanding value of total government debt was around 65% of GDP by the end of 2012, with the debt held by local governments nearly 25% of GDP.

We think the situation is still manageable. The government has enough assets to pay the unpaid debt. Meanwhile, current conditions look no worse than a decade ago, when China faced a large amount of non-performing loans taken from the state-owned banks and the fiscal situation was poorer. (Qinwei Wang)

Other Asia-Pacific

We think the Reserve Bank of India (RBI) is likely to keep the policy rate on hold at 7.25% tomorrow (06.30 BST). The RBI has cut policy rates three times since January. However, concerns about growth have been superseded by worries about the decline in the rupee. The RBI tightened liquidity in mid-July, pushing up domestic interest rates in an effort to shore up the currency. Although speculation has now switched to whether the RBI might follow up with a policy rate hike, we think this is unlikely unless the rupee falls much further. (Mark Williams)

Key Data and Events

Tue 30th    00.30  Jpn  Household Spending (Jun)     

            00.30  Jpn  Unemployment Rate (Jun)

            00.30  Jpn  Job-to-Applicant Ratio (Jun) 

            00.50  Jpn  Industrial Production (Jun Prov.)  

            06.00  Jpn  Small Business Confidence (Jul)    

            06.30  Ind  Interest Rate Announcement   

            07.00  Ger  GfK Consumer Confidence Survey (Aug)

            08.00  Spa  GDP (Q2, Prov.)  

            08.00  Spa  CPI (Jul Prov.)  

            08.30  Swe  GDP (Q2, Prov.)  

            10.00  EZ   EC Economic Sentiment (Jul)  

            13.00  Ger  CPI (Jul Prov.)  

            14.00  US   Case-Shiller 20-City House Prices (May)  

            15.00  US   Conference Board Consumer Confidence (Jul)