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

-    Euro-zone economy should have emerged from recession in Q2 (10.00 BST)

-    UK’s MPC was probably unanimous in support of “forward guidance” (09.30 BST)

-    UK unemployment may have remained at 7.8% in June (09.30 BST)

 

Key Market Themes

We expect further downward pressure on UK consumer price inflation (see below) to provide a boost to Gilts in the coming months and forecast the nominal 10-year yield to end 2013 at 2% (compared to about 2.5% now). However, we are less sanguine about the prospects for UK government bonds in 2014 and 2015.

 

The breakeven inflation rate on 10-year Gilts (the difference between the nominal yield and the real yield on index-linked bonds) has already fallen by almost 30bp since March. Nonetheless, it remains about 80bp higher than it was in 2009, when inflation itself fell to 2% to which we think it will fall by the end of this year. Granted, there is no automatic link between the breakeven inflation rate on 10-year Gilts and the actual rate of inflation. But if we are right to expect the latter to fall further, then the former may do too.

 

That being said, the decline in the 10-year breakeven inflation rate on 10-year Gilts in recent months has only served to limit a rise in the nominal yield, not prevent it. (The nominal yield has climbed 50bp since March.) This is because there has been a surge in the real yield on index-linked bonds of almost one percentage point. (See Chart 1.) This surge has been driven by concerns about an end to exceptionally loose monetary conditions in the US and what that might imply in terms of the future stance of UK monetary policy. (The real yield on US 10-year TIPS has also shot up.)

 

We think investors may have run ahead of themselves in expecting a dramatic shift in US monetary policy. And the recent introduction of “forward guidance” by the MPC suggests there could be at least a temporary divergence in the stances of conventional monetary policy in the UK and the US. Accordingly, we think there is some scope for real yields in the UK to drop back slightly by the end of this year.

Nonetheless, the prolonged period of exceptionally loose monetary conditions in the UK and other parts of the developed world is on borrowed time. The fact that short-term real interest rates have been negative since the financial crisis – as policymakers have sought to stoke demand – does not mean they will be negative on average for the next ten years, as the market still implies.

 

What’s more, an eventual unwinding of unconventional stimulus could reverse the drops seen in the term premiums on government bonds (both conventional and inflation-linked). We therefore think that real long-term yields are likely to drift up over the next few years as the monetary screws are slowly tightened.

 

Against this backdrop, while the persistence of low inflation may succeed in anchoring breakeven inflation rates, the nominal yields of conventional government bonds are still likely to rise. Our forecast is that the nominal 10-year UK Gilt yield will climb to 3% by the end of 2015. (Jessica Hinds & John Higgins)

What to watch for today: US

We suspect that producer prices were unchanged in July, which would be a weaker outturn than the small increase expected by the consensus. Our view is based on estimates that energy and food prices fell last month. Although the average gasoline price in July was higher than in June, the PPI survey is conducted in the week containing the 12th of the month. On that basis, gasoline prices fell by 1% m/m and electricity prices dropped by 2% m/m. Add in a small fall in food prices, and energy and food effects may have exactly offset a 0.2% m/m rise in core prices. It is possible that core prices will be boosted by a surge in tobacco prices related to some tax hikes at the State level. Such hikes have previously boosted prices in July. Either way, base effects mean that the annual rate of core inflation is likely to fall to around 1.3% from 1.7% in June. (Paul Dales)

 

Continental Europe

The provisional GDP release for Q2 (10.00 BST) should confirm that the euro-zone economy has finally emerged from its seven-quarter recession. Admittedly, survey indicators like the composite PMI index suggested that another small fall in GDP was likely. But the hard activity data has given a stronger picture. Euro-zone industrial production looks likely to have risen by about 1.2% in Q2, compared to Q1’s 0.2% gain. Meanwhile, the country GDP data released so far for Spain and Italy has shown a significant improvement from Q1 and Germany’s economy looks likely to have expanded by about 0.6% given strong industrial production there. Overall, then, we’ve gone with the hard data and pencilled a 0.2% rise in euro-zone GDP. Early surveys point to another expansion in Q3. (Jonathan Loynes)

 

Euro-zone industrial production data for June and Germany’s August ZEW survey (both published on Tuesday) provide further signs that the euro-zone has emerged from recession. The 0.7% monthly rise in euro-zone industrial production was a bit worse than expected (consensus 1.0%), but was the fifth rise in seven months. Over Q2 as a whole, production rose by 1.2%, rather better than Q1’s 0.2% increase. This suggests that the sector boosted quarterly GDP growth by 0.2pp after Q1’s 0.2% fall. Along with stronger growth in construction, this indicates that GDP probably posted a small rise of about 0.2%. Meanwhile, the rise in the German ZEW index of investor sentiment, from 36.3 to 42.0, was a bit better than expected. At face value, the index points to healthy annual German GDP growth of around 2%. But it has not been a particularly good predictor of growth in the past. (Ben May)

 

Japan

No major data or events scheduled for today.

 

Meanwhile, core machinery orders fell by 2.7% m/m in June (data released on Tuesday), but this only reversed a little of the 10.5% m/m gain in May. Admittedly, firms are predicting that core orders will fall by 5.3% q/q in Q3, but these projections have a poor track record. In March, firms were predicting that core orders would drop by 1.5% q/q in Q2, whereas in reality they rose by 6.8%. Capital spending has lagged well behind the recovery in the rest of Japan’s economy, but it should now start to make a decent contribution to growth from the third quarter onwards. (Julian Jessop)

 

China

No major data or events scheduled for today.

 

Other Asia-Pacific

We think that India’s wholesale price inflation (07.30 BST) stabilised in July. It has eased sharply so far this year, owing to falling global commodity prices and weak economic conditions. Looking ahead, currency weakness is likely to create some upward pressure, but WPI inflation is unlikely to break through 6% y/y. Meanwhile, consumer price inflation is likely to have eased from the recorded in 9.9% in June, but not by much. (Daniel Martin

Key Data and Events

Wed 14th     00.00  Kor  Unemployment Rate (Jul)     

             06.30  Fra  GDP (Q2, Prov.)  q/q(y/y)

             07.00  Ger  GDP (Q2, Prov.)  q/q(y/y)

             07.00  Fin  CPI (Jul) 

             07.30  Ind  Wholesale Prices (Jul)

             07.45  Fra  CPI (Jul)  EU Harm.

             08.00  Slk  GDP (Q2)  

             08.00  Hun  GDP (Q2)  Q/Q(Y/Y)    

             08.00  Cze  GDP (Q2)  Q/Q(Y/Y)    

             08.00  Aus  GDP (Q2)  

             08.30  NE   GDP (Q2, Prov.)  q/q(y/y)

             08.30  Por  GDP (Q2, Prov.)  q/q(y/y)

             09.00  Pol  GDP (Q2)   Q/Q(Y/Y)

             09.30  UK   MPC Minutes (unchanged QE – more QE)    

             09.30  UK   BoE Agents’ Scores    

             09.30  UK   Claimant Count Rate (Jul)   

             09.30  UK   Claimant Count Change (Jul) 

             09.30  UK   ILO Unemployment Rate (Jun) 

             09.30  UK   Average Earnings (Jun) (3m. av. %y/y)

             10.00  EZ   GDP (Q2, Prov.)  q/q(y/y)

             13.00  Brz  Inflation (Aug) 

             13.30  US   Producer Prices (Jul) 

             13.30  US   Core Producer Prices (Jul)  

             14.00  CA   Teranet-National Bank House Prices (Jul)

Back to News