ARE we facing an external threat to recovery? In the United States and in Europe, a change of weather looms. Across the western world stock markets have fallen ahead of a big move away from monetary easing by the US Federal Reserve, writes Bill Jamieson.
In the Eurozone an already weak recovery now has to contend with trade and financial sanctions against Russia, and a further ominous lurch towards deflation. Central bank policy elsewhere may be tightening. In the Eurozone pressure is growing for monetary easing.
How might all this affect the economy here? Business and investors will be reading the runes of the Monetary Policy Committee meeting due this Thursday. Will recent signs of a slowdown in the growth pace encourage the MPC to blow cool on expectations of an early rate rise?
We also face a notable rise in geopolitical worries, with Ukraine and the Middle East to the fore. The seasoned economist Stephen Lewis wrote last week that seldom in his more than 45 years of experience could he recall a period “when the world’s capital markets have been afflicted by so pervasive a sense of unfocused foreboding”.
From a UK viewpoint this may seem over-fretful. But after five years in which markets have been anaesthetised by unprecedented monetary support, there are threats to stability, with critical inflection points approaching.
Keen attention will focus on Bank of England Governor Mark Carney’s press conference on Thursday following the MPC’s monthly meeting. No immediate change is expected, either to the 0.5 per cent official rate or to the £375 billion total of quantitative easing. A big improvement in the jobs market across the UK, rising house prices, buoyant mortgage lending with approvals up 14 per cent year-on-year and corporate balance sheets continuing to improve all suggest that interest rates cannot long remain at their historic lows.
For the moment the recovery momentum points to an interest rate hike later this year. But wage rates have been subdued, bank lending to business is still well below pre-crisis levels and there have been signs in recent days of a slowdown in the pace of manufacturing recovery. These could push a rate rise back into the first quarter of 2015. All this – and the breaking-in of three new MPC members, Nemat Shafik, Andy Haldane and Kristin Forbes – makes rate policy all the more opaque, despite the Governor’s commitment to “forward guidance”.
The MPC must also have regard to securing a rebalancing of the economy towards growth in manufacturing, and particularly in exports. Here the picture is more problematic, especially so when looking at the Eurozone, still our principal export market.
The spectre of deflation has loomed closer with Eurostat reporting a fall in inflation to a new low of 0.4 per cent last month. As with the UK MPC, the European Central Bank is likely to wait for more data and little action is expected at its meeting this week.
But there are mounting pressures and it cannot delay for long. The economies of the Eurozone are still showing subdued recovery – growth of 1.1 per cent is expected this year and 1.7 per cent next, compared with 3 per cent plus in the UK.
Such a low growth outlook will disappoint already restive electorates: voters are weary of seemingly never-ending austerity programmes with no evident results.
Now add to this the EU’s imposition of a further set of sanctions on Russia. These will exercise further downward pressure on growth prospects. The main transmission channel is external trade. Russia is a major trading partner of the Eurozone: exports of goods and services to Russia amounted to ¤109bn (£86.7bn) last year. Eurozone exports to Russia are already down by some 15 per cent year-on-year and investment prospects are likely to suffer too, with Germany’s exposure above the Eurozone average.
Much more broad-based sanctions, a dramatic weakening of the Russian economy and, in particular, disruptions to the Russian supply of commodities (notably gas) could have a much larger impact on Eurozone growth.
Quite how the ECB will react to this is not at all clear. But as Citigroup economist Ebrahim Rahbari notes, the trajectory of Eurozone inflation is likely to remain the key driver for ECB decisions. Continued inflation undershoots will encourage it to announce a quantitative easing programme in the final quarter of this year or early next.
Among the major Eurozone countries, he adds, Germany’s exposure to Russia stands out, with Russia accounting for 3.3 per cent of total exports. Export growth to Russia has fallen in all countries recently and in most Eurozone countries the decline in exports of goods to Russia currently runs at between 10 and 20 per cent.
Eurozone countries import sizable shares of their oil and gas needs from Russia. According to Eurostat data, Russia accounted for 25 per cent of Eurozone consumption in 2012 and 26 per cent of imports for both gas and oil in addition to sizable imports of coal and some electricity. Germany is above the Eurozone average, with Russia accounting for almost 40 per cent of its gas and crude oil consumption.
UK exporters have every reason to watch this situation with concern. Damage so far may be slight but the potential for significant disruption has moved closer. And the threat posed to an economic rebalancing here should not be understated. UK exporters have every reason to hope that EU-Russia tensions will not further deteriorate. As it is, we face a distinct change in the financial weather over the next few months.