IMF slash UK growth next year

Tuesday 26th July 2016 15:32 EDT

The Bank of England’s Martin Weale signalled that he is not yet ready to vote for an interest rate cut in what will be his final meeting as a member of the Monetary Policy Committee. Weale said there had been no indication that consumers or businesses were “panic-struck” in the aftermath of the Referendum. However, this contrasts with most of the other MPC members who expect a rate cut in August. Also, Chief Economist Andy Haldane on Friday called for a stimulus package including a rate cut. With Prime Minister Theresa May indicating that she plans to wait until 2017 before triggering the formal EU exit procedure, companies’ investment decisions could be delayed for some time, and consumer confidence may be affected. Markets have yet to see any major data reflecting the state of the economy since the Brexit vote. The U.K.’s statistics office says that inflation figures due on Aug. 16th will be the first to show how the country is faring since the referendum. The U.K. is also running a large current account deficit, equivalent to 5.4% of gross domestic product, compared to a surplus across the EU. This is amongst the highest in the developed world, and investors are worried that Britain will face a recession in coming quarters and will find it increasingly hard to finance its deficit. The Pound fell against a host of its major counterparts after the International Monetary Fund slashed its forecast for UK growth next year after warning that the decision to leave the EU has damaged the British economy’s short-term prospects and “thrown a spanner in the works” of the global recovery.

Next year, the IMF believes that the UK will experience similar growth rates to Germany – the Eurozone economy most affected by the Brexit-induced slowdown – and France. The update to the World Economic Outlook said there was a risk that the impact of the UK’s decision to leave the EU could prove to be worse than expected. Sterling rose against the euro and a broadly stronger dollar on Wednesday after a Bank of England survey showed no clear evidence of a slowing of economic activity after last month's Brexit vote. Again as with Tuesday’s inflation figure, the pound edged higher off the back of the positive data, however any gains that were made were very much short lived as the pound quickly retraced back down as investors are selling of any gains in sterling in the expectation that sooner or later the economy will slow substantially. Many analysts now believe that the UK economy is shrinking, following Friday’s release of the broadest survey of business activity and confidence since last month's Referendum. The preliminary, Markit survey of purchasing managers, executives who make spending decisions at 1,250 big firms fell by the most in its 20-year history. It was consistent with an economy contracting 0.4 percent in the third quarter, contrasting with an actual reading of plus 0.4 percent in the first quarter. The Bank of England has been clear that easing monetary policy before the end of 2016 may be necessary. The Markit PMIs, which give an early indication of how gross domestic product is likely to perform, suggest the 1.8 trillion pound UK economy is shrinking faster than at any time since the aftermath of the global financial crisis. It showed the services sector - one of the few British growth drivers - has been hit especially hard by Brexit, with orders plunging and confidence crumbling. The slump is the strongest evidence yet that the vote to move out of Europe is dragging the world’s fifth largest economy into recession.

In the Futures market, the odds of the Federal Reserve increasing interest rates by December more than doubled last week to 44%. This comes after U.S. economic reports including retail sales and industrial production signaled improving growth. These odds are up from 15% after the U.K.’s vote to leave the European Union. U.S. policy makers next meet on July 26 and 27. The dollar rose to a four-month high against a basket of major currencies on Tuesday after the release of data showing U.S. housing starts rose more than expected in June, underpinning a theme of strength in the U.S. economy. Groundbreaking on U.S. homes surged 4.8 percent to a seasonally adjusted annual pace of 1.19 million units, the Commerce Department said.

The dollar rose on Wednesday, hitting its highest level in four months against a basket of currencies, as expectations rose that the Federal Reserve would tighten monetary policy. Fed funds futures rates show investors see a greater than 50 percent chance the Fed will raise interest rates at least once by its December meeting.

Market participants are not expecting any change in the ECB’s current monetary policy stance at their meeting on Thursday. However, investors are expecting the ECB President Mario Draghi to comment on the possibility of further monetary easing at its September meeting. The assessment of Eurozone economic sentiment fell to minus 14.7, down from 20.2 in June. This month’s reading was the biggest monthly drop ever.

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