In aggregate, global GDP growth has fallen back somewhat from high rates in 2017. Robust growth in the US has been more than offset by some slowdown elsewhere, in part as higher US interest rates and a stronger dollar have led to tighter financial conditions in emerging market economies. Although growth is expected to remain relatively robust in much of the world, and above estimates of potential growth, the outlook has moderated. UK financial conditions have tightened slightly further since August, but remain accommodative overall.
1.1 Global economic developments
Weighted by countries' shares in UK exports, global activity growth is expected to have slowed in Q3 to 0.5% (Table 1.A). That is a little weaker than expected at the time of the August Report and somewhat slower than the strong rates seen in 2017. Global growth remains relatively robust, however, with most of the world still growing at rates above estimates of potential growth in 2018 H1 (Chart 1.1).
Growth has been particularly strong in the US, boosted in part by an easing in fiscal policy. In contrast, euro-area growth has slowed in 2018, and by more than expected. That divergence in regions has also been apparent in capital markets and exchange rates. For example, equity prices have fallen markedly in the euro area in 2018 so far, unlike in the US. Strong US growth and a related monetary policy tightening have led to a rise in interest rates and a strengthening in the US dollar. Those developments have pushed up forward interest rates in other advanced economies, including the UK (Section 1.2), and have been associated with a tightening in financial conditions in many emerging market economies, which is weighing on the growth outlook there.
Signs of slowing global growth are apparent in indicators of global trade and investment growth, albeit from recent strong rates. World goods trade growth has moderated in 2018 (Chart 1.2). Consistent with that, survey indicators of activity in manufacturing and export-focused sectors have weakened (Chart 1.3). In addition, growth of capital goods orders — an indicator of investment — in the euro area and US has slowed.
One factor that is likely to weigh on the outlook for global activity is the prospect of trade protectionism. Tariffs applied by the US on Chinese imports, and broader aluminium and steel tariffs announced earlier in the year, have been met with reciprocal measures. Since August, the US has also proposed further increases in tariffs on Chinese imports. However, trade tensions between the US and some of its trading partners have eased somewhat, with Canada, Mexico and South Korea agreeing trade deals with the US. As discussed in Box 1, both potential and realised barriers to trade are likely to affect activity and inflation in the countries involved and, indirectly, elsewhere.
Consistent with some moderation in global activity growth and a pickup in trade tensions, prices of many commodities have fallen through the course of this year. Metals prices, in particular, are down 12% since January, though they have been more stable in recent months (Chart 1.4). In contrast, oil prices have risen over the past three months. That recent pickup mostly reflected the prospect of limited oil supply growth in coming quarters.
Global growth is expected to remain broadly stable in coming quarters, at a little above potential. The effects of tighter financial conditions, given monetary policy normalisation in advanced economies and a recent deterioration in global risk sentiment, are likely to continue affecting the pace of growth. And some direct effects from higher tariffs and the fading of the boost from US fiscal policy are also expected to weigh on growth (Section 5).
The United States
Activity growth in the US has been strong in 2018 so far, and slowed only slightly in Q3 to 0.9%, from 1.0% in Q2 (Table 1.A). That was a more modest slowdown than had been expected at the time of the August Report. Activity growth in 2018 has been underpinned by solid consumption growth, with consumer confidence remaining high (Chart 1.5). In coming quarters, US growth is expected to slow somewhat, but to remain above potential (Table 1.B).
Strong domestic demand has been supported in part by fiscal policy. Personal and corporate tax cuts were announced in December 2017, and the Bipartisan Budget Act of 2018 lifted discretionary spending caps by around US$300 billion over 2018 and 2019, equivalent to around 1.5% of GDP. The fiscal measures announced can be expected to support demand growth only for so long. That support is expected to peak in 2019 before fading thereafter. Spending caps are legislated to return to 2017 levels in 2020, implying falls in spending that would drag on growth. However there is uncertainty around the profile for fiscal policy.
Net trade weighed on growth in Q3 and is expected to continue doing so in coming quarters. Weak export growth may partly reflect the appreciation of the US dollar over 2018 (Chart 1.6). In addition, as discussed in Box 1, the prospect of trade protectionism is likely to weigh on the outlook. Although only recently implemented, there are already signs that the higher tariffs on US trading partners and associated reciprocal measures may have affected export activity. For example, the PMI measure of new export orders has fallen (Chart B) in Box 1), with many respondents citing concerns over tariffs. Rising trade tensions, alongside the moderation in the global outlook, also appear to have affected sentiment, with business confidence falling in Q3 (Chart 1.5).
Strong growth in activity in 2018 has reduced the degree of spare capacity in the US economy, and it is judged to be in excess demand. The headline unemployment rate fell to 3.7% in September, and other measures of slack, such as the rate of unemployment plus marginally attached and part‑time workers, were also close to historical lows. The fall in unemployment in recent years has been associated with steady employment growth. At the same time, the labour force participation rate has been stable, with the long‑term drag from an ageing population having been offset by a pickup in the participation rate of those aged 25–54. That is expected to continue in coming years. Consistent with tightness in the labour market, wage growth has risen over the past year (Table 1.C). That has probably contributed to a pickup in core inflation, which is a little above past averages.
Given robust demand growth and the prospect of sustained inflationary pressures, the Federal Open Market Committee (FOMC) has continued to tighten monetary policy. The Committee raised the target range for the federal funds rate to 2%–2¼% in September. The path of policy implied by market prices has risen since August (Chart 1.7), as have long-term interest rates (Chart 1.8). Market contacts attributed those increases in part to the strengthening growth outlook and greater evidence of inflationary pressures. In addition, communication by some FOMC members suggesting a tighter path for monetary policy than had previously been expected appears to have pushed up expectations of future policy rates. The Federal Reserve also continued to reduce the size of its balance sheet, which was US$300 billion lower than its September 2017 peak in the run-up to the November Report.
Quarterly GDP growth in China slowed slightly to 1.6% in Q3 (Table 1.A), as expected in August. Some activity indicators such as export order PMIs point to a further modest slowing in Q4. Credit growth has also slowed gradually, particularly from the non-bank sector, although it remains relatively robust.
Rising trade tensions with the US are likely to weigh on the outlook in coming quarters. Market contacts attributed falls in asset prices over 2018 to the anticipation of the impact of higher trade barriers, as well as associated uncertainty. The Shanghai Composite equity index is around 5% lower than at the time of the August Report, and around 20% lower over 2018 so far (Chart 1.9). Although the renminbi has been more stable in recent months, as authorities have taken some steps to support the exchange rate, it remains weaker than at the start of the year (Chart 1.6).
Growth is expected to moderate slightly to 1.5% in coming quarters. Fiscal spending and relatively robust credit growth are expected to support activity. For example, net issuance of local government bonds used to finance infrastructure projects has increased substantially. And the People's Bank of China (PBoC) has created additional room for banks to expand credit by progressively cutting the reserve requirement ratio — the reserves that Chinese banks are required to keep with the PBoC. As discussed in the Financial Policy Committee's June Financial Stability Report, there remain challenges for the Chinese authorities in maintaining robust rates of GDP growth while continuing to reduce risks to financial stability.
Non-China emerging market economies
Excluding China, emerging market economy (EME) growth slowed in 2018 Q2 to 0.9% on a PPP-weighted basis, broadly as expected in the August Report. It is expected to have slowed further in Q3. Consistent with that, manufacturing PMIs and growth in measures of industrial production have softened throughout 2018 across the largest non-China EMEs, albeit from robust levels (Chart 1.10).
Tighter financial conditions in non-China EMEs (Chart 1.11), largely reflecting the impact of the normalisation of US monetary policy, have contributed to weaker activity growth in those economies. This follows a period of relatively loose financial conditions during which some EMEs substantially increased their issuance of government or corporate debt denominated in foreign currencies, particularly US dollars. Unless borrowers have revenues in US dollars, or have hedged themselves against exchange rate moves, those debts become costlier to service if the dollar appreciates, as it has done in 2018 (Chart 1.6). In addition, absent a change in policy rates in EMEs, higher US policy rates will reduce the relative return on EME assets and, in turn, external demand for those assets.
Those effects are likely to have been exacerbated by the increase in trade tensions between the US and its trade partners over 2018. As discussed in Box 1, the integration of many EMEs into global supply chains will expose them to potential trade disruption.
Associated with that tightening in financial conditions has been a net flow of portfolio capital out of non-China EMEs since 2018 Q1 (Chart 1.12). Since the financial crisis, non-bank lending has accounted for all of the increase in foreign lending to EMEs,1 which — as discussed in the June Financial Stability Report — may have made capital flows more sensitive to changes in financial conditions. Although net outflows moderated in Q3, lower investor appetite for EME assets has continued to weigh on asset prices, with spreads on government and corporate bonds wider (Chart 1.12) and equity prices lower (Chart 1.9) over 2018. In addition, to support exchange rates and capital inflows, a number of central banks, for example in Russia, India and Indonesia, have raised their policy rates, further tightening financing conditions in those countries.
The impact of tightening global financial conditions has been particularly pronounced in Argentina and Turkey. Both countries are particularly reliant on external capital — with US dollar-denominated debt amounting to over 40% of GDP, much of it short term — and so are sensitive to the tightening in financial conditions. Those vulnerabilities have been amplified by domestic factors. For example, market contacts attributed sharp moves in asset prices during 2018 in part to domestic monetary policy developments in both countries, while weak growth in Argentina has also reflected the effects of severe drought. Despite those specific domestic circumstances there remains a risk of contagion to other emerging markets, for example if investors seek to rapidly reduce their exposures to EMEs more generally as a result.
As the recent tightening in financial conditions continues to weigh on activity, non-China EME growth is projected to remain around current rates in coming quarters, weaker than expected in August (Table 1.B). That deterioration in the outlook reflects the projected sharp slowing in growth in Argentina and Turkey, as well as the impact of the tightening in financial conditions elsewhere. That said, financial conditions remain close to past averages (Chart 1.11), and growth is expected to remain a little above estimates of potential growth in aggregate.
Quarterly euro-area GDP growth slowed to 0.2% in 2018 Q3, from 0.4%. That was lower than expected in August, and substantially lower than average growth rates of 0.7% over 2017. Although activity growth is expected to pick up, the projected path for growth in coming quarters has been revised down (Table 1.B), and is only a little above estimates of potential growth.
The slowdown in growth in 2018 has been broad-based across the large euro‑area economies. The contribution from net trade, which had driven much of the strength in 2017, has fallen in most countries in the first half of 2018. And net trade is expected to continue to be weak in coming quarters as the global outlook moderates. Consumption and investment growth had continued to support growth in 2018 H1, with survey measures of consumer and business confidence well above average, but these measures have softened in 2018 Q3 (Chart 1.5).
The euro-area unemployment rate has continued to fall, to 8.1% in September, its lowest since 2008 Q4. Consistent with a steady reduction in slack, wage growth has picked up in 2018 H1 (Table 1.C). Some spare capacity is judged to remain, however, with unemployment still above its estimated equilibrium rate. And core inflation remains subdued.
The European Central Bank (ECB) made no changes to policy rates in September or October and reiterated its past guidance that rates were expected to remain at present levels at least through the summer of 2019. However, the market-implied path for policy rates has steepened somewhat since August (Chart 1.7), which market contacts attributed in part to an upward shift in short-term interest rates globally. Most long-term interest rates in the euro area also increased over that period (Chart 1.8). Long‑term interest rates on Italian government debt have increased particularly sharply due to political developments. There was little evidence that had spilled over to other euro-area countries, however.
Global GDP growth slowed slightly in Q3
GDP in selected countries and regionsa
- Sources: Datastream from Refinitiv, IMF World Economic Outlook (WEO), National Bureau of Statistics of China, OECD, ONS and Bank calculations.
a Real GDP measures. Figures in parentheses are shares in UK goods and services exports in 2017.
b The 1998–2007 average for China is based on OECD estimates. Estimates for 2008 onwards are from the National Bureau of Statistics of China.
c The earliest observation for Russia is 2003 Q2.
d Constructed using data for real GDP growth rates for 180 countries weighted according to their shares in UK exports. Figure for 2018 Q3 is a Bank staff projection.
Quarterly GDP growth remained above potential in most parts of the world in 2018 H1
Share of global activity growing at rates exceeding estimates of potential growtha
- Sources: Datastream from Refinitiv, IMF WEO, OECD and Bank calculations.
a Averages of annualised quarterly growth in real purchasing power parity (PPP)-weighted GDP. Estimates for potential growth are Bank staff estimates for the UK, US and euro area, and IMF estimates published in the October 2018 WEO otherwise.
Growth in world trade and capital goods orders declined in 2018
World trade in goods and euro-area and US capital goods orders
- Sources: CPB Netherlands Bureau for Economic Policy Analysis, Datastream from Refinitiv, European Central Bank, US Bureau of Labor Statistics, US Census Bureau, World Bank and Bank calculations.
a Three-month moving average. Growth in US new orders for non-defence capital goods excluding aircraft, deflated by the private capital equipment producer price index, and euro-area volume of new orders for capital goods, weighted together using 2010 US and euro-area manufacturing value-added data.
b Three-month moving average. Volume measure.
Survey indicators of activity have slowed
Global purchasing managers' indicesa
- Sources: Datastream from Refinitiv, IHS Markit, JPMorgan and Bank calculations.
a Measures of current monthly composite output, manufacturing output and export orders growth based on the results of surveys in 44 countries. Together these countries account for an estimated 89% of global GDP.
Non-oil commodity prices have fallen over 2018, while oil prices have risen
US dollar oil and other commodity prices
- Sources: Bloomberg Finance L.P., Datastream from Refinitiv, S&P indices and Bank calculations.
a Calculated using S&P GSCI US dollar commodity price indices.
b Total agricultural and livestock S&P commodity index.
c US dollar Brent forward prices for delivery in 10–25 days' time.
Measures of euro-area and US consumer confidence remain robust
Euro-area and US consumer and business confidencea
- Sources: Datastream from Refinitiv, European Commission (EC), The Conference Board, University of Michigan and Bank calculations.
a Monthly data unless otherwise stated.
b University of Michigan consumer sentiment index. Data are not seasonally adjusted.
c The Conference Board measure of CEO ConfidenceTM, ©2018 The Conference Board. Content reproduced with permission. All rights reserved. Data are quarterly and not seasonally adjusted.
d Headline EC sentiment index, reweighted to exclude consumer confidence. Average of overall confidence in the industrial (50%), services (38%), retail trade (6%) and construction (6%) sectors. Data are to September 2018.
e EC consumer confidence indicator. Data are to September 2018.
Monitoring the MPC's key judgements
The US dollar has appreciated since the start of 2018
Effective exchange rates
- Sources: Bank of England, China Foreign Exchange Trade System (CFETS), ECB, Federal Reserve, JPMorgan and Bank calculations.
a JPMorgan Emerging Markets Currency Index.
b Federal Reserve US dollar nominal broad index.
c Trade-weighted index. Calculated as a weighted average of end-day spot bilateral exchange rates, using weights published by the CFETS.
Core inflation has picked up in the US, but remains subdued in the euro area
Inflation and wage growth in selected economies
- Sources: Datastream from Refinitiv, Eurostat, IMF WEO, ONS, US Bureau of Economic Analysis and Bank calculations.
a Data points for October 2018 are flash estimates.
b Personal consumption expenditure price index inflation. Data points for September 2018 are preliminary estimates.
c UK-weighted world consumer price inflation is constructed using data for consumption deflators for 51 countries, weighted according to their shares in UK imports. UK-weighted world export price inflation excluding oil is constructed using data for non-oil export deflators for 51 countries, weighted according to their shares in UK imports. Data are quarterly. Figures for September are Bank staff projections for 2018 Q3.
d For the euro area and the UK, excludes energy, food, alcoholic beverages and tobacco. For the US, excludes food and energy.
e Whole-economy total pay. Data are three-month moving averages and start in 2001.
f Compensation per employee. Data are quarterly.
g Employment Cost Index for wages and salaries of civilian workers. Data are quarterly.
Market-implied paths for interest rates have risen since August
International forward interest ratesa
- Sources: Bank of England, Bloomberg Finance L.P., ECB and Federal Reserve.
a The November 2018 and August 2018 curves are estimated using instantaneous forward overnight index swap rates in the 15 working days to 24 October and 25 July respectively.
b Upper bound of the target range.
Longer-term interest rates have increased since August
Ten-year nominal interest ratesa
- Sources: Bloomberg Finance L.P. and Bank calculations.
a Zero-coupon spot rates derived from government bond prices.
Most equity indices have fallen in 2018
International equity pricesa
- Sources: Datastream from Refinitiv, MSCI and Bank calculations.
a In local currency terms, except for MSCI Emerging Markets which is in US dollar terms.
b The MSCI Inc. disclaimer of liability, which applies to the data provided, is available here.
c UK domestically focused companies are defined as those generating at least 70% of their revenues in the UK, based on annual financial accounts data on companies' geographic revenue breakdown.
Manufacturing activity growth in non-China EMEs has begun to slow, albeit from strong rates
Indicators of EME manufacturing activity
- Sources: Datastream from Refinitiv, IHS Markit, JPMorgan and Bank calculations.
a Measure of current manufacturing output based on the results of surveys in 20 countries. Data are to September 2018.
b Weighted average of industrial production across Brazil, India, Indonesia, Mexico, Russia, South Africa and Turkey. Weighted according to their shares in total GDP using the IMF's market exchange rate weights. Data are to August 2018.
Financial conditions in non-China EMEs have tightened
Non-China EME financial conditions indexa
- Sources: Bloomberg Finance L.P., Datastream from Refinitiv and Bank calculations.
a Financial conditions indices (FCIs) based on Koop, G and Korobilis, D (2014), 'A new index of financial conditions', European Economic Review. The FCIs summarise information from the following financial series: term spreads; interbank spreads; corporate spreads; sovereign spreads; long-term interest rates; policy rates; equity price returns; equity return volatility; house price returns; and credit growth. Calculated as the average of the following country FCIs: Argentina, Brazil, Bulgaria, Chile, Colombia, Hungary, India, Indonesia, Malaysia, Mexico, Peru, Philippines, Poland, Russia, South Africa, Thailand, Turkey and Vietnam.
The net flow of portfolio capital into non-China EMEs has been negative in 2018
EME net portfolio capital inflows and bond spreads
- Sources: Datastream from Refinitiv, Institute of International Finance, JPMorgan and Bank calculations.
a JPMorgan composite emerging market corporate and government bond index. Monthly average. The October 2018 data point is the average of daily data up to 24 October. The JPMorgan disclaimer of liability, which applies to the data provided, is available here.
b Net non-resident portfolio inflows to the following EMEs: Brazil, Bulgaria, Chile, Hungary, India, Indonesia, Malaysia,
1.2 UK financial conditions
Having already tightened steadily over 2018, UK financial conditions have tightened slightly further since August, though they remain accommodative overall. Bank Rate and market interest rates have risen from low levels, and that is feeding through to the rates facing households and companies. Moves in equity prices and corporate bond spreads have also raised the cost of funding for companies, reflecting a decline in risk sentiment as the global outlook has moderated. UK asset prices remain sensitive to developments related to the UK's withdrawal from the EU.
Market interest rates
In August, the MPC raised Bank Rate to 0.75%. That had been anticipated well ahead of the announcement with most short-term interest rates rising earlier in 2018 (Chart 1.13). The MPC voted to make no changes to monetary policy at its September meeting (Box 2). In the run-up to the November Report, stronger‑than‑expected activity and inflation outturns, as well as increases in short‑term interest rates internationally, have pushed up the market-implied path for Bank Rate. It is now expected to reach around 1.4% in three years' time, up from 1.1% in August (Chart 1.7).
Long-term UK interest rates have also risen since August, despite falling back in the run-up to the November Report (Chart 1.8). Those rates have been affected in part by the increase in long-term interest rates in other countries.
Retail interest rates
The rise in Bank Rate in August, and the associated rise in short-term risk-free rates earlier in the year, have pushed up most bank lending rates. The average interest rates on new variable rate lending — which account for most corporate lending and around 10% of new mortgage lending — have risen since the time of the August Report (Table 1.D). Interest rates on new fixed-rate mortgage lending rose earlier in the year as the relevant risk-free rates upon which those are benchmarked rose in anticipation of the change in Bank Rate (Chart 1.13).
The pickup in the cost of bank funding in wholesale markets over 2018 (Chart 1.14) should also place upward pressure on retail lending rates. The rise in bank funding costs appears to have been largely driven by the same factors that have pushed up spreads in corporate bond markets more generally, such as a fall in global risk sentiment. In addition, as discussed in the June Financial Stability Report, stronger bank debt issuance has added to the upward pressure on funding spreads. That increased issuance reflects, in part, the need for banks to meet incoming regulatory requirements, as well as the end of the drawdown window for the Term Funding Scheme in 2018 Q1.
Despite some increase in most mortgage lending rates over 2018, the average rate on new lending remains lower than mid-2016 (Chart 1.15). That largely reflects the effects of increased competition in the retail banking market as lenders have reduced margins on some products to maintain market share. As a result, the average rate paid on the stock of outstanding lending remains much lower than in the first half of 2016 (Chart 1.15), despite the more recent pass-through of higher risk-free rates.
Deposit rates have generally risen by less than the pickup in risk‑free rates over 2018, and are expected to adjust only gradually in coming quarters. That partly reflects developments since the financial crisis. Prior to 2008, sight deposits were several percentage points below Bank Rate and lending rates (Chart 1.15). But as there are limits to banks' capacity to lower deposit rates below 0%, deposit rates did not fall as much as Bank Rate during the crisis. As Bank Rate rises, the corresponding rise in deposit rates is therefore likely to be somewhat less as the spread between deposit rates and Bank Rate normalises.
Developments in other components of banks' balance sheets may also influence the path for deposit rates. On the asset side, to the extent that competition continues to weigh on lending rates, banks may moderate the pickup in interest paid on the stock of deposits to mitigate any erosion of their margins. Acting in the opposite direction, however, the recent pickup in wholesale market bank funding costs may increase banks' demand for retail deposits and push up deposit rates over time.
Corporate capital markets
Many large UK companies use both domestic and international markets to raise funding. Spreads on corporate bonds across the main markets in which UK companies borrow have been broadly stable since the August Report but remain wider than they were at the start of 2018 (Chart 1.16). Market contacts have cited a number of drivers of the widening in spreads, including the fall in global risk sentiment, the prospective end of the ECB's corporate bond purchase programme and US corporate tax reform in early 2018, which encouraged share buybacks among US companies and may have reduced demand for European debt.
Despite this widening over 2018, corporate bond spreads remain at low levels comparable with those seen before the financial crisis. Moreover, as discussed in the June Financial Stability Report, in some corporate bond markets, particularly in the US, those low spreads have been accompanied by an easing in non-price terms, such as weaker covenants. The recent pickup in leveraged lending, including in the UK (Section 2), has also been accompanied by an increased share of deals with weaker covenants.
Equity prices fell in the run-up to the November Report (Chart 1.9). Investor risk sentiment has deteriorated in part due to geopolitical developments. In addition, the prospect of a higher path for US interest rates has also weighed on equity prices. Among UK-listed companies, the equity prices of those with a substantial focus on the euro area — defined as companies with more than 40% of revenue derived from the euro area — have underperformed other companies substantially since June, perhaps reflecting increased uncertainty around the potential impact of the UK's withdrawal from the EU.
In the run-up to the November Report, the sterling ERI was 1% higher relative to three months ago (Chart 1.6). It remained 16% below its November 2015 peak, however.
As has been the case since the referendum, sterling will be particularly responsive to developments related to the UK's withdrawal from the EU. Implied volatilities from sterling options — measures of perceived risk around the exchange rate — have risen recently (Chart 1.17). And movements in the cost of insuring against a large depreciation relative to a large appreciation — known as the risk reversal — suggest that the weight market participants are placing on a future depreciation has risen (Chart 1.17).
1 For more details see Carney, M (2018), 'True Finance — Ten years after the financial crisis'.
Short-term interest rates increased in 2018
Bank Rate and selected market interest rates
- a Spot overnight index swap rates.
Mortgage interest rates have increased in 2018
Retail interest rates on lending and depositsa
- a The Bank's quoted and effective rate series are weighted averages of rates from a sample of banks and building societies with products meeting the specific criteria. Data are not seasonally adjusted.
b Sterling-only end-month quoted rates. The latest data points are flash estimates of provisional data for October 2018, due to be published on 7 November. Some of the differences in the rates between products will reflect sampling differences.
c Sterling-only average monthly effective rates. The latest data points are for September 2018.
UK bank funding spreads have widened over 2018
UK banks' indicative funding spreads
- Sources: Bank of England, Bloomberg Finance L.P., IHS Markit and Bank calculations.
a Constant-maturity unweighted average of secondary market spreads to mid-swaps for the major UK lenders' five-year euro-denominated bonds or a suitable proxy when unavailable. For more detail on unsecured bonds issued by operating and holding companies, see the 2017 Q3 Credit Conditions Review.
b Unweighted average of spreads for two-year and three-year sterling quoted fixed-rate retail bonds over equivalent-maturity swaps. Bond rates are end-month rates and swap rates are monthly averages of daily rates. October 2018 bond rates are flash estimates of provisional data, due to be published on 7 November.
The spread between Bank Rate and deposit rates remains below pre-crisis levels
Bank Rate and selected household effective interest rates
- a Effective rates on sterling household loans and deposits. The Bank's effective rate series are weighted averages of rates from a sample of banks and building societies with products meeting the specific criteria. Data are not seasonally adjusted.
b Data are only available from 2004.
c End-month rate.
Corporate bond spreads have widened during 2018
International non-financial corporate bond spreadsa
- Sources: Datastream from Refinitiv, ICE/BoAML Global Research and Bank calculations.
a Option-adjusted spreads to government bond yields. Investment-grade corporate bond yields are calculated using an index of bonds with a rating of BBB3 or above. High-yield corporate bond yields are calculated using aggregate indices of bonds rated lower than BBB3. Due to monthly index rebalancing, movements in yields at the end of each month might reflect changes in the population of securities within the indices.
The decline in the risk reversal suggests that the weight on sterling depreciating further has risen during 2018
Six-month sterling-US dollar risk reversal and implied volatility
- Sources: Bloomberg Finance L.P. and Bank calculations.
a 25-delta risk reversal. Risk reversals show the difference between the implied volatilities of equally 'out of the money' put and call options. Negative risk reversals mean that it is more expensive to insure against currency depreciations than appreciations.
Box 1: The impact of trade barriers on the global economy
Over 2018, barriers to trade have risen, in particular between the US and China, as has the risk of more widespread trade protectionism. Major trade measures announced during 2018 have so far taken the form of changes to tariffs — taxes on goods imported from abroad. Barriers to trade can also be increased through non‑tariff measures on goods and services imports, such as the imposition of import quotas or changes to the regulatory environment. The specific impact of trade measures will depend on their scale and type, though all have the broad effect of increasing the cost of trade and, all else equal, reducing trade flows between countries.
A broad-based increase in the barriers to trade between countries could have a material impact on global activity and, in turn, on the UK economy. In particular, the overall impact could extend well beyond the direct effects on those countries immediately involved. This box explains the channels through which trade barriers, particularly higher tariff barriers, affect activity and inflation, and sets out estimates of the possible impact of higher tariffs.
How could trade barriers affect activity and inflation?
Higher trade barriers will affect an economy through a number of channels. Some of those will be direct, such as disrupted supply chains and higher import costs, which reduce trade flows. Trade measures may also affect an economy through indirect channels, by affecting business or consumer confidence and financial conditions and, over the medium term, by reducing openness and therefore productivity. Given the integration of global supply chains and financial markets, those effects may spread beyond those countries that are directly involved.
Higher trade barriers will disrupt trade flows and can lower demand for the output of the countries involved. Increases in tariffs by country A on imports from country B will, all else equal, lower external demand for goods and services from country B. In addition, to the extent that companies in country A rely on imports from country B for their own production, trade barriers may affect domestic activity in country A as well, at least temporarily while supply chains are shifted. Those effects may be offset to some degree by other related factors. In country A, trade barriers to imports may stimulate domestic production of substitutes over time. And to the extent that its currency depreciates in anticipation of the higher cost of exporting, that should support activity in country B.1
Higher trade barriers will also push up prices in country A, as companies pass the higher cost of imports to their customers. The extent and pace of such pass-through to consumer prices will vary according to the type of trade barrier. For example, the pass-through of tariffs on capital or intermediate goods imports to consumer prices will typically be slower than equivalent tariffs on consumer goods. Further out, although the degree to which inflation increases will depend on the monetary policy response in country A, in all cases, higher import costs will reduce real incomes. That, in turn, will weigh on domestic demand, which could mitigate some of the direct inflationary impact of higher tariffs.
The effect of bilateral trade measures may also spill over to activity in other countries that are integrated into the supply chains of countries A and B. Other countries could face lower external demand if they supply exporters in country B who have been affected by country A's tariffs. Most countries have become increasingly integrated into global supply chains over time, particularly in Asia (Chart A). At the same time, other countries could benefit from diverted trade flows, as households and companies in country A seek alternatives to imports from country B, though it will often take time to shift supply chains.
The direct effects from higher trade barriers are only one part of the overall impact and are likely to be amplified by their indirect effects. Uncertainty around demand growth and the prospect of lower profitability could undermine business confidence and, in turn, investment. Any pickup in risk aversion in financial markets as a result of trade uncertainty could also lead to a tightening in financial conditions.
Over the medium term, persistently higher trade barriers, and the implicit reduction in countries' openness to trade, will affect productivity and potential supply growth. For example, a reduction in the size of the potential market available could hamper the ability of domestic firms of a given country to specialise, making it more difficult for them to exploit areas of comparative advantage and to achieve economies of scale. Further, a reduced openness to trade could lower the degree of competition, as well as firms' capacity to learn ideas and practices from foreign companies. And there is also some evidence to suggest that lower openness may increase income volatility within a country by reducing diversification in its sources of demand and supply.2
The impact of recent trade tensions
So far, the increase in trade barriers over 2018 has been largely limited to trade flows between the US and China. Following tariff increases on steel and aluminium earlier in the year, the US has increased tariffs on US$250 billion of Chinese imports, with China reciprocating with higher tariffs on US$110 billion of US imports. Anticipation of higher trade barriers has contributed to a slowing in survey measures of export orders in those countries (Chart B). And market contacts attribute some of the recent falls in asset prices in China and — given their role in Chinese supply chains — other emerging market economies to uncertainty about trade policy (Section 1.1). The MPC judges that those recent bilateral tariff increases will reduce GDP in China and the US by around 1% and ½% respectively over the next three years. The effects are likely to be largely confined to the countries directly involved, with small spillovers to some emerging market economies.
Although trade tensions between the US and some of its trading partners have eased somewhat - with trade deals agreed with Canada, Mexico and South Korea in recent months - the prospect of more widespread trade protectionism remains a risk. That would have much greater implications for the global outlook. For example, Bank staff estimates suggest that a scenario in which the US raised tariffs by 10 percentage points on all its trading partners could, if reciprocated, reduce global output by over 1% through direct channels, with US activity particularly affected.3
The trade measures implemented by the US and China so far are likely to have only a limited effect on the UK economy, largely through trade links with those countries. Slower growth in the US and China — which together accounted for 21% of UK exports in 2017 — could weigh somewhat on external demand in the UK. Nevertheless, a more substantial and widespread increase in trade barriers may have more material implications for UK activity both through their direct impact on external demand, and indirectly, by raising uncertainty and tightening financial conditions.
Integration into global supply chains has been increasing
Global supply chain participation indexa
- Sources: IMF WEO, OECD and Bank calculations.
a The index adds together the share of foreign value added embedded in a country's exports and the share of domestic value added embedded in a country's exports which is subsequently used by an importing country to produce their exports.
b Includes Cambodia, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand and Vietnam. Weighted using the IMF's purchasing power parity (PPP) weights.
c Includes 63 countries, accounting for 87% of global output in 2011 on a PPP-weighted basis. Weighted using the IMF's PPP weights.
Survey indicators of export orders have deteriorated in 2018
Survey measures of manufacturing export orders
- Sources: Datastream from Refinitiv, IHS Markit, JPMorgan, US Institute for Supply Management and Bank calculations.
a Measure of export orders growth based on the results of surveys in 44 countries. Together these countries account for an estimated 89% of global GDP.
Box 2: Monetary policy since the August Report
The MPC's central projection in the August Report was for GDP to grow by around 1¾% per year on average over the forecast period. Although modest by historical standards, that growth rate was slightly faster than the diminished rate of supply growth, which was projected to average around 1½% per year. As a result, a small margin of excess demand was projected to emerge by late 2019 and build thereafter, feeding through into higher growth in domestic costs than had been seen over recent years. The contribution of external cost pressures, which has accounted for above-target inflation since the beginning of 2017, was projected to ease over the forecast period. Taking these influences together, and conditioned on a gently rising path for Bank Rate, CPI inflation was projected to remain slightly above 2% through most of the forecast period, reaching the target in the third year.
At its meeting ending on 12 September 2018, the MPC noted that recent news in UK macroeconomic data had been limited and the MPC's August projections appeared to be broadly on track. UK GDP grew by 0.4% in 2018 Q2 and by 0.6% in the three months to July. The UK labour market had continued to tighten, with the unemployment rate falling to 4.0% and the number of vacancies rising further. Regular pay growth had risen further to around 3% on a year earlier. CPI inflation was 2.5% in July.
The global economy still appeared to be growing at above‑trend rates, although recent developments were likely to have increased downside risks around global growth to some degree. In emerging market economies, indicators of growth had continued to soften and financial conditions had tightened further, in some cases markedly. Recent announcements of further protectionist measures by the United States and China, if implemented, could have a somewhat more negative impact on global growth than was anticipated at the time of the August Report.
The MPC continued to recognise that the economic outlook could be influenced significantly by the response of households, businesses and financial markets to developments related to the process of EU withdrawal. Since the Committee's previous meeting, there had been indications, most prominently in financial markets, of greater uncertainty about future developments in the withdrawal process.
The Committee judged that, were the economy to continue to develop broadly in line with the August Report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to the 2% target at a conventional horizon. As before, those projections were conditioned on the expectation of a smooth adjustment to the average of a range of possible outcomes for the United Kingdom's eventual trading relationship with the European Union.
The Committee judged that the current stance of monetary policy remained appropriate. Any future increases in Bank Rate were likely to be at a gradual pace and to a limited extent.