The outlook for global growth has deteriorated a little, in part reflecting escalating trade tensions.
The market path for interest rates has fallen further in the UK since May, as in other advanced economies.
The probability market participants attach to a no-deal Brexit has increased. This has contributed to the lower path for UK interest rates and the 4% depreciation of sterling.
1.1 Global economic developments
Since May, the outlook for global growth has deteriorated a little. In 2019 Q2, UK-weighted world GDP growth appears to have slowed slightly to 0.4% (Table 1.A), slightly lower than expected in May. US and euro-area GDP growth both slowed, following surprising strength in Q1, to 0.5% and 0.2% respectively. Growth in emerging markets has been weaker than projected in the May Report, having slowed in the past year reflecting a previous tightening in financial conditions.
Higher-frequency indicators further suggest that global output growth may have weakened in recent months. Global PMIs have continued to fall since May, particularly in the manufacturing sector, where the output index has dipped below 50 (Chart 1.1). Forward-looking surveys suggest that growth is likely to stabilise in the near term. For example, the manufacturing export orders index has remained at a similar level over the past three months (Chart 1.1).
Softer global growth — particularly in the manufacturing sector — is likely at least in part to reflect the impact of trade tensions, which have increased over the past year and intensified further since May. The US and China both implemented higher tariffs over 2018, with the US applying tariffs to US$250 billion of imports from China, and China reciprocating with tariffs on US$110 billion of imports from the US. Tariffs were due to increase in 2019, but at the time of the May Report, those were not assumed to be implemented, given that trade talks between the two countries appeared to be progressing positively. Trade talks subsequently broke down, however, and tariffs were increased.
As well as the tariffs implemented so far, other developments have added to concerns about trade protectionism. For example, the US announced plans to impose further tariffs on all remaining imports from China, although in June both parties agreed to continue talks. The US administration is also considering whether to impose tariffs on automotive products, including those imported from the EU, with a decision expected later this year.
Trade tensions are likely to have affected the global economy through both direct and indirect channels. Tariffs introduced by the US and China have had a direct effect on their bilateral goods trade, with both Chinese imports from the US and US imports from China having fallen in the year to 2019 Q1. There are also likely to have been wider indirect effects via reduced global business confidence. Sentiment in the manufacturing sector has fallen over the past year, consistent with weaker world trade growth (Chart 1.2). Indicators of uncertainty about economic policy, including trade policy, have also picked up (Chart 1.3). That is likely to have weighed on investment, which has been a key driver of the recent slowdown in advanced-economy growth. Consumption growth has remained resilient, however.
Over the forecast as a whole, trade tensions are expected to drag on GDP growth by more than was assumed in May. Tariffs are projected to reduce GDP in the US by 0.5%, and in China by 0.4% once some offset from looser policy is incorporated. The overall impact is to lower PPP-weighted world GDP by 0.2% via direct channels, which weighs on UK GDP growth by 0.1%. It is also likely that there have been spillovers via business confidence, although the MPC’s central forecast assumes that they are only modest. A severe shock could lead to a much larger impact (Table 1.B).1
Price pressures in major advanced economies have been subdued. Inflation has remained weak in the euro area recently (Table 1.C). It was 1.3% in June, below the European Central Bank’s (ECB’s) target, despite a pickup in unit labour cost growth over the past year to above its pre-crisis average. Inflation in the US was close to 2% during most of 2018, but it was below the Federal Reserve’s target in June 2019 at 1.4%. The Federal Open Market Committee (FOMC) has noted, however, that transitory factors such as financial services fees and a methodological change to clothing price collections may be weighing on measured inflation.
Measures of inflation expectations derived from financial market prices have also fallen in the euro area and the US. In the euro area, the five-year inflation swap rate, five years forward, has fallen by around 40 basis points since late 2018 (Chart 1.4) to an all-time low in June. The equivalent measure in the US has also fallen over that period, but its level is higher at around 2%. By contrast, UK inflation swap rates have changed little since May (Section 4).
Weaker-than-expected activity data, trade tensions and low inflation may all have contributed to the marked fall in the market-implied paths for policy rates in the US and euro area (Chart 1.5). Nonetheless, the fall in US forward interest rates appears large relative to the news in the data and the estimated impact of the tariffs implemented to date. It is therefore possible that the falls in US forward interest rates also reflect perceptions of increased risks around the global outlook — for example that tariffs increase further — as well as a weaker central projection for global growth.
Lower interest rate expectations may also reflect central bank communications. In the euro area, interest rate expectations fell sharply after the President of the ECB stated that additional stimulus would be required if inflation fails to return to the target. In the US, the median projection of FOMC participants for the federal funds rate at the end of 2020 fell from 2.6% in March to 2.1% in June, indicating a lower expected path for interest rates. [The FOMC then reduced its target range for the federal funds rate at its July meeting.] There has been little change to monetary policy in China since May, although fiscal policy has been loosened significantly since the start of the year.
The fall in market-implied paths for interest rates has supported equity prices. Equity prices were slightly higher in the US in the run-up to this Report than in May. They were broadly unchanged in the euro area, but a little lower across emerging markets (Chart 1.6). Over the period as a whole, corporate bond spreads are little changed. Overall, global financial conditions are estimated to be looser than at the time of the May Report, reflecting the fall in forward interest rates in advanced economies, which are likely to contribute to looser financial conditions in emerging markets.
In the MPC’s projection, the easing of global financial conditions supports a gradual pickup in world GDP growth to its potential rate. The forecast is nonetheless a little weaker than in May. That reflects the downward impact of higher tariffs and the related effect of weaker sentiment (Section 5).
1. For details, see Carney, M (2019), ‘Sea change’.
Global GDP growth appears to have slowed slightly in 2019 Q2
GDP in selected countries and regionsa
- Sources: Eikon 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 exports in 2017.
b Estimates from 2010 Q4 onwards are from the National Bureau of Statistics of China. Earlier estimates are based on OECD data.
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 2019 Q2 is a Bank staff projection. The latest US and euro-area GDP data for 2019 Q2 have not been incorporated into this projection.
Survey indicators of global output growth have fallen, particularly in the manufacturing sector
Global purchasing managers’ indicesa
- Sources: Eikon from Refinitiv, IHS Markit and JPMorgan.
a Measures of current monthly composite (services and manufacturing) output, manufacturing output, and manufacturing export orders growth based on the results of surveys in 44 countries. Together these countries account for an estimated 89% of global GDP.
World trade in goods growth has remained weak and sentiment in the manufacturing sector has deteriorated further
World trade in goods and OECD business confidence in the manufacturing sector
- Sources: CPB Netherlands Bureau for Economic Policy Analysis, OECD and Bank calculations.
a OECD indicator based on the arithmetic average of seasonally adjusted net balances for expected production, levels of order books and stocks of finished goods in the manufacturing sector.
b Three-month moving average. Volume measure.
Measures of global economic policy uncertainty remain elevated
Global economic and trade policy uncertainty
- Sources: policyuncertainty.com and Bank calculations.
a Monthly measure of media citations of terms related to economic policy uncertainty, based on data from 20 countries. The index is weighted by PPP-adjusted GDP and together these countries account for an estimated 70% of global GDP. For details, see Baker, S R, Bloom, N and Davis, S J (2016), ‘Measuring economic policy uncertainty’, The Quarterly Journal of Economics.
b Quarterly measure based on the number of references to terms related to trade and uncertainty in Economist Intelligence Unit country reports. The index is equally weighted, based on data from 143 countries.
Trade tensions are expected to have a modest direct effect on GDP, but the indirect effects could be larger
Estimated impacts on the levels of GDPa
- a Peak impacts over a three-year period.
b Measures already implemented are the US tariffs on steel and aluminium, the tariffs on US$250 billion of US imports from China and those on US$110 billion of Chinese imports from the US.
c The direct tariff impact on Chinese GDP is smaller than the estimate in Box 1 of the November 2018 Report, because this estimate assumes that the Chinese authorities loosen policy to offset some of the impact of higher tariffs.
Inflation has been subdued in the euro area and the US
Inflation in selected economies
- Sources: Eikon from Refinitiv, Eurostat, ONS, US Bureau of Economic Analysis and Bank calculations.
a Personal consumption expenditure price index inflation.
b For the euro area and the UK, excludes energy, food, alcoholic beverages and tobacco. For the US, excludes food and energy.
Implied inflation expectations in the US and euro area have fallen since the May Report
Changes in five-year, five-year forward inflation compensation since the start of 2018a
- Sources: Bloomberg Finance L.P. and Bank calculations.
a Derived from swaps. The instruments used are linked to the UK RPI, US CPI and euro-area HICP measures of inflation respectively.
1.2 Domestic financial conditions
Market interest rates, sterling and equity prices
The market-implied path for Bank Rate has fallen over the past three months, continuing its decline since late 2018. It now implies a 25 basis point cut in Bank Rate over the coming year (Chart 1.5). Over the forecast period, the market implied path is on average around 70 basis points lower than in November and around 30 basis points lower than in May. Long-term UK interest rates have also fallen by around 40 basis points since May.
Bank staff analysis suggests that the decline in UK forward interest rates since May can partly be attributed to global factors. For example, trade tensions and perceived downside risks to the global economy may have driven investors towards risk-free assets such as government bonds, reducing the yields on those assets.
Lower interest rates also reflect changing views among market participants about the probabilities of different Brexit outcomes. The latest betting odds suggest that the perceived probability of no deal has risen. The Reuters survey, which asks respondents about the probability of a disorderly Brexit, suggests that probability has also risen materially since May. As the weight attached to the possibility of a no-deal Brexit has increased, financial market participants have marked down their expectations for the path of interest rates.
Financial market participants’ expectations that the economy would be weaker in the event of a no-deal Brexit also mean that the sterling exchange rate tends to depreciate as the probability of a no-deal Brexit rises. The sterling ERI has fallen by 4% since the May Report (Chart 1.7). Sterling implied volatility has increased since May and the cost of insuring against a large depreciation - known as the risk reversal - has also risen. Since the forecast was finalised, sterling has depreciated further by around 2%, while sterling implied volatility and the risk reversal have increased a little more.
The growing perceived probability of a no-deal Brexit has put downward pressure on the equity prices of UK-focused companies (Chart 1.6). In contrast, the equity prices of UK-listed companies with significant overseas operations have risen, such that the FTSE All-Share index has been broadly unchanged. Because much of those companies’ profits is earned in foreign currency, their sterling value is mechanically boosted by the exchange rate depreciation.
Credit conditions facing companies and households
Corporate credit conditions were little changed in 2019 Q2. Corporate bond spreads across the main markets in which UK companies borrow are broadly similar to those at the time of the May Report. The cost and availability of bank lending to companies was also little changed in Q2, according to the Credit Conditions Survey. Contacts of the Bank’s Agents reported some tightening in credit conditions for firms in a few sectors, for example construction and high-street retail.
For households, most mortgage rates were unchanged over 2019 Q2, and have now been stable for over a year. That is despite spreads on unsecured bank funding having fluctuated substantially. As discussed in Box 1 of the February 2019 Report, wholesale unsecured funding spreads are likely to be less important for retail banks’ loan pricing than in the past. That is because the large retail banks have increased their share of deposit funding — particularly sight deposits — relative to wholesale funding.
Although rates on consumer credit have been little changed since the run-up to the May Report (Table 1.E), there has been some tightening in credit conditions in the unsecured lending market. Credit card rates have increased over the past year, and respondents to the Credit Conditions Survey have been reporting falls in the availability of unsecured credit, as well as tighter credit scoring criteria, for some time. Respondents also reported that default rates on unsecured lending had risen for the third consecutive quarter in 2019 Q2. Supervisory intelligence indicates that default rates nevertheless remain at low levels, and other indicators of household distress have not worsened.
Overall domestic financial conditions
A summary measure of UK financial conditions suggests that conditions have loosened since May (Chart 1.8). That reflects the fall in market interest rates and the sterling ERI, partly offset by higher credit spreads as banks have not yet passed through the fall in risk-free rates to lending rates.
That easing in financial conditions provides some support to UK growth in the MPC’s forecast compared with the May Report. Market movements have been partly driven by an increase in the perceived likelihood of a no-deal Brexit, however, which is not consistent with the MPC’s forecast conditioning assumption of a smooth Brexit. That tension is discussed further in Box 6 in Section 5.
Market-implied paths for interest rates have fallen further since the May Report
International forward interest ratesa
- Sources: Bloomberg Finance L.P. and Bank calculations.
a All data as of 24 July 2019. The August and May 2019 and November 2018 curves are estimated using instantaneous forward overnight index swap rates in the 15 working days to 24 July 2019, 24 April 2019 and 24 October 2018 respectively.
b Upper bound of the target range.
The FTSE All-Share index is broadly unchanged, but equity prices have fallen for domestically focused UK firms
International equity pricesa
- Sources: Eikon 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.
Sterling has fallen since May
Monitoring the MPC’s key judgements
Retail interest rates remain low
Selected household quoted ratesa
- a The Bank’s quoted rate series are weighted monthly average rates advertised by all UK banks and building societies with products meeting the specific criteria. Not seasonally adjusted. Data for July are flash estimates and subject to change until they are published on 7 August. In February 2019 the methodology used to calculate these data was changed. More information is available here.
UK financial conditions have loosened since the May Report
Contributions to changes in the UK Monetary and Financial Conditions Index since the May 2019 Reporta
Sources: Bloomberg Finance L.P., Eikon from Refinitiv, ICE/BoAML Global Research and Bank calculations.
a The UK Monetary and Financial Conditions Index (MFCI) summarises information from the following series: short-term and long-term interest rates, the sterling ERI, corporate bond spreads, equity prices, and household and corporate bank lending spreads. The series weights are based on the marginal impact of each variable on the UK GDP forecast. The chart shows changes in the MFCI from the average level over the 15 working days to 24 April 2019. An increase in the MFCI signals tighter financial conditions and a decrease signals looser conditions. For more information, see the Bank Overground post ‘How can we measure UK financial conditions?’.
Box 1 Monetary policy since the May Report
At its meeting ending on 19 June 2019, the MPC noted that the near-term data had been broadly in line with the May Inflation Report, but that downside risks to growth had increased. Globally, trade tensions had intensified. Domestically, the perceived likelihood of a no-deal Brexit had risen. Trade concerns had contributed to volatility in global equity prices and corporate bond spreads, as well as falls in industrial metals prices. Forward interest rates in major economies had fallen materially further. Increased Brexit uncertainties had put additional downward pressure on UK forward interest rates and had led to a decline in the sterling exchange rate.
As expected, recent UK data had been volatile, in large part due to Brexit-related effects on financial markets and businesses. After having grown by 0.5% in 2019 Q1, GDP was now expected to be flat in Q2. That in part had reflected an unwind of the positive contribution to GDP in the first quarter from companies in the UK and the EU building stocks significantly ahead of Brexit deadlines. Looking through recent volatility, underlying growth in the UK appeared to have weakened slightly in the first half of the year relative to 2018 to a rate a little below its potential. The underlying pattern of relatively strong household consumption growth but weak business investment had persisted.
CPI inflation had been 2.0% in May. It was likely to fall below the 2% target later this year, reflecting falls in energy prices. Core CPI inflation had been 1.7% in May, and core services CPI inflation had remained slightly below levels consistent with meeting the inflation target in the medium term. The labour market had remained tight, with data on employment, unemployment and regular pay in line with expectations at the time of the May Report. Growth in unit wage costs had remained at target-consistent levels.
At the time of its June meeting, the MPC judged that the existing stance of monetary policy remained appropriate. The Committee continued to judge that, were the economy to develop broadly in line with its May Inflation Report projections that included an assumption of a smooth Brexit, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon.
The MPC noted that the economic outlook would continue to depend significantly on the nature and timing of EU withdrawal, in particular: the new trading arrangements between the EU and the UK; whether the transition to them is abrupt or smooth; and how households, businesses and financial markets respond. The appropriate path of monetary policy would depend on the balance of these effects on demand, supply and the exchange rate. The monetary policy response to Brexit, whatever form it takes, would not be automatic and could be in either direction.