In among all the concern about economic growth rolling over, it is important to recognise that central banks are still heading to the exit. Just before Christmas the Sveriges Riksbank, the world’s oldest central bank, raised rates for the first time in this cycle, a move that went largely unnoticed.
In its monetary report, the Riksbank acknowledged that countries were entering ‘a phase of more subdued GDP growth’ globally. The central bank referenced the uncertainties surrounding ‘the UK’s withdrawal from the European Union and the ongoing trade conflict between the US and several other countries’. But, as with other countries the ‘supply of labour has increased rapidly, which, together with the strong economic activity, has contributed to the employment rate and labour force participation rate reaching historically high levels in Sweden… The percentage of companies stating that they are experiencing labour shortages is the highest… (since) 1996.’
At the same time as the Riksbank was raising rates, the European Central Bank was publishing articles. The first examined wage drift in the euro area, giving the ECB more confidence that the significant pick-up in wages seen in the euro area will be sustained. A second argued that the slowdown of 2018 was largely the result of external developments and temporary factors. With the Philips curve (which identifies the inverse relationship between unemployment and inflation) kicking in and wages accelerating, the intended direction of travel for the ECB remains clear, at least for now.
Which brings us to the Bank of England. Many economists have not bought into the view that the bar for the BoE raising rates again is relatively low. There still seems to be a perception that in the event of a no-deal Brexit, the BoE would cut rates. This may of course be true but does not take on board the risk that in a truly disorderly Brexit, with perhaps a change of government, the BoE may be forced to raise rates in defence of the pound.
BoE data released last week highlight the role played by foreign buying of the gilt market in financing the UK current account deficit, which widened to 4.9% of GDP in the third quarter of 2018. Net foreign buying of gilts was £2.4bn in November, after £5bn in October. Indeed, between the third quarter of 2016 and the third quarter of 2018, net foreign buying of gilts totalled £59.1bn, roughly one-third the size of the current account deficit (£183.4bn), further highlighting the risk of a no-deal Brexit.
The end of quantitative easing brings with it the risk of a significant snap-back in capital flows globally. Latest monthly data show net euro area buying of foreign bonds falling further into October, with potentially important implications for the euro-dollar exchange rate. Net euro area buying of debt securities internationally is back to levels seen before QE was introduced. Net foreign selling of Italian debt securities was €3.3bn in October, a month when the Italian-German spread widened again. That brought the total net foreign selling of Italian bonds to €50bn in the first 10 months of last year.
In 2017 the euro area benefited from substantial net foreign buying (€487.1bn) of its equity markets. The figure for the first 10 months of 2018 was still €155.7bn, including €10.4bn of net foreign selling of euro area equities in August and a further €5.8bn in September, followed by €2.3bn of net foreign buying in October.
With net foreign buying of euro area equities so correlated to economic surprises, it is important for equity markets that economic growth starts surprising on the upside again. Arguably, given how downbeat expectations for 2019 are, that may not be difficult. The only year since European economic and monetary union commenced in 1999 to see net foreign selling of euro area equities was 2008, the year of the great recession.
David Owen is Managing Director and Chief European Economist of Jefferies.