Yield curves almost everywhere have been flattening. At the long end of yield curves, bonds have been rallying all year. This is to be expected in Europe, where growth remains lacklustre, inflation is very weak, and the ECB is firmly in easing mode. However, even in the UK and the US, where the market has been gingerly pricing in the beginning of (perceived) hiking cycles, long bonds have been rallying.
Much has been made of the made of Chancellor George Osborne’s success with austerity and the UK’s eruption back into growth, confounding his critics. However, ‘austerity’ has been more of a publicity exercise. Government spending as percentage of GDP has fallen only slightly, but is still higher than it ever was before the financial crisis.
We have seen strong coincident activity in the UK in recent months, helped in part by a government-engineered boost to the housing market, which has lifted consumer spirits and caused retail sales to surge. Our leading indicator anticipated this upturn in the economy, and it continues to see no blots on the horizon (ie over the next 6 to 9 months), although this month it has leveled off slightly rather than continuing to climb.
There are some notable reasons for near-term reasons for optimism in the UK. The housing market seems to be picking up, industrial production growth is looking up together with PMI data and the equity market has done well. All these are real and significant signs of a better economy in the UK, but the structural challenges remain.
Data in the UK have taken an unequivocally positive turn. PMIs for services, construction and manufacturing are at 3 year highs. Furthermore, the underlying picture is healthy, with the new orders to inventory ratio for manufacturing surging to 1.4. This has resulted in growth forecasts being upgraded, including the OECD, which now sees annualized growth in 2H13 of 3.5%, compared to the BoE’s last estimate of 2.8%.
Data in the UK has been broadly positive, with much fanfare over revised GDP data showing the UK avoided the dreaded ‘double dip’. This is a trivial distinction; the reality is the UK is still bumping along the bottom. Manufacturing…
The UK Treasury’s decision to transfer coupon income from the Bank of England’s Asset Purchase Facility is a step towards ‘fiscal dominance’, where the fiscal authority ultimately gains the upper hand from the central bank and we see monetisation of public sector debts and deficits.
The strength of sterling has been in part due to some safe-haven flows from the Middle East (where sometimes GBP is seen as a preferable safe-haven to the USD or CHF), but this is not the fundamental driver.
Despite an historic low Bank of England base rate, the spread between the standard variable rate (SVR) for mortgages in the UK and the base rate widened significantly in the aftermath of the financial crisis, and has continued to trend higher.