UK: Eyes turn to the referendum on 23 June
PM David Cameron reached consensus with EU counterparts on the UK’s reform requests ahead of a referendum on its EU membership. The deal includes: (i) an “emergency” brake usable for seven years to suspend in-work social benefits to EU workers for a four-year period and under special conditions; (ii) ability to abide by new specific provisions from the single rulebook on financial regulation; and (iii) acknowledgement that the UK is not committed to further EU political integration. The question at the 23 June referendum will be “Should the United Kingdom remain a member of the European Union or leave the European Union?”. We continue to expect the UK will remain in the EU (even if by a narrow margin). However, the fears of a UK exit from the EU will affect sentiment and possibly delay investment decisions (see EH’s Economic Insight 30 November 2015). We expect the negative impact will be highest in Q2 but it is already visible in declining portfolio investment (-GBP85bn since Q2 2015, with a potential Brexit explaining around 40% of the fall and the rest reflecting the general economic environment (including GDP slowdown, dovish monetary policy and external headwinds). We expect GDP growth will slow to +2% in 2016, from +2.2% in 2015, and to +1.9% in 2017.
China: It’s complicated
USD-denominated exports contracted further in January (-11.2% y/y from -1.4%) and producer prices contracted for the 47th consecutive month (-5.3% y/y). Total Social Financing, which is a measure of aggregate financing flows, increased to RMB3.4tn (from RMB1.8tn in December 2014). Banks issued RMB2.5tn of new loans. While this surge is partly due to seasonal factors (liquidity injection ahead of the Lunar New Year holidays) it also reflects a more accommodative PBoC monetary stance. In the short term, this could support firm domestic demand growth in Q1. In the longer term, a sustained increase of this magnitude, particularly if it is directed at companies, increases the need for deleveraging. Corporate debt is already around 160% of GDP, industrial profits were down -2.3 y/y in 2015 and growth in insolvencies in 2016 is forecast at +20%. We expect the authorities will step up fiscal support (deficit target of -3.5% of GDP, at least) with further tax cuts and more fiscal spending for infrastructure and social welfare. GDP growth may decelerate but is likely to remain around +6.5%.
U.S.: A hint of inflation
A leading index of consumer confidence fell from 97.8 to 92.2 in February, driven by “turmoil in the financial markets”. Existing home sales increased by +0.4% m/m in January, to the second highest level in nine years, and by +11% y/y. Median prices slipped -3.2% m/m (+4.8% y/y). Housing starts and permits fell by -3.8% m/m (+1.8% y/y) and -0.2% m/m (+13.5% y/y), respectively. The homebuilder sentiment index fell in February from 61 to a still strong 58, but it was the lowest since May 2015. Meanwhile, two regional Fed manufacturing surveys continued to signal contraction, but manufacturing industrial production gained +0.5% m/m in January (+1.2% y/y). The gain was driven by a sharp +2.8% m/m increase in motor vehicle production and by a very strong +6.2% y/y. Consumer prices were flat, but the core rate (excluding food and energy) gained +0.3% m/m. On a y/y rate, core CPI is now 2.2%, the highest since June 2012, and markedly above last January’s 1.6%. Core producer prices gained +0.4%, but the y/y rate remained at a low +0.7%.
Eurozone: Softer business confidence. Don’t panic!
Preliminary estimates of February PMI signal a mild slowdown in overall activity, with the composite PMI at 52.7 (-0.9pps), the third consecutive month of deceleration since a four-year peak of 54.3 in December 2015. This stems mainly from weakness in the manufacturing sector, with the PMI down to 51.0 from 52.3 the previous month and 53.2 in December. The services sector showed stability, with the PMI at 53.0 (53.6 in January). While France’s composite PMI registered contraction in February, at 49.8 from 50.2 in January – reflecting weaker services, 49.8 from 50.3 – the overall picture is one of recent relative stability. In contrast, Germany showed significant weakening in manufacturing, down to 50.2 from 52.3 in January and 53.2 in December. New orders in the manufacturing sector increased at the slowest pace since July 2015, while new export orders increased only marginally, pointing to difficulties for exporters with exposure to the emerging markets. We expect Eurozone GDP growth will be modest in 2016, probably slightly weaker than the current forecast of +1.7% (+1.5% in 2015).