Deeper Double-Dip in UK
GBP came under pressure on Wednesday with cable dropping 75 pips after UK Q2 GDP fell by 0.7% q/q and 0.8% y/y, much weaker than consensus estimates. The UK’s ONS reported the Q2 GDP fall of 0.7% q/q was the largest decline since Q1 2009, while the y/y decline of 0.8% was the deepest since Q4 2009. There was a high degree of uncertainty behind the estimates and the ONS said the impact of the Jubilee and weather is not yet fully known. The euro rallied on ECB member Nowotny’s comments that he can see the arguments in favour of giving the ESM a banking license. We view these comments as being slightly taken out of context, however, and our rates strategists still see any such move as unlikely. They note that Mr. Draghi has repeatedly rejected the idea, stating in December that the spirit of the Treaty (with respect to rules about state monetary financing) needs to be respected and saying in the last monthly press conference that acting outside of its mandate would destroy its credibility. Nonetheless, with the investor base aggressively short euros, the admission that this idea is at least under discussion was enough to prompt a short squeeze. German IFO data surprised to the downside with the July business climate 103.3 vs 104.5 consensus, but investor focus is clearly shifting towards front-running any signs of progress from the policy side, even if as we mentioned, this may be slightly misguided. Late during the US session on Tuesday, a Wall Street Journal article reported that FOMC officials are growing increasingly “impatient” with the faltering pace of the US recovery and are therefore “moving closer to taking new steps”. The article has also mentioned the possibility of the Fed reducing the Interest on Reserves. Similar procedures are being mulled elsewhere, but the effect on money markets could prove disruptive, as we have already seen in the Eurozone where the ECB’s deposit rate cut has led to the closure (but not liquidation) of many money-market mutual funds, depriving funding markets of much-needed short-term liquidity. Meanwhile, in Australia CPI came in at 0.5% in Q2, a touch weaker than expected but our economists note that the print means the RBA will likely hold rates. Our economists have adjusted forecasts for policy and now no longer expect any more cuts from the RBA. Upside pressure on the AUD is likely to continue if the RBA conditions accordingly. In addition to stellar sovereign ratings, the yield advantages are now even clearer, especially in an environment where the major economies are seeking new possibilities to reduce borrowing costs and increase money multipliers.
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