Sunday 22 September 2019

Daily Market Update: Euro zone unemployment falls by more than expected, while core inflation again ticks higher


Simon Barry

Friday’s session featured some mildly encouraging news on the euro zone economy.

The unemployment rate in the zone fell by more than expected to reach a new cycle low of 10.8% in October – its lowest level in over three and a half years. While this is still a very hig level of joblessness (contrast Friday’s 10.8% with the 5‐5.5% rates in the US and UK at present, for example), at least a downward trend has become increasingly well‐established. Peak unemployment in the zone was 12.1% in March‐May 2013 and the rate has been edgin lower since then, consistent with the modest recovery that has since taken hold in the euro zone economy. On the prices side, headlin inflation was in line with market forecasts at 0.0% in the year to October, up from ‐0.1% in September.

But core inflation was a touch firmer than expected in rising to 1% in October from 0.9% the previous month. Core inflation has been ticking higher in recent months since hitting record lows of 0.6% earlier this year, and taking this mini‐trend together with the coming upward move in headline inflation (energy base effects will likely see headline inflation rise by about 1% points by January) should serve to ease concerns about deflation risks in the zone. Indeed, there are probably some hawks on the ECB’s Governing Council who are looking at the latest trends in confidence, unemployment and inflation and questioning the merit of pulling the trigger on more stimulus. It would be a major surprise at this stage, however, if Draghi didn’t deliver on his very dovish signal from last month’s press conference, though the recent newsflow may see the amount of any new stimulus coming in towards the more modest end of the possible range of outcomes.

Elsewhere, in the US real consumer spending was in line with market forecasts in rising by 0.2% in September. This was an outcome that resulted in another very solid quarter for the US consumer with the 3.2% annualised growth in Q3 following on from the very punchy 3.6% chalked up in Q2. A strong upside surprise in the Chicago PMI (which jumped from 48.7 in September to 56.2 last month) also offered encouragement on US growth momentum. In contrast, price developments remain subdued, evidenced by modest downside surprises in both the core PCE deflator and long‐term inflation expectations in the university of Michigan survey on Friday.

This leaves the big picture facing the Fed largely unchanged: the economy (especially the domestic‐facing elements) looks in pretty goo shape, but strong price pressures are largely absent, for the time being at least. The Fed itself has squared this circle by emphasising the role of the labour market in shaping its forward‐looking view on inflation pressures, with continued improvement in the jobs marke underpinning its expectation for a gradual acceleration in inflation back to the 2% target from the 1.3% reading on core inflation posted on Friday. This leaves the focus for the week ahead squarely on Friday’s official employment report. This will be the second‐last jobs report before the Fed’s next meeting in mid‐December and so this week’s figures will play a very important role in shaping investor expectations for that meeting.

Our own sense – importantly influenced by the solid ongoing improvement in jobless claims ‐ is that we may see a firmin in the pace of jobs growth in October after two disappointing readings in August and September. The market too is expecting a better number (180k this time vs. an average of around 140k in the two prior months) though we wouldn’t be surprised to see an even stronger number on Friday. In turn, that leaves us favouring a stronger dollar for the coming week, especially vs. the euro: the greenback opens at $1.1025 and $1.5450 against the euro and pound respectively, a combination that leaves Eur/GBP at around 71.4p as the first session of the European trading week kicks off.

Elsewhere in the US, both the ISM Manufacturing & ISM Non‐Manufacturing are expected to be released for October, today and Wednesday respectively. Expectations are for the Manufacturing index to fall from 50.2 in September to the breakeven level of 50.0. However, the much more important Non‐Manufacturing index is expected to hold up far better, with expectations for a reading of 56.5 – consistent with rapid expansion – coming off the back of a 56.9 release in September.

Manufacturing PMIs are released in the UK today. Expectations are for a marginal decline from 51.5 in September to 51.3 in October. However, this decline is expected to be more than offset by a gain in the service PMIs on Wednesday, from 53.3 to 54.5, which would leave the composite figure edging up from 53.3 to 53.6. The Bank of England MPC makes a policy announcement on Thursday. Althoug there are virtually no expectations for a change in rates, the decision is released alongside the bank’s quarterly Inflation Report, a crucial steer on future policy. The MPC will have a difficult task in balancing a desire to remind markets that their outlook is more hawkish than expectations are allowing for with an acknowledgment that the economy did not evolve quite as well as they would have wished in Q3. Our view is that the bank will likely use the report to illustrate that they do not fully endorse the benign expectations currently priced into UK interest rate markets. The standard way to do this would be to produce an inflation forecast that shows a modest overshoot of CPI relative to the 2% target in 2‐3 years, which is what we expect them to do. We think that this could lead to some upward pressure on UK market interest rates and sterling’s exchange rate as we look to the week ahead. On Friday, UK industrial production is expected to decelerate in September to 1.3% y/y following 1.9% in August.

In the Euro Area, retail sales are expected to accelerate from 2.3% in August to 3.0% y/y in September on Thursday. Finally, ECB President Draghi speaks on Tuesday and Thursday.

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