Monday 26 August 2019

Global trade headwinds force a turn in the interest rate cycle

Fed chairman Jerome Powell (centre) with Francois Villeroy de Galhau, Bank of France governor and French finance minister Bruno Le Maire at the G7
Fed chairman Jerome Powell (centre) with Francois Villeroy de Galhau, Bank of France governor and French finance minister Bruno Le Maire at the G7

Conall Mac Coille

This week and last, attention has turned to whether central banks will soon be forced to use aggressive stimulus to counteract a global slowdown, largely brought on by Donald Trump's trade wars.

In this context, Mario Draghi's comments following the European Central Bank's policy decision on Thursday were underwhelming; not as dovish as some had hoped for.

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Nonetheless, the ECB still signalled fresh stimulus is coming, with Draghi commenting that the trigger for action would be core inflation remaining weak. However, with only three months left of Draghi's eight-year tenure, it will be left to Philip Lane and Christine Lagarde to oversee the next round of ECB stimulus policy.

Unfortunately, Irish homeowners with tracker mortgages look set to be disappointed. The ECB may well restart its quantitative easing programme and cut the deposit rate faced by banks, encouraging them to lend to households and businesses. However, a cut in the ECB's main refinancing rate, against which interest rates on tracker mortgages are set against, seems less likely.

In the coming week, attention turns to the Federal Reserve, expected to cut its policy rate by 0.25pc to 2-2.25pc. This will represent something of a U-turn for the Fed, coming only six months after its last rate hike in December. Despite claims from some commentators that the US economy could see a recession in 2020, there has been little sign of a slowdown. Jobs growth has remained strong. The last time the US unemployment rate was as low as 3.8pc was when Neil Armstrong walked on the moon.

And, of course, there is the steady steam of criticism of the Fed from Trump, arguing rates should be 1pc lower. Earlier this summer, former Fed vice-chair Stanley Fischer argued against any stimulus whatsoever, warning that a rate cut could threaten the independence of the Federal Reserve and would be inappropriate given the strength of the labour market.

Fed chairman Jay Powell hasn't made any attempt to persuade investors they may be mistaken in their belief a July rate cut is a foregone conclusion. Instead, Powell has highlighted the US economy faces cross-currents from Chinese trade tensions, uncertainty and a weaker global economy.

Powell is not alone in these concerns. Just this week, the IMF revised down its forecast for world GDP growth to just 3.2pc in 2019, the weakest pace in 10 years, when the global economy was still recovering from the financial crisis.

However, the IMF still expects the US economy to grow at a reasonably healthy pace of 2.6pc in 2019 and 1.9pc in 2020. If so, anything more than an 'insurance' cut from the Fed, to guard against the risk of slower growth and persistently weak CPI inflation, looks unwise. Instead, investors are pricing a much more aggressive course of action; three rate cuts by end-2019, expecting the Fed's policy rate to be slashed to 1.5-1.75pc.

Bear in mind the Fed's last 'dot-plot' (signalling where policymakers see interest rates going) showed that a majority of the Federal Open Market Committee still expected rates to be on hold by December.

Clearly, markets believe a much deeper, pernicious US downturn is on the way.

Perhaps the central banker with the biggest communications challenge is the Bank of England governor Mark Carney.

Only in May, Carney was warning that interest rates would have to rise faster than markets were pricing in. Two months on, the governor's tune has changed.

This week, the National Institute of Economic and Social Research became the latest body to warn the UK could suffer a technical recession through the summer months. So the coming week's August Inflation Report will be closely watched to see how deep the Bank of England believes the malaise in the UK economy will be.

In fairness to Carney, he has perhaps done the best job among central bankers of explaining why the economic outlook has become so uncertain. The Bank of England's economists have estimated Trump's threatened tariffs on China could reduce world GDP growth by 0.6 percentage points.

Carney also explained the impact could be far larger because global supply chains are far more integrated than in the past.

On that point, the recent synchronised downturn in global goods trade, business confidence and capital goods orders across the OECD could well signal a sharper deterioration than perhaps even the IMF's recent pessimistic forecasts suggest.

In short, across the world, companies are now putting off investment and hiring because of uncertainty on trading arrangements, be it US/China trade relations, or the UK's relationship with the EU. And all this has occurred even before the UK faces up to the risk of the worst possible outcome: a no-deal Brexit.

Post-Brexit rebound in the Irish housing market

New data from the Banking and Payments Federation Ireland this week showed the Irish housing market experienced a post-Brexit bounce once the original March 29 deadline had passed. Some €1.9bn of new mortgage loans for house purchase were drawn down in April-June, up 11pc on 2018. First-time buyer loans showed particularly strong growth, up 16pc to €1.1bn.

Despite fears of institutional investors crowding out home buyers, the number of first-time buyer loans was 5,040, up 11pc on the year. This is double the pace of growth in overall housing transactions, of 5pc.

In contrast, the buy-to-let mortgage market shows no signs of life. Through April to June, there were just 303 buy-to-let mortgage loans, down 20pc on 2018.

The first six months of 2019 were the weakest half for buy-to-let mortgage lending since 2014. Small investors wary of rent controls and stretched affordability are still exiting the market. This is good news for first-time buyers but bad news for those seeking rental accommodation.

First-time buyers are also taking on ever higher levels of mortgage debt. The average mortgage loan to first-time buyers was €226,000 in the past three months, a fresh high, up 4.4pc on the €216,000 recorded 12 months ago. Despite fears of falling house prices in Dublin, if first-time buyers are taking on more debt, it suggests upward pressures will soon emerge.

That said, the average mortgage loan to second or subsequent buyers was €255,000 between April and June, up only a paltry 0.2pc on the year. This is where the squeeze from the tightening of lending rules in 2018 was really felt, with only 10pc of second and subsequent buyers allowed to exceed the 3.5 times loan-to-income multiple.

However, June's mortgage approvals suggest conditions for movers may also be loosening. In June, the average approval to second and subsequent buyers was €269,000, up 5.2pc on the year, and for first-time buyers €236,000, up 4pc.

So absent a hard Brexit, or other unforeseen shock, house prices look set to rise at a modest pace. Average mortgage approvals are now rising slightly faster than wage growth, which has been above 3pc for some time. Essentially, house prices are rising at a natural rate, in line with incomes, but without home buyers taking on additional leverage, held in check by the Central Bank's mortgage lending rules.

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