UK economy in focus after Moody’s downgrade

CMC Markets

Last week saw European equity markets complete their fifth successive week of gains, helped by rising optimism that despite a series of false starts, we could be nearer to a significant thaw in US, China trade relations than we’ve been for quite some time.

Bond markets also appear to have been caught up in the recent enthusiasm with yields rising sharply at their fastest pace for quite some time, while gold prices slid to a three month low.

While perceptions of a thaw in US, China relations has been one factor behind this sharp rise in yields, along with a steepening of the yield curve, there has also been the expectation that the US won’t implement any new tariffs on the European auto sector later this week.

This was after outgoing European Commission President Jean Claude Juncker said that the US would not be imposing them on Wednesday, while President Trump is due to give a speech on trade policy tomorrow, having said on Friday that he had not agreed to roll back tariffs on China, despite many reports to the contrary, which helped fuel last week’s “risk on” rally.

US Federal Reserve Chairman Jerome Powell is also expected to give testimony to policymakers on Capitol Hill this week in his latest testimony on how the US economy is faring, while we’ll also get some important Chinese economic numbers.

The Chinese economy is starting to show signs of a modest improvement if recent PMI numbers are any sort of guide, however the latest inflation data painted a rather different picture, with producer prices slipping 1.6%, while the headline CPI numbers jumped sharply, to 3.8% as Chinese consumers had to contend with surging pork prices, on the back of the swine flu epidemic, which has resulted in widespread culling of Chinese pigs. This may also help explain why China increased its demand for US pork imports last week.

On Friday, ratings agency Moody’s downgraded the UK’s credit outlook from stable to negative, citing risks from higher government borrowing, and political instability, thus joining its counterparts, Fitch and Standard and Poor’s, which already have the UK on negative watch. There was a time a few years ago when an action such as this from a ratings agency would have prompted a market reaction, however those days are long gone.

While a ratings or outlook downgrade, is never particularly welcome news, such is the state of the world economy, and the fractious nature of global politics, the UK is hardly alone, and probably has a more stable and predictable outlook when compared to Europe’s institutions, though that could change on December 12th.

It’s also set to be a big week for UK economic data this week, with the latest inflation, wages and unemployment numbers due out, as well as a host of other economic reports, including GDP and retail sales.

Today we’ll get to find out if the UK economy slipped into recession in Q3, after a contraction in Q2. Recent PMI’s would appear to paint a rather feeble rebound from a disappointing Q2, however sometimes these can paint a much more pessimistic view of the economy than is immediately apparent.

Expectations are for the economy to rebound by 0.3% in Q3, more than offsetting the contraction in Q2, part of which was caused by a slowdown in the aftermath of economic activity being pulled forward into Q1, just before the first Brexit extension of 29th March. The rebound is largely expected to have been driven by the services sector, which makes up almost 80% of the UK economy and tends to do all the heavy lifting in most cases. The services sector is expected to contribute 0.4% of growth in Q3, with private consumption also contributing to a healthy rebound.

Both imports and exports are also expected to rebound modestly after a really poor Q2.

Given the current climate politically this would certainly be good news politically for the Conservative party as markets look ahead to next month’s election, and certainly calls into question last weeks calls by two Bank of England policymakers to cut interest rates by 25bps.

In terms of the rest of the economy, manufacturing has struggled over the course of the last three months, though to be fair, so has the rest of Europe, and this is likely see another contraction in industrial and manufacturing production in September of 0 1% and 0.2% respectively.

EURUSD – the euro has slid back sharply after last week’s failure to overcome the 1.1180 area and 200-day MA. The speed of the decline suggests we could see a move towards 1.0980 with a break opening up a return to the October lows of 1.0880.

GBPUSD – the inability to hold recent gains above the 1.30 area earlier this month has seen the pound slide back. A move towards the 200-day MA at 1.2680 looks a possibility having slipped below the 1.2840 area.

EURGBP – currently trading sideways above the 0.8570 area with resistance at the 0.8670 area. A break below the 0.8570 level has the potential to open up a move towards the 0.8410 area and the lows this year.

USDJPY – has edged beyond the 200-day MA and the 109.20/30 area, however could run into resistance at the 109.80 area, though the bigger level is likely to be found at the 110.20 area. This is trend line resistance from the 2018 highs at 114.75. Support is likely to come in at the 109.00 area.