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Markets Weekly

14 February 2020

4 minute read

Week ahead

Next week’s key macroeconomic data for the main developed economies start on Tuesday with the UK’s December unemployment figures. The number of vacancies rose for the first time in seven months in November, with those in employment climbing at its strongest pace in over 50 years at 208,000. That said, December’s election may make it difficult to get a true gauge of the resilience of the jobs market.

UK inflation and retail sales data for January follow on Wednesday and Thursday respectively. Inflation fell to a three-year low in December, hitting 1.3%. January’s data is unlikely to show much of a pick-up, with the rate of price increases remaining significantly below the central bank’s target.

Retail sales ended 2019 poorly and survey data is not suggesting spending bounced back in the new year. Also on Thursday, January US housing starts is out. In December, housing starts rose to a 13-year high of 1.61m and consensus expects 1.39m this time.

The week closes with February’s flash purchasing managers’ index readings for the UK, eurozone and the US. January showed signs in the UK of a “Boris bounce”, with manufacturing at the 50 mark (implying output is neither expanding or contracting) and services moving into expansion.

The eurozone has also showed signs of improvement of late, though manufacturing is still contracting, while services has been weakening, but still expanding. The US remains the only region out of the three still in expansionary territory for both manufacturing and services. That said, a sustained rebound will be contingent on progress on the trade front and the coronavirus epidemic.

Chart of the week

The low inflation, low unemployment paradigm

The traditional inverse relationship between unemployment and inflation seems, at face value, intuitive. As companies hire more workers, the pool of employable people begins to fall, resulting in companies having to pay higher salaries to lure workers or those that are inactive. In turn, higher salaries and the need for companies to preserve their margins means prices of final goods and services increase. That’s the theory.

We have seen the unemployment rate in the eurozone, UK and the US touch a 12, 44 and 50-year low, respectively, over the past few months. However, inflation has remained noticeably below the central banks’ targets across all respective regions.

Partially explaining the breakdown in the relationship between unemployment and inflation is how consumers have used their earnings. Since the financial crisis, consumers for the most part have had to juggle paying down debt and spending combined. Consequently, businesses have struggled to increase prices of final products due to the fear of deterring consumption further.

Simultaneously, costs of production have increased through tariffs, in particular with regards to the US, and in the case of all three regions, uncertainty leading to the delay/postponement of investment decisions.

While firms have substituted labour for capital (explaining the high employment level), the participation ratio in the US has continued to increase, with the ratio at 63.4% in January, a seven-year high. This remains however well below the participation ratio observed pre-2008.

Chart of the week

This combined with higher costs and lower productivity have meant real earnings growth has not been meaningful enough to generate demand-pull pressures.

At the US Federal Reserve’s January meeting, Chairman Powell acknowledged the disinflationary trend seen globally and his desire to avoid it in the US. The European Central Bank is also conducting a strategic review with both central banks appearing to favour inflation at or slightly above, as opposed to below, target.

However, as we note in our Outlook 2020, the room left for monetary policy to stimulate the economy and inflation is limited. A move towards more fiscal spending seems more likely to unlock productivity gains and generate demand-pull inflation.

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