Cautious pessimism

by **Cals** Mon 23 Apr 2012, 17:12

Cautious pessimism

23/04/12 @ 07:14 GMT by Simon Smith, Chief Economist

During April, markets have displayed a far more cautious tone to that seen through most of the first quarter. FX markets were earlier than most to adopt this tone, with high-beta currencies turning at the start of March, much earlier than most equity markets. As we enter the last full week of April, this approach seems set to continue. The first round of voting in the French presidential election campaign has strengthened the view that Sarkozy is unlikely to see a second terms and markets are slightly nervous regarding his likely successor, Francois Hollande. The US Federal Reserve also meets this week, but all the signs are that it is unlikely to satisfy those hoping for a fresh round of quantitative easing, despite the ongoing underlying weakness of the economy. Furthermore, the latest PMI data from China (HSBC manufacturing series) increased to 49.1 (from 48.3), keeping alive concerns about the extent of the slowdown currently being seen in China. Finally, the latest producer price inflation data in Australia appear to have further cemented the case for a fresh rate cut next month. Cautious pessimism is likely to remain the theme as we head into month end.

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Commentary

Another eurozone leader set to bite the dust. The first round of the French presidential campaign saw the incumbent Sarkozy win just 27% of the vote yesterday. His socialist rival François Hollande took nearly 29%. Whilst this may not seem like a huge divide, there is a strong feeling that the second round will see Hollande take the majority of support from the minor parties that received votes from those disaffected with Sarkozy. Hollande has softened his rhetoric as the campaign has progressed, but nevertheless markets are naturally nervous. He has thrown out hostile words towards the ECB, the ‘fiscal compact’ and other budgetary measures in recent months. As most new leaders have found though, the numbers are the same whoever is at the helm and whoever wins will face the same tough budgetary battles to retain the full faith of bond markets in the months ahead.

The pound’s purple patch. Friday’s better than expected retail sales figures make it even more likely that the UK economy avoided falling back into recession last quarter. In the three months to March, the volume of retail sales rose by 0.8%, quite a respectable performance. Moreover, apart from sluggish demand for clothing and footwear, growth in consumer demand in the first quarter was broadly based. Naturally, the month of March was aided by a surge in fuel sales; it being the warmest March for 55 years also helped. Also, preparedness by retailers to offer keener pricing has encouraging spending on a more general level – for the March quarter the retail price deflator rose by just 0.4%. Indeed, in non-store retailing, significant price deflation was apparent in the most recent quarter. Placed alongside firmer house prices, stronger employment growth and decent anecdotes emerging from both the services and manufacturing sectors, it is clear that the UK economy did better in Q1 than expected. Indeed, MPC perma-dove Adam Posen was moved to opine that the economy is actually stronger than the official data will show. In response, cable moved is at 1.61 and EUR/GBP has fallen to a new 20-month low of 0.8177. GBP/AUD has jumped through 1.56, a four-month high.

The risks in Germany. The key Ifo data on Friday was modestly above expectations, but in the current environment that was enough to give the single currency a lift to the European session highs above the 1.3165 level. Following the decline in GDP in the final quarter of last year, there has been a strong focus on the pace of momentum of the German economy and specifically questions as to whether that was a brief blip or the start of a more sustained slowdown. The Ifo data, together with other survey releases, are erring towards the latter, although they are not suggesting that the economy saw a strong reversal upward during the first quarter. But the central issue is the extent to which the German economy can continue to grow despite what is going on in the European banking sector. The data last week from Spain has reminded us that the situation is primarily a banking/credit bubble rather than a sovereign crisis (though this is of course a by-product). The main risk in Germany is that this bubble manifests itself in a further contraction of lending through the year, more aggressively impinging on the German economy. The eurozone already experienced a sharp fall in lending towards the end of last year and the YoY pace of lending to households risks falling into negative territory over the next couple of months. Such a trend will impact Germany, but less so than other nations, so the divide between the core and the remainder will continue to grow.