June 2017

• Lowflation is back. Core inflation is softer than expected, notably in the US and Europe, but also in other countries like China. The resultant flattening bond yields (before this week’s sell-off) are complicating the task of the Fed and other central banks as they contemplate a rise in interest rates. Their conundrum is exacerbated by the recent decline in oil and commodity prices, which exerts a drag on headline inflation. Low inflation reflects structural headwinds to growth: despite the end of ultra-loose monetary policies, low interest rates are here to stay.

• In just a few short months, the tide has turned with unexpected velocity: gloominess now characterises the UK and optimism continental Europe, where the momentum for further integration is growing. National moods and the stories behind them matter a great deal because both positive and negative narratives are contagious and often become self-fulfilling prophecies. Will European optimism endure? It’s too early to tell but consumers keep spending while business investment is picking up. Italy may dampen the mood: it is the most fragile Eurozone economy and the only European country where Euro-scepticism is alive and kicking. But whatever happens in Italy, the Eurozone will not disintegrate.

• Meanwhile, the UK is sleepwalking towards an uncertain and chaotic Brexit. The Tories’ electoral humiliation means that PM May has lost both her majority and her authority. Hence, it is hard to imagine a favourable scenario in which the government and Parliament would agree on a desired path and complete the myriad of necessary agreements with the EU within the required timeframe. This messy, uncertain, political drama will play out against a backdrop of falling real wages and decelerating GDP growth. Contrary to the past, the benefits of a depreciating currency are now offset by higher priced imported components in the global supply chain. In today’s world, movements in exchange rates have a declining impact on trade, meaning that the UK economy won’t benefit from a lower GBP. . .

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