The Federal Reserve is expected to cut the Fed funds rate by a quarter of a point next week, despite the fact that the US economy is doing well. Friday’s employment report could show that another 200,000 jobs were created in July and that unemployment is near a 50-year low. The Conference Board is likely to say that consumer confidence, while off its recent peak, is still near an 18-year high. The S&P is likely to say that house prices are now rising, having sagged until the spring. And the Institute for Supply Management (ISM) is expected to say that, although manufacturing growth has slowed recently, the sector is still expanding.
So why cut? One reason is as a precaution: the inverted yield curve suggests there’s a risk of recession. Also, inflation dangers seem to have receded: Friday’s figures should show that wage inflation has flatlined so far this year.
A third reason, though, is that weakness in the rest of the world threatens the US economy. Purchasing managers are likely to report that manufacturing output is falling in China and the eurozone. And official figures on Wednesday could show that eurozone real GDP growth in the second quarter (Q2) slipped to just 0.2 per cent. With other figures that day showing that core inflation is steady at 1.2 per cent – well below the ECB’s target – there is perhaps a stronger case for the ECB to relax monetary policy than for the Fed to do so.
Weakness in the eurozone is hurting the UK. Purchasing managers might say on Thursday that manufacturing activity fell again in July. They are likely to report a drop in construction too, in part because of uncertainty about Brexit.
We’ll also see weakness in the housing market. The Nationwide could say that house prices have barely changed at all in the past 12 months, while the Bank of England is likely to say that mortgage approvals have flatlined for the past two years.
We could also see a slowdown in consumer credit growth to a five-year low – although this might be a healthy sign of some people using higher wages to cut borrowing, rather than an unhealthy sign of low confidence.
Despite all this, the Bank of England's monetary policy committee is likely to leave monetary policy unchanged next week. One reason for this is that it fears inflation might rise as the economy approaches full capacity (because years of stagnant productivity have reduced the UK’s potential supply) and as low unemployment pushes up wage growth.
