Royal Bank of Scotland : Economics Weekly - Deflation

The European Court of Justice has opened the door for Mario Draghi & co. to embark on QE, which is likely to start this week this week. In anticipation, the Swiss National Bank last week gave up trying to control the value of its currency. Despite also cutting its main interest rate to -0.75% (not a typo), the franc rose by 20% against the euro, imparting a further deflationary jolt to the Swiss economy where prices are already falling.

UK consumer prices rose by 0.5%y/y in December, the slowest on record and a big fall on the previous month's 1%y/y. Energy costs were the driving force. Falling pump prices cut motoring costs by 10.5%. This is mainly the "right kind" of low inflation, caused more by low world energy prices than a weak domestic economy. But "core" inflation that strips out volatile elements fell, too, to 1.3%y/y. That's one reason why markets reckon Bank Rate won't rise until late next year.

With transactions falling -0.8%y/y in November, slower house price growth is here. Prices rose 10%y/y in November according to the ONS, down from a peak of 12.1%y/y in September. London is leading the way, with the latest RICS survey pointing to a further slowdown. With the mortgage market steam out of running, attention is switching to credit cards and personal loans, with the interest rate on a £10k personal loan now almost as low as a variable rate mortgage.

Average UK service sector profitability was the highest on record in Q3 of last year, buoyed by the economic recovery. Manufacturing profitability also climbed, to its highest rate since early 2002. However, it was not all good news, as falling oil prices took their toll on companies operating on the UK Continental Shelf. Profitability plunged to the lowest on record, dipping below that of services companies for the first time since records began in 1997.

US inflation slowed to 0.8%y/y in the last month of 2014, down from 1.3%y/y a month earlier. The falling oil price meant petrol (or gas if you prefer) was 20% cheaper than a year ago. Core inflation, which excludes food and energy prices, also fell but by just 0.1% to 1.6%y/y. There's nothing in these numbers to encourage the Fed to raise rates.

US retail sales fell 0.9%m/m in December, with most types of retailers suffering. That's a steep decline, more like the kind of number we'd see in a recession. It's also a surprising one. It contrasts with an economy adding jobs at a rapid rate and in which consumer confidence is strong and actually grew in December. However, the annual growth rate of 3.2%y/y was better. For the moment, it's best to treat this as a blip.

Last week it was more investment, this week it's more debt. The news from China in the early part of the year is all too familiar. There was £180bn in new borrowing during December (including bank loans and corporate bonds). That's more than half of the value of London's economy in a year. Despite this, the last six months of 2014 saw the lowest growth of credit in over ten years. If China is binning the debt bottle, it's proving susceptible to numerous relapses.

The UK's trade deficit has narrowed on the back of lower oil prices. Other oil importers are benefitting too. China and the Eurozone already had big trade surpluses but these reached record highs in both regions in Q4 2014 as a result of cheaper oil. Meanwhile, Japan's current account surplus rose to its highest level since early 2011. Oil again, and higher earnings from its investments abroad thanks to the drop in its currency provided the leg-up.

Eurozone industrial output rose in November 2014. The 0.2% monthly increase may not sound like much. But it's welcome news both across the single currency area as well as the UK. The Oscar went to Ireland, the region's star producer. Industrial output slowed, that's slowed, to 4.6%m/m (that's 72% annualised in the improbable event it remains the same). The "Razzie" went to Norway, outside the EU and the Eurozone, where output fell by 1.6%m/m.  

One consequence of the Swiss National Bank's decision to let its currency appreciate is that any Swiss national looking to buy a house in Switzerland's most popular London destination of Kensington and Chelsea saw average prices fall from 2.15mn francs at 9:29am to 1.86mn francs at 11:30am.