Royal Bank of Scotland : Economics Weekly - Stressful

The results of the European Central Bank's stress tests were announced over the weekend, showing that 25 banks had failed. Of these, 12 have already raised enough capital and reduced risks, leaving 13 who will now have to take action. This clean-up is an important part of the Eurozone's response to the financial and sovereign debt crises. The ECB is trying to make sure that the banks it now regulates are healthy enough to withstand the shocks that will inevitably be thrown at them. The hope is that those banks that have passed can now put this uncertainty behind them and focus on providing support to the economy. With the Eurozone economy spluttering, that can't come soon enough.

UK economic growth slowed slightly in Q3, to 0.7%q/q, from 0.9%q/q in Q2. As usual, services did most of the work, contributing 0.58 of the 0.7% increase. But since services account for an estimated 78% of the UK economy, that's not surprising. In fact if anything, production and construction are growing faster, and services are growing slightly slower, than they were in the years leading up to the downturn. The UK economy is now estimated to be 3% larger than it was in September 2013. Good yes, but below the 3.5% the Bank of England hoped for in its last Inflation Report. So oddly, despite growing above trend, this figure arguably makes a rate raise slightly less likely rather than more so.

Minutes from the MPC's October meeting showed members balancing the economy's conflicting messages. Yet another month of data showed that growth is good, with unemployment falling but little evidence of that feeding through into wages or inflation. The two members who voted for rates to rise last month did so again, but failed to convince any of their colleagues to join their cause. The seven who want to keep rates where they are appear happy to wait and see how fast the UK and Eurozone economies are slowing before taking any action.

The volume of UK retail sales fell by 0.3% in the month to September. While a monthly fall is not uncommon (since the tail-end of 2011 it's happened almost every other month on average), it does suggest a diminishing appetite for spending. Sales grew by just 0.3% in the three months to September, the weakest this year. Rising prices are not the cause. Indeed retailers are cutting prices to try and attract shoppers. Prices are typically 0.9% lower than they were last year and 1.4% lower if we include the cost of filling up your car. No sign of inflationary pressure here either.

We are half way through the government's fiscal year and if the second half is much like the first then the borrowing target set in the Budget will likely be missed. Net borrowing over the past six months has been £5.4bn greater than it was in the same period of 2013. That is going to make it hard to beat the Office for Budget Responsibility's estimate of an £11bn fall over the full year. With economic growth so strong and yet the deficit still stubbornly large the Autumn Statement is likely to see more of the gap classed as structural rather than cyclical. And that means more austerity.

The Eurozone Purchasing Managers' Index (PMI) bucked expectations by eeking out a small rise in the flash estimate for October. The composite reading, which covers both manufacturing and service sectors rose from 52 to 52.2. That expansion is welcome but does little to allay fears of recession or deflation, particularly as activity in France fell further with its PMI now down to 48, suggesting an even faster rate of contraction.

China's economy grew by 7.3%y/y in Q3, an envious rate of growth by most country's standards. But it's China's slowest pace since the financial crisis hit over five years ago. Slower credit growth and falling property prices are taking their toll. But even this relatively low figure may be overstating things. China's reported GDP figure always comes in remarkably close to the forecast figure. In India the average difference between the reported and forecast figures is three times larger than China's. And the spread of outcomes is wider too. It's going to take more than a simple GDP reading to identify the full extent of China's slowing economy.

US inflation remains subdued. Consumer prices increased by 1.7%y/y in September. Higher food prices offset lower energy costs. In the labour market, real wages edged up by only 0.3y/y. With plenty of spare capacity in production industries and the job market some way off full employment, it's no surprise that inflation continues to undershoot the Fed's target. The only surprise is that some Fed members continue to muse about the need for higher interest rates. They are unlikely to prevail any time soon.