Increased Brexit drama follows last week’s trade war escalation
In the UK, Brexit drama has increased. Last Friday’s cabinet meeting saw Prime Minister, Theresa May, present a new strategy for Brexit. The “facilitated customs agreement” repeats the plan for the UK to collect EU tariffs on its behalf, but set UK tariffs for goods bound for the UK. This will now be done with regulatory alignment for goods and agricultural products, with a “joint institutional framework” overseeing agreements. Formally this will end the European Court of Justice’s jurisdiction in the UK, but UK courts will take EU case law into consideration. A full white paper from the UK government is due on Thursday. Brexit minister David Davis and junior minister Steve Baker both resigned at the weekend. Foreign secretary Boris Johnson announced his resignation on Monday afternoon ahead of May’s Parliamentary address. While a softer Brexit stance should resonate with Parliament’s view, it remains to be seen whether or not other Tory party Brexiteers will acquiesce. We continue to believe that Brexiteers will wait until after the UK officially leaves the European Union next year before reasserting their position, but short-term political risks have materially increased in the last few days. May asked the EU not to immediately reject its position. The EU will likely applaud the ‘softening’ of UK red lines and has promised to offer more in response. However, plans for the UK’s much greater surplus-generating service sector remain exempt and still face a material and damaging increase in trade restrictions under the government’s new plan compared with the benefits it currently enjoys.
The US took another step towards trade war escalation last week by imposing tariffs on $34bn of Chinese exports in response to its investigation over the protection of intellectual property. As promised, China has retaliated with a proportional response – matching US tariffs on agricultural and auto products. The imposition of these tariffs is likely to have a negligible impact on both GDP and inflation in the US and China. However, US President Donald Trump has threatened to react if China retaliated by broadening the tariffs to products worth $200bn. So far this has not materialised. We maintain that US strategy is likely to be designed to achieve trade concessions to open trade further - particularly with China. If so, the coming weeks might see a renewed impetus for negotiation. However, the risk is that the US has started on a process of escalation that will be increasingly difficult to walk back from and risks a more material detrimental effect on US and global growth prospects.
US payrolls rose by 213,000 in June, pushing the average monthly increase above 200,000 in the first half of 2018, the firmest since the second half of 2015. This suggests an acceleration in underlying activity in the US economy. This week should confirm that outlook with May’s Job Openings and Labour Turnover Survey and jobless claims likely to maintain alternative observations on the labour market that are consistent with solid activity. Yet focus this week will shift to inflation with producer and consumer price inflation prints on Wednesday and Thursday. CPI inflation is forecast to rise further as the continued impact of elevated oil prices boosts gasoline prices. However, ‘core’ CPI inflation is forecast to rise to 2.3% - its highest for around one and a half years. While risks have risen around the outlook for US activity, building inflation pressure is likely to see the US Federal Reserve continue with its gradual withdrawal of policy stimulus over the coming quarters.
Euro area: Euro zone industrial production (Thursday)
US: Consumer credit (Monday), PPI (Wednesday), CPI, budget statement & jobless claims (Thursday)
Market and asset types measured by the following indices: Equities = MSCI. Fixed Income = JP Morgan and BofAML.
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