Global economic trends support interest rate divergence

Having consistently surprised on the upside over the last four weeks or so, global economic activity was weaker than forecast last week. That said, at minus 11 and minus 5 respectively, both the Relative Performance Index and the index less prices (RPI-P) only point to a very limited degree of underperformance. Moreover, regional trends continue to argue in favour of a prospective divergence in central bank policies that should widen interest rate differentials in favour of the dollar.

In the U.S., the shift in market sentiment towards higher-for-longer Federal Reserve interest rates remains underpinned by unexpectedly strong economic activity. At 12, neither the RPI nor the RPI-P is deep in positive surprise territory but the overall picture is robust enough to suggest that pressure on the central bank to ease has diminished significantly in recent weeks.

In Canada, a mixed bag of data was on balance weak enough versus expectations to nudge the RPI (minus 2) just back below zero. Taken together with a small positive reading on the RPI-P (6), the message is that overall economic activity is essentially performing as anticipated leaving intact speculation about a Bank of Canada ease in June.

In the Eurozone, the RPI-P (minus 15) joined the RPI (minus 25) in negative surprise territory last week showing that the real economy is also now struggling to keep up with expectations. The slide below zero follows a decent run of unexpectedly firm data and will only strengthen the current market conviction that the European Central Bank will be lowering key interest rates in June.

In the UK, unexpectedly firm inflation and wage growth saw the RPI end the week at 14 and the RPI-P at 12. While not far above zero, both readings show enough overall economic outperformance to strengthen the case for no cut in Bank Rate until much later in the year.

In Switzerland there were no surprises in the latest producer and import price data leaving the RPI (minus 20) and RPI-P (minus 6) still indicating disappointingly soft economic activity. Another rate cut by the Swiss National Bank this quarter remains a real possibility.

In Japan, surprisingly strong news on manufacturing orders and the trade balance contrasted with unexpectedly soft inflation and lifted the RPI to 15 and the RPI-P to 33. The mixed economic picture and weak yen complicate the job of Japan’s policymakers and should increase the chances that the Bank of Japan will make no further change to interest rates this week.

In China, March’s string of positive RPI prints was reflected in surprisingly firm first quarter growth. However, at now minus 34 and minus 27 respectively, both the RPI and RPI-P show economic activity underperforming in March which might presage a more subdued second quarter.