AUD and CNY lower as Chinese PMI hits 3 month low on credit and domestic demand fears

• 2 MPC members vote for a 25bps rate rise at August meeting minutes show

• Divergence seen between arguments on growth versus inflation and wages

• Federal Reserve minutes less dovish than previous, point to job improvements

• AUD and CNY lower as Chinese PMI hits 3 month low on credit and domestic demand fears

Hawks on both sides of the Atlantic are starting to circle their dovish colleagues. Policymakers at both the Bank of England and the Federal Reserve have started moves towards higher rates in their respective economies, it was revealed yesterday, and while the latter is in language only, the former is now seeing votes for higher rates.

We knew this day would eventually come. To be honest, from someone who has spent most of the past ten years watching central banks, it is finally exciting to have someone stand against the consensus and make sure that these decisions are nothing more than a procession of continual Zero Interest Rate Policy (ZIRP).

It has taken three years but the UK economy is in a strong enough place that some policymakers believe rate rises are now appropriate. Both Martin Weale and Ian McCafferty, the two most hawkish members of the Monetary Policy Committee, voted for a 25bps increase on the basis of increasing economic growth and the belief that the increases in the labour market participation are a symbol of increased wage pressures in the near-future. This is the first real test of dissent against Mark Carney.

The majority of the Bank of England, who remained on hold, are focused on the weakness in wages at the moment and the effects that a series of rate rises will have on the levels of indebtedness that UK households are currently under. The appreciation of the pound that a series of rate rises would cause is likely damaging to any prospects of a rebalancing effort by UK business.

We take on board the dissenters’ view that an increase in rates sooner allows for a more gradual glide path higher but we cannot balance that up against the recent cut in wage growth to 1.25% from 2.5% at last week’s Inflation Report and Tuesday’s slip in inflation pressures.

It has become clear upon reading through this month’s minutes that the Bank of England miscalculated the path of inflation. June’s CPI reading unexpectedly leapt to 1.9%; the fastest rate since January with clothing, food and transport contributing well. What was more of a surprise is the rally in core prices to 2% given the move higher in sterling since the beginning of the year. The Bank of England expected this trend to continue or at least stabilise. It has not, and yesterday’s decline to 1.6% shades the viability of the decision to hike rates.

The impact on sterling was slight pop higher as the surprise was digested. The Monetary Policy Committee is made up of nine members, all of whom exhibit different views on the state of play in the UK economy. The fact is Weale and McCafferty are the hawks of the Monetary Policy Committee and that is widely known. Both have made noises about rate hikes in recent months but a 7-2 voting record obviously doesn’t indicate a change in policy yet. We would need to see three more from the centre to shift views as well.

Who moves next from the centre ground? Chief Economist Andy Haldane or Deputy Governor Broadbent possibly. They have been less vocal on the need for a tighter monetary policy but we expect their speeches to be closely monitored in the coming months. I think the voting split will remain 7-2 for a while and if it does, sterling will not be running too much higher, data dependent of course.

In the US, we have not got to the point of votes for rate rises. This month’s minutes do show us an FOMC that is more than happy to upgrade their views on the US economy, and through that the prospects for rate increases, following the recent run of job gains. “Many” participants said that they might have to raise borrowing costs sooner than they had anticipated. What these comments symbolise is that the Federal Reserve’s protestations that policy is data-dependent are correct but that achieving a consensus on policy anytime soon will prove difficult.

The speed of the recovery has picked up into Q3 but the debate over slack remains key. The comments around labour markets were slightly less dovish than previous communications but the relationship between improvements in jobs metrics and inflation, particularly in wages, will be the metric that will eventually move rates higher. We still think that the Fed finally starts to take interest rates higher in Q3 2015.

The USD’s run continues this morning, hitting fresh 11 month highs against the euro and four month highs versus the yen and pound.

AUD has taken a lump lower following a stinking PMI number from the Chinese manufacturing sector. Growth slowed to a crawl with an index reading of 50.3 for August’s preliminary reading from HSBC. This represents a three month low should it be confirmed in ten days’ time as a slowdown in credit lending and fears over a property bubble combine with concerns over the true level of domestic demand within China itself. More policy easing looks to be on the cards in the short-term. The yuan has fallen by the most in a day since July through the session so far with AUDUSD falling to its lowest level since May.

Similar preliminary figures from France, Germany and the wider Eurozone are due this morning as well and should they slip into contractionary territory, will increase political pressure on the European Central Bank to further loosen policy as soon as it can. UK retail sales are expected to have moved higher in July following the impact of the price cuts that so damaged the CPI basket on Tuesday. Markets are looking for a 0.4% rise month-on-month at 09.30.

Have a great day.