UK slips into deflation putting more pressure on BoE to delay rate hike

• More disappointing Chinese trade data raises emerging market concerns;

• UK slips into deflation putting more pressure on BoE to delay rate hike;

• German sentiment slides on emerging market slowdown and VW emissions scandle.

Data from the UK and the eurozone added to the already downbeat mood in the markets that started overnight when China released another batch of worrying trade data. Investors may be willing to cheer negative data when it’s coming from the US and potentially forcing the Fed to delay the dreaded rate hike but when the data points to further woes in emerging markets, increased pressure on eurozone powerhouse Germany and further deflationary pressures in the UK, investors are not so happy.

The most worrying aspect of the Chinese data was the 20.4% drop in imports, which points to further suffering for the countries trading partners in the region. Many emerging market countries are reliant on China for their exports and if domestic demand is declining, this potentially poses a big problem for them. It should be noted that this is a dollar-denominated decline and therefore overall trade volumes are not suffering to the same extent, but the situation is still worrying, particularly for commodity exporters to China.

The slowdown in China is not just having a detrimental effect on emerging markets, Germany is also suffering as it has strong trade ties with the region. We have already seen economic sentiment decline quite considerably this year due to the emerging market slowdown and the latest crisis involving Volkswagen has added to that, with the motor industry accounting for around a fifth of total exports. It’s worth noting that the current conditions component of the ZEW release remained fairly strong which suggests the economy isn’t suffering too much yet but there is clearly a rapidly deteriorating confidence in that to continue.

The UK slipped into deflation last month with clothing prices rising lower than normal and fuel prices continuing to weigh on the headline reading. Core prices rose by 1% which was unchanged from a month earlier but below expectations of a slight improvement. The data is largely consistent with the recent analysis from the Bank of England which warned last week that inflation will remain below 1% until Spring next year. The reaction to today’s release suggests people are continuing to push back interest rate hike expectations for the UK, with some suggesting it won’t come until the end of next year at the earliest. I remain unconvinced that the BoE will wait that long to raise rates, especially if wage growth continues to rise at the pace it has been this year. The argument remains that raising later and faster poses a greater threat than earlier and slower. If wage growth eases, there may be more reason to hold.

The US session is looking a little quieter today from a data perspective but attention will now switch to corporate earnings season. Today we’ll get third quarter earnings from JP Morgan, Intel and Johnson and Johnson to name a few, as earnings season gets underway. It will be interesting to see in the coming weeks how companies view current economic conditions and whether they believe the emerging market slowdown will pose as big a threat to the US as is being suggested at the moment. If so, it would only give the Federal Reserve another reason to delay the rate hike into next year.

The S&P is expected to open 9 point lower, the Dow 94 points lower and the Nasdaq 28 points lower.