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What’s the economic reality of this week’s news?

18 May 2018

On Wednesday it was revealed that wage growth in the UK has outpaced inflation once again, a headline grabbing event, but has is it an indicator of a real trend in the UK and does a potential move in the inflationary environment mean a headache for the Bank of England?

The central bank, now heavily data dependent, elected to hold UK interest rates at 0.5% last week, owing to weaker GDP growth and a bigger than expected fall in inflation. So, while workers will welcome the real (albeit slight) gain in living standards, the fact that it wasn’t accompanied by a rise in interest rates means we could see more inflationary pressures in the longer-term, particularly if the labour market tightens further.

Unless there is a significant strengthening in overseas demand for UK goods and services, current domestic dynamics would suggest the BoE remains on hold, amid a soggy Brexit-induced outlook.

Remember Greece and the Euro-crisis? It’s been a few years since we’ve had to examine the Eurozone staring down the barrel of credit default, but Italy has a new government of disruptive populists who, like Donald Trump, are determined to pursue an agenda of national interest. Unlike Greece, Italy is the third largest economy in the eurozone and the potential for contagion across the banking sector is real and as disruptive as its coalition government of extremes.

As such Italian debt rose to its highest since October on Wednesday, after the draft coalition agreement between the countries two largest political parties surfaced. Today, with a new coalition agreement being put to the parties’ members, gaining the keys to government is only a matter of days.

The Five Star Movement and the Northern League, both anti-establishment populist parties, emerged as the biggest forces in Italy’s parliament back in the March election. Since then, the prospect of their forming a government together was long thought of as the most disruptive outcome by European leaders. Now that they have formed a government that “binds two political forces that are and remain alternative,” according to the M5S leave leader Luigi Di Maio, that most disruptive outcome has become a reality.

This could be hugely significant. Italy accounts for around 15% of the eurozone’s GDP, behind only France and Germany. In contrast, the Greek economy that caused so much panic years ago accounts for just 1.8% of eurozone GDP. In short, Italy matters.

We have discussed Trumplomacy over recent weeks and whether his twitter account is actually a tactic in his ‘art of the deal’ or a random disruptor that blindsides his own advisers. Trump’s successful presidential campaign  accused  China of stealing American jobs, yet he now wants to save Chinese technology firm ZTE – a firm sanctioned by his own administration to rescue Chinese jobs.

Trump sanction busting his own administration has serious effects – he’s about to renew US sanction on Iran and last Sunday warned of possible sanctions against European firms that do business with Tehran after pulling out of the Iran nuclear deal last week.

Trump’s staggering about turn over ZTE is, to his critics, further evidence that his decision making is more about him than the national interest, he makes far reaching policy decisions without regard for the risks. ZTE concessions could form the basis an embargo busting trade deal for the US and China, but as we have said before the market reaction if there really is no strategy is unknown.

Chinese negotiators are in Washington this week and then onto North Korean talks. Can he deliver on deals after bullying his counterparts to the table? We, and the markets will finally know in the coming weeks.

Finally, I’m not sure how many of our readers are parents, if you are, you will be very familiar with the concept of fairness. Being a parent teaches you a lot about fairness. The lesson that children have to learn is that sometimes, no matter how well you behave, you can’t always get what you want. Any parent will tell you that they’re used being told “it’s so unfair”.

Emerging market companies will probably be sharing that sentiment at the moment. Emerging markets, via both equities and bonds, have been under relative pressure for the past few weeks. Despite the fact that, domestic demand in the countries that make up the MSCI’s emerging market group has been good, we expect emerging market equities to remain under pressure for at least a few weeks.

Emerging markets will just have to accept that sometimes it isn’t fair. Luckily for them as for anyone, it gets easier as you grow.