Weak Q2 gives way to firmer Q3?

• US has posted positive surprises, key data this week will shape Fed’s decision next month.  
• Euro area GDP looks set to confirm contraction in Q2, German economy to escape fall.  
• UK releases to provide initial insight into Olympic effect. 

Market sentiment remains positive amidst mixed economic news ...Global economic news has been mixed over the past week, with Chinese updates falling short of market expectations suggesting a more persistent slowdown. Yet markets have maintained a more upbeat tone with European equity markets up around 3% from their end-July levels. In part, this reflects continued optimism founded in the latest ECB announcements. However, it also recognises a stronger tone in US economic releases, with the US surprise index turning upwards since June, most recently with solid payrolls, jobless claims and trade releases.

Is the US heading for a firmer Q3 ? ...The coming week will focus on survey and official evidence from the US to see if this momentum continues. July’s retail sales release provides some of the first evidence for Q3. Our global team expects sales to post their first monthly gain for four months, with recent declines underpinned by falling gasoline prices rather than contracting volumes. Industrial output, released the following day, will further bolster the Q3 outlook. However, most attention will be reserved for the August business surveys. We forecast modest gains for both the Empire and Philadelphia Fed surveys, reversing the latter’s steep decline last month. These will guide expectations of any imminent stimulus from the Federal Reserve, an outlook that has become more equivocal with the latest signs of jobs market resilience. July's CPI inflation will be important here. We expect the annual rate to remain at 1.7%, but a 0.3% monthly gain would reflect the more recent upturn in oil prices, which may constrain the appetite for further stimulus.

Euro earea Q2 GDP to contract, Germany to buck trend... Preliminary GDP estimates for France, Germany and the wider euro area are likely to complete a downbeat assessment of Q2. Notwithstanding recent declines in German industrial activity, we expect the economy to have posted modest expansion in Q2. Warnings from the Bank of France counsel caution for the outlook for France, where we expect a contraction. Given the declines reported in Spain and Italy over the course of this week, the outlook for the euro area as a whole is for a decline in Q2 and we expect a modestly bigger drop than consensus, forecasting -0.3%.

UK witnesses mixed preliminary Olympic effect ... The UK posts key releases over the coming week, although some will add to the confusion on the underlying pace of expansion in the domestic economy. This week’s significant upward revisions to industrial and construction sector output raises the likelihood of an upward revision to Q2 GDP. However, if this reflects a smaller bank holiday effect, Q3’s rebound may be correspondingly smaller. Retail sales on Thursday provide some of the first official figures for July and the initial impact of the Olympics. We forecast a 0.7% drop in sales volumes with a damp start to the month compounded by, what our own proprietary data suggests, subdued sales in the first week of the Olympics, maybe reflecting travel concerns or simply people watching TVs, not buying them. Labour market figures will be watched closely, with some evidence of a pre-Olympic boost last month. An Olympic effect should continue this month and help contain the rise in jobless to 7.5k on the month. August's MPC minutes on Wednesday are unlikely to surprise markets with the Committee likely to have unanimously supported the policy status quo after July's changes. Yet markets will closely scrutinise the Committee's discussion of underlying trends for clues on the likely path of activity and policy over the coming quarters.

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