Political developments dominate year end

• Wake of Japanese elections will see the focus turn to monetary policy.  
• Fiscal cliff discussions likely to extend into 2013 at cost to wider economic activity.  
• Busy UK data calendar suggests weak end to 2012.  

Year end looms large ...Liquidity is already starting to fade in key markets ahead of year-end. Key events including any reaction after the Japanese General Election and ongoing negotiations over the fiscal cliff will continue to occupy market thinking. The UK posts most of the rest of the year’s data across the course of this week.

Will Japanese elections shape the monetary outlook? ...Sunday sees Japan’s General Election, with polls suggesting that the LDP, led by former Prime Minister Shinzo Abe, will return to power having only been out of office in seven of the last sixty years. Abe’s proposed policies, particularly the implications for the Bank of Japan, have caused most interest. The election is unlikely to have an immediate influence on the Bank of Japan at its meeting on Thursday - we see policy unchanged. However, Abe‘s proposed “bold easing” policy has been weighing on currency markets with associated declines in the yen making it the worst performing currency against the US dollar in 2012. And with the dollar already weak against other Asian currencies, Japan’s competitiveness has improved markedly. Our global team forecasts that this boost, coupled with a pick-up in global and Asian demand, should lift Japan from its current recession next year. We forecast GDP growth of 1% in 2013 as a whole.

US'fiscal cliff' to extend the congressional session?...Congress continues to fall short of a resolution of the 'fiscal cliff' and without formal announcement at the time of writing, we expect negotiations to go beyond the end of the Congressional session and into next week. With the deadline rapidly approaching we will watch for discussions of contingency measures that can stall the impact of the cliff into next year. In reality a more measured solution looks destined to fall into January, leaving markets increasingly edgy about the impact on the economy - particularly as the debt ceiling limit will also be approaching fast at this point. Indeed, this impact is becoming more evident already. Declines in consumer confidence and the NFIB small business survey suggest increasing evidence of cliff uncertainty. Our global team also expects the coming week’s Empire and Philadelphia Fed surveys to remain subdued reflecting these worries. The coming week will also see Q3 GDP estimates, which we expect to be revised higher, and housing releases, which we expect to continue an upbeat tone providing an upside risk to growth next year.

UK completes releases for 2012 ... A busy UK calendar sees several of the month’s remaining releases squeezed into the week. Inflation looks set to rise modestly in November, we forecast to 2.8%, as utility tariff hikes start to be included. The continuation of these and food price increases should push inflation higher to around 3% over the next six months. We expect November’s retail sales to rise modestly by 0.3% following October’s drop, but the trend on the high street looks set to remain soft in the run up to Christmas. Moreover, the final estimate of GDP could see a modest downward revision in Q3 to 0.9% from 1.0%, reflecting the now weaker growth in industrial activity. In combination, this suggests a soft end to 2012 and we will watch Wednesday’s MPC minutes to see what influence this had on the Committee's thinking in December. We expect a slow start to next year, but forecast gradual acceleration to deliver 1% growth for 2013 as a whole.

Euro area's divergent trends?...By comparison a light data calendar in the euro area leaves the focus on the German IfO index and French business confidence indicator. Usually these indices move in much the same way. Yet we will watch for any signs of divergence as suggested in the preliminary service PMI reports.

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