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01/08/2009 | Bank of England Policy Meeting Dominates the U.K. Economic Week Beginning 3 August

Howard Archer

The Bank of England's Monetary Policy Committee meeting will be the focus of attention, amid huge uncertainty as to the future of its quantitative easing program. Meanwhile, the July purchasing managers' surveys will be closely scanned for an idea of how the economy is shaping up in the third quarter following second-quarter GDP contraction of 0.8% quarter-on-quarter.

 

Bank of England August Policy Meeting

The likely outcome of the 5–6 August meeting of the Bank of England's Monetary Policy Committee (MPC) is both extremely easy and very difficult to call. The easy call is that the MPC will keep interest rates at their record low level of 0.50%. Indeed, we strongly suspect that interest rates will stay at 0.50% deep into 2010. The difficult call is what will the MPC decide to do about quantitative easing. We lean toward the view that the MPC will choose to use the final £25 billion that Chancellor Alistair Darling has authorized it to spend, taking the amount up to £150 billion, but to indicate that it is not looking to spend any more than this, for now at least. We expect the MPC to indicate that it will continue to monitor the situation very closely and not to shut the door on further quantitative easing in the future.

The minutes of the July MPC meeting revealed that all nine committee members voted in favor of holding interest rates at 0.50% and in not increasing the total of £125 billion being spent on the purchase of assets under the quantitative easing (QE) program. The minutes indicated that the MPC felt that there was no pressing need to extend the QE program in July, but preferred to review the situation at its 5–6 August meeting when it would have access to the Bank of England's new inflation and GDP forecasts. This is not unusual, as the MPC has historically been more prone to make policy adjustments during the months when the new Bank of England projections are available. This would also give the committee another month to monitor what impact the QE enacted so far is having, although MPC members have repeatedly stressed in recent speeches and interviews that it is premature to come to any conclusion on this as it will take several months for the effects to work through.

U.K. recovery hopes have recently taken a significant knock, with the news that GDP contracted by a further 0.8% quarter-on-quarter (q/q) in the second quarter. Although this was down markedly from contraction of 2.4% q/q in the first quarter and 1.8% q/q in the fourth quarter of 2008, it was still a substantial drop and suggests that recovery hopes are based on a rockier base than had been previously thought. Indeed, it was a markedly worse performance than the MPC had expected, as the minutes of its July meeting had observed that latest surveys "were consistent with a smaller contraction in GDP in Q2 than the Committee had anticipated two months ago" (when the Bank of England's last GDP and inflation forecasts were done) and that "the momentum going into the second half of the year was greater than the Committee had expected in May."

In fact, second-quarter contraction of 0.8% q/q and earlier downward revisions to the national accounts data mean that GDP was down by 5.6% year-on-year (y/y) in the second quarter, rather than by 4.7% as the Bank of England projected in May.

Although the latest data and survey evidence has been firmer overall, this firming has been by no means universal, and significant uncertainty remains about the strength of economic activity over both the near term and farther out. On the positive side, retail sales rose by a healthy 1.2% month-on-month (m/m) in June and housing market activity is currently continuing to pick up from very low levels. Nevertheless, the Confederation of British Industry (CBI) industrial trends survey indicated a marked relapse in activity in July while latest hard data show industrial production falling anew in May.

Furthermore, the MPC clearly still has serious concerns about the medium-term economic outlook, and members have repeatedly indicated their worry that economic activity could be hindered for some considerable time to come by the ongoing need for financial institutions, households, and companies to adjust their balance sheets. Furthermore, the MPC also noted that "the weakness of bank lending continued to hang over the prospects for recovery."

Indeed, while the most recent survey evidence such as the Bank of England's Trends in Lending report for July indicates that banks are becoming modestly more prepared to step up their lending, there is currently still little evidence of this in the latest hard data. Furthermore, the Bank of England's regional agents concluded in their July report that while some of their contacts felt that banks' appetite for lending had increased, "the availability and cost of finance remained a key concern for many firms." The agents reported that "there were further widespread reports that spreads and fees were being increased sharply on renewal or review of facilities." This may only have a limited impact on the MPC's thinking, though, as committee members have repeatedly stressed in recent speeches and interviews that it is premature to come to any conclusion on the effectiveness of QE as it will take several months for the effects to work through.

Meanwhile, consumer price inflation moderated to 1.8% in June from 2.2% in May, thereby dropping below the Bank of England's 2.0% target rate for the first time since September 2007. Consumer price inflation still seems likely to dip under 1.0% later this year and to remain under the 2.0% target level for an extended period. This is due to increased spare capacity, reduced wage growth, companies' limited pricing power through the supply chain, and a likely ongoing need for many retailers to price attractively to get consumers to spend. Furthermore, sterling has climbed significantly off its lows seen around the turn of the year. We suspect that even if the current improvement in economic activity is sustained, it will not be strong enough for some considerable time to come to significantly lift underlying inflationary pressures.

Following the recent consensus within the MPC on QE and interest rates, it is very possible that divisions could emerge within the committee on whether to extend QE, and to what extent. Given the surprisingly deep second-quarter GDP contraction and major uncertainties about the outlook for the economy and bank lending, we suspect that the MPC will conclude at its August meeting that there is a strong enough case to use the final £25 billion of the £150 billion that it is currently permitted to spend on QE. The MPC may also indicate that it is keeping all its options fully open going forward, given not only the uncertainties over the economic outlook, but also over the effectiveness of the QE that has been enacted so far.

Main Economic Releases

The week is very heavy on manufacturing news, kicking off with the purchasing managers' index (PMI) for July on Monday. We expect this to show some deterioration compared with June, thereby at least temporarily ending the recently improving trend. Specifically, we forecast the PMI to ease to 46.5 in July, after trending up to a 13-month high of 47.0 in June from 34.9 in February. A reading below 50.0 indicates contracting activity. The CBI has already released its industrial trends survey for July, which very disappointingly revealed a marked relapse in order books. Indeed, at -59% in July, the balance of manufacturers reporting that their order books are at normal levels was the weakest since January 1992. This appeared primarily to be due to a weakening in domestic orders as the export orders balance improved modestly compared with June.

Industrial production and manufacturing output data for June are released on Wednesday. We forecast industrial production to have been flat m/m in June after falling by 0.6% in May. This would leave production down 11.4% y/y. Manufacturing output is also seen unchanged m/m in June after dipping 0.5% in May. This would result in a drop of 12.0% y/y. Although manufacturers are no longer suffering the very sharp fall in orders and output seen in the latter months of 2008 and early 2009, they still face a very difficult environment, and the suspicion remains that sustainable growth in the sector could remain elusive for some considerable time to come. Whereas leaner stocks and a competitive pound are helping their position, manufacturers are still battling muted domestic demand, difficult conditions in overseas markets, and intense competition. Furthermore, the CBI's July survey indicated that stock levels are still relatively high while manufacturers will be hoping that sterling does not strengthen further, having moved up significantly from its lows seen around the turn of the year.

Producer price data for July (Friday) should provide further evidence of manufacturers' limited pricing power in the face of still-muted demand and intensified competition. Specifically, we expect producer output prices to have edged up by just 0.1% m/m in July after falling by 0.2% in June, thereby causing prices to have fallen by 1.6% y/y. Core output prices are also forecasted to have risen by 0.1% m/m in July, which would cause them to be down by 0.4% y/y. Meanwhile, the consensus is for producer input prices to have fallen by 0.7% m/m in July, primarily because of a softening in oil prices and the firmer pound. Consequently, producer input prices are seen falling 11.1% y/y in July, reflecting the fact that oil and commodity prices are substantially lower than the levels seen a year ago.

The construction PMI for July (Tuesday) is likely to show that the sector is still contracting markedly, but at a reduced rate compared with earlier this year. We expect the PMI to have eased further to 44.0 in July, from 44.5 in June and a 13-month high of 46.0 in May. Nevertheless, this would still be well above the all-time low of 27.8 in February (the series started in 1997). A level of 50.0 indicates unchanged activity. The construction sector is being helped to a limited extent by the government bringing forward some infrastructure spending as part of its efforts to boost the economy, while recent modestly, but steadily, rising housing market activity—and increased optimism about the outlook—is starting to feed through to support house building activity. Even so, serious concerns remain about the outlook for the construction sector, with the housing market and commercial property sectors still facing significant problems. The preliminary national accounts data show that construction output dropped by a further 2.2% q/q in the second quarter after plunging 6.9% in the first quarter. Output was down by 14.7% y/y in the second quarter.

The service sector PMI (Friday) is forecasted to indicate that the sector again achieved moderate expansion in July after apparently returning to growth in May. Specifically, we expect the business activity index to be 51.5, which would be little changed from 51.6 in June and 51.7 in May. This would be modestly above the 50.0 level that indicates unchanged activity and up from a record low of 40.1 last November. May was the first time since April 2008 that the business activity index had been above 50.0. The Bank of England's regional agents reported in their July survey that "on average, the pace of contraction in demand for consumer services had eased" while gradually improving housing market activity and some pickup in business activity are also helping the services sector. It should be noted, though, that the modest expansion in services activity indicated by the purchasing managers' survey in both May and June and the average of 50.7 in the second quarter are somewhat at odds with the preliminary national accounts data showing that service sector output contracted by 0.6% q/q in the second quarter.

Meanwhile, the Halifax lender is forecasted to report during the week that house prices rose by 1.0% m/m in July, after falling by 0.5% in June and rising by 2.6% in May. This would cause the y/y drop in house prices to moderate to 12.2% in the three months to July, from 15.0% in the three months to June and a peak of 17.7% in the three months to April. The Nationwide lender has already reported that house prices rose by 1.3% m/m in July, which was the third successive increase on that measure. Buyer interest has been lifted substantially by the sharp overall fall in house prices from their autumn 2007 peak levels and markedly reduced mortgage interest rates, and this is gradually but steadily feeding through to lift housing market activity. Furthermore, house prices are currently being supported by a lack of properties for sale. Nevertheless, housing market activity is still muted compared with long-term norms, while credit conditions remain tight and economic fundamentals are still far from favorable for the housing market. Consequently, we suspect that house prices are likely to suffer relapses over the coming months despite their current firmer tone.

 

3 Aug - Manufacturing Purchasing Managers' Index, July: 46.5
4 Aug - Construction Purchasing Managers' Index, July: 44.0
5 Aug - Service Sector Purchasing Managers' Index, July: 51.5
5 Aug - Industrial Production, June (Month-on-Month): 0.0%
5 Aug - Industrial Production, June (Year-on-Year): -11.4%
5 Aug - Manufacturing Output, June (Month-on-Month): 0.0%
5 Aug - Manufacturing Output, June (Year-on-Year): -12.0%
7 Aug - Producer Price Output Inflation, July NSA (Month-on-Month): +0.1%
7 Aug - Producer Price Output Inflation, July NSA (Year-on-Year): -1.6%
7 Aug - Core Producer Price Output Inflation (ex Food, Tobacco etc.) July SA (Month-on-Month): +0.1%
7 Aug - Core Producer Price Output Inflation (ex Food, Tobacco etc.) July SA (Month-on-Month): -0.4%
During Week - Halifax House Prices, July (Month-on-Month): +1.0%
During Week - Halifax House Prices, July (Year-on-Year): -12.2%

Global Insight (Reino Unido)

 


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