Bank of England October Monetary Policy Meeting

There is no doubt that the Bank of England's Monetary Policy Committee will keep interest rates at 0.50% at its October meeting (on Wednesday/Thursday). We also suspect that the MPC will keep the amount being spent on Quantitative Easing (QE) at £175 billion, while the committee does not seem inclined, for now at least, to cutting the interest rate that it pays on commercial banks' reserves in an attempt to try and get them to inject more liquidity into the financial system.

We do not expect the October meeting of the Bank of England's Monetary Policy Committee to result in any major policy changes. Pressure for immediate further Bank of England action has been alleviated by the economy's probable return to growth in the third quarter, latest Bank of England survey evidence suggesting that banks will increase their lending in the fourth quarter, and the fact that the current programme of asset purchases under the Quantitative Easing policy will last until the November MPC meeting.

The case for MPC inaction this month is reinforced by the fact that they will have the Bank of England's new growth and inflation forecasts (produced for the November Quarterly Inflation Report) available for their November meeting. Significantly, when the MPC held off from acting at their July meeting, the committee cited the desire to see the Bank of England's new GDP and inflation forecasts (being produced for the August Quarterly Inflation Report) as a factor in their decision. The MPC then raised the amount being spent on Quantitative Easing by £50 billion to £175 billion at their August meeting when they had new growth and inflation projections.

Although the MPC has become modestly more upbeat about the near-term outlook for the economy, the committee nevertheless continues to have serious concerns about the strength and sustainability of the upturn, particularly given the ongoing need and desire for financial institutions, households, and companies to improve their balance sheets. Recent indications from MPC members also indicate that they are still very worried over the lack of bank lending, particularly to small and medium-sized firms.

Meanwhile, although the MPC believes that consumer price inflation will be higher in the short term than previously thought, the committee still expects inflation to be limited over the medium term by substantial spare capacity and high unemployment, coupled with likely gradual recovery.

Latest data and survey evidence seem unlikely to have materially changed the MPC's views on growth and inflation since their September meeting, so they seem likely to remain in "wait and see" mode at their forthcoming October meeting.

While we do not expect any change in Quantitative Easing this month, we certainly would not rule out an eventual further extension. Indeed, a £25 billion rise to £200 billion in November remains very possible—especially as Bank of England Governor Mervyn King was in favour of Quantitative Easing being lifted to £200 billion rather than to £175 billion in August. Although King did not vote for an increase to £200 billion in September, the minutes of that meeting recorded that"for those members who preferred a larger stimulus at the August meeting, a larger asset programme could still be justified." Much is likely to depend on whether or not there are any genuine signs that bank lending is picking up, as this is vital to sustainable recovery prospects. This is also likely to be the key factor determining whether or not the Bank of England eventually cuts the interest rate that it pays on commercial banks' reserves. The Bank of England has indicated that it has no imminent plans to do this.

What is much clearer is that interest rates will remain at 0.50% for some considerable time to come. Indeed, we do not expect any rises until at least the final months of 2010.

Main Economic Indicators to Be Released

The service sector purchasing managers' index (out on Monday) is forecast to indicate that the sector expanded in September at the strongest rate since September 2007, and for a fifth month running. Specifically, we expect the business activity index to climb to 54.5 from 54.1 in August, thereby taking it further above the 50.0 level that indicates unchanged activity. The Bank of England's regional agents reported in their September survey that "demand for consumer services had increased in recent months, leaving the level of activity broadly unchanged from a year earlier." Recent improving housing market activity and some pick up in business activity is also helping the services sector.

Industrial production and manufacturing output data for August (out on Tuesday) are expected to show further expansion, albeit at a reduced rate, after activity picked up markedly in both July and June. It seems odds-on that the industrial sector expanded in the third quarter, thereby helping the economy return to growth after five quarters of deep overall contraction. Industrial production is forecast to have risen by 0.2% month-on-month in August after growing 0.5% in July and 0.6% in June. This would reduce the year-on-year drop to 8.7% in August from 9.3% in July. Manufacturing output is seen growing by 0.3% month-on-month in August, after jumping 0.9% in July and expanding 0.6% in June. This would cut the year-on-year decline to 9.2% from 10.1%.

The manufacturing sector is currently benefiting markedly from the substantial stock adjustment that has taken place, while the more competitive pound is helping the sector by making U.K. manufacturers more competitive in their domestic markets as well as through helping exporters. On top of this, demand is showing signs of picking up at least temporarily in important overseas markets, as well as at home. Nevertheless, manufacturers still face an uncertain future, as serious doubts remain about the strength of demand over the medium term.

Producer price data for September (out Friday) should indicate that, despite some recent firming in activity, manufacturers' pricing power is still pretty limited due to substantial excess capacity and intense competition. Furthermore, demand is still far from robust. Specifically, we expect producer output prices to have risen 0.2% month-on-month in September, as they did in August. Nevertheless, producer prices are expected to have been flat year-on-year in September compared to drops of 0.4% in August and 1.3% in July. This is due to the year-on-year measure being pushed up by sharp monthly drops in producer prices from August 2008, as oil prices started to fall back substantially from their July 2008 peak levels. Core output producer prices are also forecast to have risen by 0.2% month-on-month in September following a similar rise in August; this would cause the year-on-year increase to rise to 0.9% in September from 0.7% in August. Meanwhile, the consensus is for producer input prices to have fallen by 0.8% month-on-month in September, primarily due to oil prices being softer overall in September compared to August. Nevertheless, the year-on-year fall in producer input prices is seen narrowing to 6.7% in September, from 7.5% in August and 12.2% in July. This also reflects the fact that input prices started to fall sharply in August 2008, as oil prices retreated from their July 2008 record high levels around US$147/barrel.

The trade deficit (out Friday) is expected to have narrowed to £2.3 billion in August from £2.5 billion in July. This would also be clearly below the average monthly deficit of £2.7 billion in the first seven months of 2009, and substantially below the average monthly shortfall of £3.2 billion in 2008. The sharp overall depreciation of sterling has boosted the competitiveness of U.K. exporters, while there are increasing signs that domestic demand is now picking up in some key overseas markets, including the United States and Eurozone. The improvement in the trade surplus may be limited by firming U.K. domestic demand lifting imports.

The Halifax lender is forecast to report during the week that house prices rose by 0.9% month-on-month in September, which would be similar to the 0.8% increase seen in August. Consequently, the year-on-year fall in house prices is expected to moderate to 7.7% in the three months to September from 10.1% in the three months to August and a peak of 17.7% in the three months to April. The year-on-year fall is seen slowing to 5.6% in September itself from 7.6% in August. The Nationwide lender has already reported that house prices rose 0.9% month-on-month in September after an increase of 1.4% in August.

Buyer interest has been lifted substantially by the sharp overall fall in house prices from their autumn 2007 peak levels and very low mortgage interest rates. 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 to long-term norms, while credit conditions remain tight and economic fundamentals are still far from favourable for the housing market. Consequently, we suspect that house prices are likely to suffer relapses over the coming months despite their current firmer tone.

5 Oct - Service Sector Purchasing Managers Index, September: 54.5
6 Oct - Industrial Production, August (Month-on-Month): +0.2%
6 Oct - Industrial Production, August (Year-on-Year): -8.7%
6 Oct - Manufacturing Output, August (Month-on-Month): +0.3%
6 Oct - Manufacturing Output, August (Year-on-Year): -9.2%
9 Oct - Visible Trade Balance, August (GBP/Month): -6.3
9 Oct - Non-EU Visible Trade Balance, August (GBP/Month): -3.6
9 Oct - Total Trade Balance, August (GBP/Month): -2.3
9 Oct - Producer Price Output Inflation, September NSA (Month-on-Month): +0.2%
9 Oct - Producer Price Output Inflation, September NSA (Year-on-Year): +0.0%
9 Oct - Core Producer Price Output Inflation (ex Food, Tobacco etc.) September SA (Month-on-Month): +0.2%
9 Oct - Core Producer Price Output Inflation (ex Food, Tobacco etc.) September SA (Month-on-Month): +0.9%
During Week - Halifax House Prices, September (Month-on-Month): +0.9%
During Week - Halifax House Prices, September (Year-on-Year): -7.7%