Bank of England December Policy Meeting

The December meeting of the Bank of England's Monetary Policy Committee (MPC) seems highly unlikely to deliver an early Christmas present for the economy, as both Quantitative Easing and interest rates both seem odds-on to be kept at current levels. Indeed, this could well be the case for many months to come. While the Bank of England appears to be keeping all of its options open, we suspect that the majority of MPC members would prefer not to increase Quantitative Easing again following November's £25-billion extension to £200 billion unless the economy suffers a serious relapse in 2010. Nevertheless, any policy tightening is still a long way off given that significant, sustainable recovery remains very far from certain, and we expect interest rates to stay down at 0.50% until at least late 2010 and very possibly beyond.

With the economy looking highly likely to be finally returning to growth in the fourth quarter and November's £25-billion extension to the Bank of England's Quantitative Easing programme planned to last through to February, there seems little need for the MPC to act this month.

The fact that the MPC chose to extend Quantitative Easing by £25 billion (to £200 billion) in November—rather than increase it by £50 billion, as they had in August and May—and to enact it at a slower rate over the next three months, suggests they believe the economy needs less support, as recovery finally looks to be getting under way. We also suspect that the MPC are trying to gradually wean the economy off Quantitative Easing and are keen not to upset the markets by bringing it to an abrupt halt. This would risk sending gilt yields up significantly, which the Bank of England would want to avoid.

While it is clear the MPC were surprised by the further contraction in GDP in the third quarter, the testimonies of MPC members to parliament's Treasury Committee in late November—as well as their recent speeches and interviews—indicate they believe the U.K. economy has now turned and improvement will occur from the fourth quarter. Furthermore, a recent upward revision to construction output in the third quarter means that the U.K. economy may only have contracted 0.1% quarter-on-quarter in the third quarter, rather than 0.3% quarter-on-quarter, as currently shown. The Bank of England's GDP forecasts contained in the Quarterly Inflation Report also point to a marked pickup in growth going forward, although the bank stresses this is from a low base following the sharp recession the United Kingdom has suffered and that excess capacity will persist for some considerable time to come.

The central bank also acknowledges that significant downside risks persist to the growth outlook. In particular, the Bank of England's policymakers still have major worries that recovery could be held back over the medium term by muted bank lending as banks repair their balance sheets, as well as by consumers looking to save more as a consequence of higher debt levels and concerns about the future, including the extended tighter fiscal policy that will be needed. Companies may also be reluctant to invest given concerns about the outlook and profits. The MPC is wary that unemployment could yet increase significantly further despite the labour market being more resilient than expected.

Meanwhile, it is clear the MPC is prepared to look past the likely sharp spike in consumer price inflation over the coming months. Consumer price inflation jumped from 1.1% in September to 1.5% in October, and it could very well reach 3.0% in the early months of 2010. This is due to unfavourable base effects resulting from the substantial falling back in oil prices in the final months of 2008 and early months of 2009, as well as last December's value-added tax (VAT) cut from 17.5% to 15.0% dropping out of the calculation. Furthermore, VAT will rise back up to 17.5% in January. Further out, the Bank of England expects inflation to fall back below 2.0% in the second half of 2010 and to be around its 2.0% target level on a two-year horizon. Inflation is expected to be primarily limited by significant excess capacity persisting over the medium term.

The minutes of the November MPC meeting reveal that the committee discussed the case for cutting the interest rate that the Bank of England pays on a proportion of commercial banks' deposits. This was seen as putting downward pressure on short-term market rates, and it could also encourage banks to lend more. While the MPC decided not to go down that route for now, it is on the table and may be enacted if bank lending fails to pick up significantly over the coming months.

The door is not shut on further Quantitative Easing, particularly given that the Bank of England sees major uncertainties and risks surrounding both the growth and inflation outlooks. Nevertheless, with the economy highly likely returning to growth in the fourth quarter and inflation now moving back up and set to spike up markedly over the next few months, we suspect that November marked the final extension to the Quantitative Easing programme unless the economy suffers a major relapse in 2010. While the Bank of England expects inflation to fall back later on in 2010 after spiking up in late 2009/early 2010, most MPC members may be reluctant to further extent Quantitative Easing given the risk that inflation could prove stickier than expected and inflation expectations could start to rise.

Any policy tightening still looks a long way off, and we expect interest rates to stay down at 0.50% until at least late 2010. Indeed, the Bank of England could very well delay raising interest rates until 2011. Furthermore, the eventual increases in interest rates are likely to be limited to counter the restrictive impact of the very tight fiscal policy that is need to rein in the bloated public finances.

Forthcoming Data Releases

The British Retail Consortium (BRC) retail sales monitor for November (out overnight on Monday/Tuesday) is expected to show markedly stronger sales compared to a year earlier. The consensus is for total retail sales to have risen 4.9% year-on-year, while sales are seen growing 4.0% on a like-for-like basis (which strips out the effect of additional floor space). The Confederation of British Industry has already released its distributive trades survey for November, which showed that the balance of retailers reporting that their sales volumes were up year-on-year rose to a two-year high of +13%. However, it needs to be borne in mind that year-on-year comparisons in retail sales are now benefiting from the fact that sales were particularly weak a year earlier.

It may be that the consumer is perking up for Christmas, with a large number of people determined to spend a bit more and have a really good time after enduring a very difficult year. Significantly, very low mortgage interest payments and moderate inflation are boosting the purchasing power of a good many people, giving them scope to step up their discretionary spending. It is also likely that a significant number of consumers are making purchases of relatively big-ticket items ahead of the VAT hike from 15.0% to 17.5% at the beginning of January.

Nevertheless, the concern remains that any significant pickup in spending over the final weeks of the year could very well prove temporary and that the upside for consumption will be limited for some time to come. Indeed, the mixture facing consumers hardly make for a heady cocktail for heady spending. The ingredients include high and still-rising (albeit at a reduced rate) unemployment, low and still-slowing earnings growth, elevated debt levels, ongoing tight credit conditions, January’s VAT hike, concerns that other taxes may be increased before long as part of the efforts to rein in the bloated government deficits, and still-serious worries over the state of the economy. Indeed, the Bank of England has identified the need for, or desire of, consumers to improve their personal finances as one of the key threats to economic growth over not only the near term but also further out

The week is heavy on manufacturing data and surveys. We expect industrial production (out on Tuesday) to have grown 0.5% month-on-month in October, causing the year-on-year decline to narrow to 7.6%, from 10.3% in September. Industrial production previously rebounded 1.6% month-on-month in September, after slumping 2.6% month-on-month in August when many companies shut down for a summer break. Within this, manufacturing output is also forecasted to have grown 0.5% month-on-month in October, with the year-on-year drop moderating to 7.1%, from 9.3% in September.

The Confederation of British Industry (CBI) industrial trends survey for December is also out on Tuesday, and it is expected to show that the balance of manufacturers reporting that their orders are at normal levels rose modestly to a 2009 high of -44%. The balance climbed to an 11-month high of -45% in November, -48% in October, and a 17-year low of -58% in March. The balance of companies expecting output to rise over the next three months is also likely to be similar to the November and October outturns of +4%. This was the strongest level since March 2008.

The manufacturing sector appears to be seeing limited recovery, but is not racing ahead. In the near term at least, manufacturers should benefit from markedly reduced stock levels, while the weak pound is helping exporters and making U.K. manufacturers more competitive in their domestic markets. On top of this, domestic demand is picking up in important overseas markets, including the Eurozone and the United States, while the survey evidence indicates it is also improving at home. Nevertheless, serious doubts remain about the strength of demand for manufactured goods over the medium term, particularly once stimulative measures start being withdrawn.

Producer price data for November (out Friday) should indicate that manufacturers' pricing power is pretty limited due to substantial excess capacity and intense competition. Furthermore, demand is clearly still far from robust despite some improvement. Specifically, we forecast producer output prices to have risen by a modest 0.2% month-on-month in November, as they did in October. Nevertheless, the year-on-year increase in producer output prices is expected to spike up to 2.8% in November, from 1.7% in October and 0.4% in September due to unfavourable base effects resulting from the sharp monthly drops in producer prices in the latter months of last year as oil prices fell back substantially from their July 2008 peak levels. Core output producer prices are also expected to have risen 0.2% month-on-month in November; this would cause the year-on-year increase to rise to 2.1%, from 2.0% in October and 1.4% in September. Meanwhile, the consensus is for producer input prices to have risen by 0.6% month-on-month in November, primarily due to recently higher oil prices. Sterling's weakness may well also have pushed input prices up. The year-on-year rise in producer prices is seen jumping to 4.1% in November, from 0.1% in October. This also reflects the fact that input prices fell sharply from August 2008 as oil prices retreated from their July 2008 record high.

The total trade deficit (out Wednesday) is expected to have narrowed to £3.0 billion in October after spiking to an eight-month high of £3.5 billion in September from £2.2 billion in August. Nevertheless, this would still be above the average monthly deficit of £2.7 billion in the first nine months of 2009. Similarly, the visible trade deficit is forecasted to have narrowed to £6.8 billion in October, after jumping to £7.2 billion in September from £6.1 billion in August. Again, though, this would still be above the average monthly deficit of £6.7 billion in the first nine months of 2009. While it is hoped that the trade deficit will narrow over the coming months as exports increasingly benefit from sterling's weakness and improving domestic demand in key overseas markets, the trade deficit is currently being lifted by substantially increased car imports resulting from demand being pushed up by the government's car scrappage scheme.

The Halifax lender is expected to report during the week that house prices rose 0.5% month-on-month in November, which would be a fifth successive increase but down appreciably from a gain of 1.2% in October. Consequently, the year-on-year fall in house prices is expected to moderate to 1.5% in the three months to November from 7.4% in the three months to October and a peak of 17.7% in the three months to April. However, house prices would be up 1.8% year-on-year in November itself, compared to a drop of 1.5% in October. The Nationwide lender has already reported that house prices rose 0.5% month-on-month in November, which matched October's increase. This caused them to be up 2.7% year-on-year.

While housing market activity has been lifted to a limited extent by the still-significant fall in house prices from their 2007 peak levels and low mortgage interest rates, the upside continues to be limited by unfavourable economic fundamentals (notably high and still-rising unemployment, low and still-moderating earnings growth) and ongoing relatively tight credit conditions. In addition, house price/earnings ratios are currently moving back up because of the firming in house prices from their early-2009 lows. Furthermore, the threshold for having to pay stamp duty of 1% will move back down to properties costing £125,000, from £175,000 at the end of this year.

We suspect that still-relatively-low housing market activity and still-largely-unfavourable economic fundaments mean that the firming in housing prices seen since March/April will fizzle out before long and house prices will suffer a relapse in 2010. This is even more likely to occur if more properties come on to the market as a result of the recent firming in prices, given that a shortage of properties has been a key factor supporting house prices in recent months.

8 Dec - British Retail Consortium Monitor Total Sales, November (Year-on-Year): not forecast
8 Dec - British Retail Consortium Monitor Like-for-Like Sales, November (Year-on-Year): not forecast
8 Dec - Industrial Production, October (Month-on-Month): +0.5%
8 Dec - Industrial Production, October (Year-on-Year): -7.6%
8 Dec - Manufacturing Output, October (Month-on-Month): +0.5%
8 Dec - Manufacturing Output, October (Year-on-Year): -7.1%
8 Dec - CBI Industrial Trends, Total Orders, December: -44%
9 Dec - Visible Trade Balance, October (GBP/Month): -6.8
9 Dec - Non-EU Visible Trade Balance, October (GBP/Month): -3.5
9 Dec - Total Trade Balance, October (GBP/Month): -3.0
11 Dec - Producer Price Output Inflation, November NSA (Month-on-Month): +0.2%
11 Dec - Producer Price Output Inflation, November NSA (Year-on-Year): +2.8%
11 Dec - Core Producer Price Output Inflation (ex Food, Tobacco etc.) November SA (Month-on-Month): +0.2%
11 Dec - Core Producer Price Output Inflation (ex Food, Tobacco etc.) November SA (Month-on-Month): +2.1%
During Week - Halifax House Prices, November (Month-on-Month): +0.5%
During Week - Halifax House Prices, November (Year-on-Year): -1.5%