Only marginal GDP growth in the fourth quarter of 2009, current sharply rising consumer price inflation, still-low money-supply growth and muted bank lending to businesses, and the imminent exhaustion of the quantitative easing program of £200 billion combine to present the Bank of England's Monetary Policy Committee (MPC) with a very challenging February meeting.

The 3–4 February meeting has major implications for monetary policy, as even if the MPC does nothing it will signal at least a temporary pause in the quantitative easing program that it has been following since March 2009. The further £25 billion allocated by the Bank of England to the program in November 2009 (bringing the total to £200 billion) is due to be spent by early February. Furthermore, the MPC will have the Bank of England's new GDP and consumer price inflation forecasts available at its February meeting, and it is significant that the committee's last three extensions to its quantitative easing program have occurred in the months that it has had new forecasts: May, August, and November.

It had looked odds-on that the MPC would bring a halt to its quantitative easing program in February given the economy's widely anticipated return to growth in the fourth quarter of 2009, and the sharper-than-expected spike in consumer price inflation in January (to 2.9% from 1.9% in November and a five-year low of 1.1% in September). In addition, there were hints in the latest surveys that bank lending to businesses could be starting to rise.

Nevertheless, the fact that the economy could only crawl out of recession in the fourth quarter of 2009 with markedly-less-than-expected GDP growth of 0.1% quarter-on-quarter has heightened concerns about the strength and sustainability of the United Kingdom's recovery. A much weaker Confederation of British Industry (CBI) distributive trades survey for January will also have done little to settle nerves, even allowing for the fact that retail sales were clearly hit by the heavy snow's keeping people from the shops. Meanwhile, latest hard data indicate that money-supply growth remains worryingly low and bank lending to businesses is muted.

At the same time, the MPC will not have been happy to see consumer price inflation spiking to 2.9% in December. While the Bank of England had been expecting inflation to jump in late 2009/early 2010 and forecasts it to fall below its 2.0% target level later in 2010 and during 2011, December's increase was appreciably more than expected. It not only suggests that the peak in consumer price inflation will be 3.5% or higher, rather than 3.0% as had been forecasted by the Bank of England in its November quarterly forecast, but it also increases the risk that inflation will not fall as quickly or as far as projected. Indeed, the MPC will note that a survey by Citi/YouGov showed a marked pickup in inflation expectations in January

On balance, we believe that the MPC is most likely to hold off from further extending the Bank of England's quantitative easing program at its 3–4 February meeting. Nevertheless, we expect the MPC to keep the door open to further quantitative easing by indicating that it is keeping all of its options open and will be prepared to act if the economy fails to develop recovery during the early months of 2010.

Meanwhile, there is no doubt that the Bank of England will keep interest rates at 0.50% at its February meeting. Indeed, it still seems highly likely that the bank will keep interest rates at 0.50% until at least late 2010 and very possibly beyond, given likely persistent concerns over the strength and sustainability of the recovery. Furthermore, the eventual increases in interest rates are likely to be limited to counter the restrictive impact of the tight fiscal policy that will increasingly have to be enacted from 2011/12.

Main Economic Releases

Mortgage Approvals in December and House Prices in January

The Bank of England is expected to report on Monday that mortgage approvals for house purchases continued their recent steady, but gradual upward trend in December, but remained well down on long-term norms. Mortgage approvals were likely lifted to a limited extent at the end of 2009 by buyers looking to beat the lowering of the price threshold for stamp duty on house purchases to £125,000 from £175,000 in January. We forecast mortgage approvals to have climbed to a 22-month high of 62,000 in December from 60,518 in November and a record low of 27,162 in November 2008. Even so, they remain very low compared with past norms. Indeed, the Bank of England's data show that mortgage approvals averaged 92,400 a month between 1993 and 2009. It has also been considered that usually monthly mortgage approvals of 70,000–80,000 are consistent with stable house prices.

The Bank of England is also forecasted to report that net mortgage lending amounted to £1.7 billion in December. This would be up from £1.5 billion in November and would be more than double the average level of £0.7 billion over the past six months. Again, though, this is still low compared with past norms.

The Halifax should also release its house price index for January during the week. It is forecasted to show an increase of 0.8% m/m, which would be a seventh successive increase, but down from a gain of 1.0% in December. Consequently, the year-on-year rise in house prices is expected to pick up to 3.7% in the three months to January from 1.1% in the three months to December. House prices would be up 3.8% y/y in January itself.

While housing market activity has been lifted to a limited extent by the significant fall in house prices from their 2007 peak levels and low mortgage interest rates, the upside continues to be limited by unfavorable economic fundamentals. In particular, unemployment is high and likely to rise further in 2010 (despite the dip in the number of jobless at the end of 2009) and earnings growth is low. Meanwhile, credit conditions are only easing gradually. In addition, house price/earnings ratios are currently moving up because of the firming in house prices from their early-2009 lows. Furthermore, the threshold for having to pay stamp duty of 1% moved down to properties costing £125,000 from £175,000 in January.

We suspect that still relatively low housing market activity and still largely unfavorable economic fundamentals mean that a relapse in house prices is likely at some point in 2010, and prices may well be essentially flat over the year as a whole. 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 since early 2009. Much will also clearly depend on whether the economy can build on its marginal return to growth in the fourth quarter of 2009.

Consumer Credit in December

The Bank of England is expected to report on Monday that net consumer credit fell a further £0.4 billion in December. This would be a sixth successive net repayment in consumer credit, and similar to November's level of £376 million.

The ongoing net repayment in consumer credit in December is expected to be the consequence of many consumers' desire to reduce their debt, low demand for credit, and a lack of availability of unsecured credit from banks. Elevated and rising debt levels mean that there is an urgent need for many consumers to improve their balance sheets, while still serious concerns over jobs and the economic outlook are causing a substantial number of people to want to save more. This was highlighted by latest data showing that the household savings ratio spiked to an 11-and-a-half-year high of 8.6% in the third quarter of 2009. Significantly, the Bank of England has identified the need for, and desire of, consumers to improve their balance sheets as a major factor that could limit economic growth over the medium and longer term. Meanwhile, very tight credit conditions continue to make it generally difficult for people to borrow.

Manufacturing Activity and Prices in January

The manufacturing purchasing managers' index (PMI; out Monday) is expected to show that the sector continued to expand in January, but lost a little momentum as it was affected by the extreme weather. Specifically, we forecast the PMI to have edged back to 54.0 in January after rising to a 25-month high of 54.1 in December. Even so, this would still be clearly above the critical 50.0 level that indicates expanding activity. In fact, the industrial trends survey of CBI showed clear improvement in January as orders rose to a 13-month high and production expectations increased, but there was further very bad weather after the CBI's survey was completed.

The overall impression is that the manufacturing sector is currently seeing limited recovery but is far from racing ahead. In the near term at least, manufacturers should benefit from markedly reduced stock levels, while the weak pound is helping exporters in addition to making U.K. manufacturers more competitive in their domestic markets. On top of this, domestic demand has firmed in important overseas markets including the Eurozone and the United States. 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 January (out Friday) are likely to show that the y/y increase in output prices climbed to a 13-month high of 3.7% in January from 3.5% in December. While this is largely the consequence of unfavorable base effects resulting from the sharp fall in oil and commodity prices a year ago, there are signs that manufacturers may be trying to take advantage of some recent limited improvement in activity to push through price increases and support their margins in the face of recently rising input costs. Indeed, core producer output prices rose 0.5% m/m in December, sending the y/y increase to a nine-month high of 2.6%.

We remain dubious that manufacturers will be able to significantly lift their prices over the coming months given substantial excess capacity and elevated competition amid still challenging conditions. While the manufacturing sector appears to be recovering to some extent after a largely dismal 2009, it is still hardly racing ahead. Consequently, we expect the y/y increase in core producer output prices to have been stable at 2.6% in January. Meanwhile, the consensus is for producer input prices to have risen 0.5% m/m in January, thereby causing the y/y increase to be 6.3%. Again, this reflects very unfavorable base effects resulting from the sharp fall in oil prices a year ago, while sterling's weakness has clearly had an upward impact on input prices.

Construction in January

The construction PMI (Tuesday) is likely to show that activity in the sector deepened in January as it was hit by the bad weather. Obviously, construction activity is particularly at the mercy of the elements. We expect the PMI to have fallen to an eight-month low of 45.5 in January from 47.1 in December. This would take it further below the 50.0 level that indicates unchanged activity.

It is worth noting that in contrast to the service sector and manufacturing, the hard data for construction activity has recently been firmer than the survey evidence. While the PMI indicates that construction activity continued to contract through 2009, the national accounts data show that construction output was flat q/q in the fourth quarter of 2009 following growth of 1.9% in the third quarter and 0.6% in the second quarter.

The overall impression is that the construction sector is stabilizing after enduring a major recession, and it should be helped by the economy edging out of recession in the fourth quarter of 2009 and hopefully gradually developing recovery in 2010. Nevertheless, the construction sector still faces serious obstacles. Serious concerns and uncertainties persist over the prospects for the commercial property sector in particular. Over the long term, the construction sector will be hit by the government's need to significantly rein in its spending for an extended period as this is bound to hit expenditure on infrastructure and public buildings.

Service Sector in January

The service sector PMI (Wednesday) is forecasted to indicate that activity expanded for a ninth successive month in January, but again at a modestly reduced rate compared with December because of the bad weather's effects. Specifically, we expect the business activity index to have fallen to 56.3 in January from 56.8 in December. Even so, this would still be substantially above the 50.0 level that indicates unchanged activity.

There are indications that consumer spending on services has improved to a limited extent recently, while the increase in housing market activity is also helping the services sector. Demand for business services also appears to be picking up.

Nevertheless, the survey evidence currently needs to be treated with caution. Despite the purchasing managers' business activity index pointing to the services sector expanding in the fourth quarter of 2009 at the fastest rate since the third quarter of 2007, the preliminary GDP data showed service sector output edging up by just 0.1% q/q. The purchasing managers' survey also pointed to clear service sector growth in the third quarter of 2009, yet the national accounts data report contraction of 0.2% q/q.

By Howard Archer

1 Feb - Bank of England Consumer Credit, December (GBP/Billion): -0.4
1 Feb - Bank of England Net Lending Secured on Dwellings, December (GBP/Billion): +1.7
1 Feb - Bank of England Number of Loan Approvals for House Purchase, December (000s): 62
1 Feb - Manufacturing Purchasing Managers' Index, January: 54.0
2 Feb - Construction Purchasing Managers' Index, January: 45.5
3 Feb - Service Sector Purchasing Managers' Index, January: 56.3
5 Feb - Producer Price Output Inflation, January NSA (Month-on-Month): +0.3%
5 Feb - Producer Price Output Inflation, January NSA (Year-on-Year): +3.7%
5 Feb - Core Producer Price Output Inflation (ex Food, Tobacco etc.) January SA (Month-on-Month): +0.3%
5 Feb - Core Producer Price Output Inflation (ex Food, Tobacco etc.) January SA (Month-on-Month): +2.6%
During Week - Halifax House Prices, January (Month-on-Month): +0.8%
During Week - Halifax House Prices, January (Year-on-Year): +3.7%