Forthcoming data are likely to show another marked rise in inflation in January, while retail sales are likely to have been hit markedly by the bad weather.
Annual consumer price inflation data (out Tuesday) are likely to show a further substantial increase to a 14-month high of 3.5% in January, from 2.9% in December and a five-year low of 1.1% in September. This would take consumer price inflation more than one percentage point above the Bank of England's target level of 2.0%, thereby requiring the bank's governor, Mervyn King, to write an open letter to Chancellor Alistair Darling explaining why inflation has overshot on the upside and what the central bank is doing about it.
January's further spike in consumer price inflation is expected to be primarily due to value-added tax (VAT) rising from 15.0% to 17.5% at the start of the month. In addition, it appears that retailers engaged in less discounting in the post-Christmas clearance sales in 2010 compared with 2009 when they were particularly worried about consumers' willingness to spend amid plunging economic activity, and had high stock levels. Inflation has also been pushed up markedly from September's low by very unfavorable base effects resulting from the sharp falls in oil prices a year earlier and the December 2008 VAT cut dropping out of the calculation.
Core consumer price inflation is seen rising to 3.4% in January, from 2.9% in December, largely because of the VAT hike and less discounting. In addition, annual underlying retail price inflation should have spiked to 4.6% in January, from 3.8% in December and 1.9% in October. Finally, the year-on-year (y/y) increase in retail prices is seen rising to 3.7% in January, from 2.4% in December and 0.3% in November. Prior to this, there were eight months of deflation on this measure including a peak drop of 1.6% in June. This deflation was the consequence of mortgage interest payments being much lower y/y because of the Bank of England's slashing interest rates 450 basis points between October 2008 and March 2009.
Consumer price inflation should peak around January's expected level of 3.5% and then fall appreciably. Indeed, we believe it could well be back under 2.0% by the end of the year. Given that oil prices bottomed out early in 2009 and then firmed, base effects should become more favorable. Meanwhile, underlying prices pressures should be contained by substantial excess capacity, muted recovery, wage moderation, and the need for retailers to price competitively in the face of still-limited consumer spending.
Data on Wednesday may well reveal that unemployment has fallen modestly further after dropping late in 2009. We expect claimant-count unemployment to have fallen by 8,000 in January, after dropping 15,200 in December and 10,800 in November. The claimant-count unemployment rate is seen stable at 5.0%. The number of jobless on the International Labour Organization (ILO) measure is seen falling around 12,000 in the three months to December, which would follow a drop of 7,000 in the three months to November (the first decline since the three months to May 2008). This would take the number of unemployed on the ILO measure down to 2.449 million and keep the ILO unemployment rate at 7.8%.
Although unemployment may have fallen modestly further, we suspect that the number of jobless is yet to peak. This is despite the fact that the economy crawled out of recession in the fourth quarter of 2009. It is also true that the rise in unemployment is being limited to some extent by companies and workers being flexible in trying to avoid permanent job losses, including the use of such measures as wage freezes or pay cuts, extended unpaid leave, career breaks, and working part time.
Significantly, full-time employment is still falling appreciably. Indeed, latest data show that it fell 113,000 in the three months to November, although total employment only fell 14,000 as part-time unemployment rose 99,000.
It is also evident that the recent falls in unemployment have been influenced markedly by people withdrawing from the labor market for the time being at least. Significantly, the employment rate for people aged 16–64 fell to a near-13-year low of 72.4% in the three months to November. Assuming that at least some of these people return to the labor market as the economy starts to recover, it will push unemployment up.
While the economy crawled out of recession in the fourth quarter of 2009, activity is still unlikely to be strong enough in 2010 to prevent further net job losses. Doubts and concerns over the strength and sustainability of any recovery are likely to encourage businesses to keep their labor forces as tight as possible. In addition, significant job cuts in the public sector could well occur this year as part of the efforts to rein in government expenditure. We suspect that unemployment could yet rise to a peak around 2.75 million on the ILO measure in late 2010 or early 2011. At least, though, this is markedly below the 3.0-million level that had long been feared.
Average weekly earnings are expected to have risen just 0.8% y/y in the three months to December, as they were limited by low bonus payments. Furthermore, underlying average weekly earnings have been under serious downward pressure from high unemployment, still-significant job insecurity, recent low inflation, and the need for companies to contain their costs in the face of still-muted demand and reduced profitability. As a result, annual average weekly earnings growth (regular pay, excluding bonus payments) is seen limited to 1.1% in the three months to December.
Minutes of the February Bank of England MPC Meeting
Wednesday also sees the release of the minutes of the February meeting of the Bank of England's Monetary Policy Committee (MPC). At the meeting, the MPC brought its quantitative easing program to at least a temporary halt after spending a total of £200 billion, while also keeping interest rates down at a record low of 0.50%. Given the generally dovish tone of the subsequently released Bank of England's Quarterly Inflation Report for February, we suspect that there may well have been a split vote among the nine MPC members as to whether or not to extend quantitative easing.
Indeed, the Quarterly Inflation Report and Bank of England governor Mervyn King's accompanying comments indicated that the door is still very much open to further quantitative easing should the recovery falter markedly over the coming months and also suggested that any interest-rate hikes are some considerable way off. The report was less optimistic on growth than was the case in the November report and still saw consumer price inflation receding appreciably despite spiking more in the near term than had previously been expected. Also significantly, the Bank of England's growth and inflation forecasts were based on fiscal policy as it currently stands, and it seems highly likely that further major fiscal tightening over the medium term will be announced after the general election, whichever party holds power.
The public finances for January (Thursday) will undoubtedly once again make unpleasant reading, but they will hopefully at least show that the rate of deterioration is now moderating in reaction to the economy crawling out of recession in the fourth quarter of 2009 as well as recent improved unemployment trends. The November and December public finance data both showed less marked deterioration in the public finances compared with the corresponding month in the previous year, and tax revenues will start to benefit to a limited extent in January from VAT rising from 15.0% to 17.5% again. In fact, January traditionally sees a surplus on the public finances as it is a key month for tax receipts. We are looking for a repayment on the Public Sector Net Borrowing Requirement (PSNBR) of £3.5 billion in January. This would be down from repayments of £5.4 billion in January 2009 and £14.1 billion in January 2008.
Even if the rate of deterioration in the public finances does show further evidence of moderating in January, it will not mask the fact that major fiscal surgery is needed for an extended period involving further (and clearer) spending cuts as well as tax hikes. Chancellor Alistair Darling still faces a very difficult budget in March, as the December 2009 Pre-Budget Report left many questions unanswered over how exactly the government will return the public finances to health over the medium term. While it is likely that many spending cuts and tax rises will not be announced before the looming general election, if the next government fails to address the issues at an early stage, it is likely that the credit agencies and the markets will lose patience, with dire consequences for the U.K. economy.
Confederation of British Industry Industrial Trends Survey
The Confederation of British Industry (CBI) industrial trends survey for February is also out on Thursday, and it should show that the balance of manufacturers reporting that their orders are at normal levels improved to -37%, from -39% in January and a 17-year low of -58% in March 2009. Manufacturing output jumped 0.9% month-on-month (m/m) in December, causing it to be up 0.8% quarter-on-quarter (q/q) in the fourth quarter of 2009. Overall industrial production was up 0.5% in December and 0.4% q/q in the fourth quarter of 2009.
It appears that manufacturers are currently benefiting appreciably from leaner stock levels, improved competitiveness in both domestic and foreign markets stemming from the weak pound, and firmer demand in key overseas markets, including the Eurozone and the United States. There are also signs that domestic demand is picking up. Hopefully, therefore, the industrial sector can see decent expansion in the first quarter of 2010 and help the economy to continue to grow, although it must be borne in mind that the sector only accounts for 17.2% of GDP. Furthermore, serious uncertainties remain about the strength of demand for manufactured goods over the medium term, particularly once stimulative measures start being withdrawn.
Retail sales volumes (Friday) are forecasted to have fallen 0.7% m/m in January, thereby limiting y/y growth to just 0.9%. Retail sales are expected to have been hit hard in January by a triple whammy of bad weather, the VAT hike from 15.0% to 17.5%, and reduced discounting by retailers compared with a year earlier in the clearance sales.
We suspect that the upside for consumer spending—and hence overall economic growth—will be limited in 2010 as households face still very challenging conditions, notably including high unemployment, still markedly falling full-time employment, low earnings growth, high debt levels, and January's VAT hike. Meanwhile, still-serious concerns about the economic outlook and jobs are likely to maintain consumers' desire to improve their personal finances. Consumers will also be wary that further out they are very likely to face higher taxes as part of the major corrective action that will be needed to rein in the government finances. It has been mooted for example that the Conservatives could raise VAT to 20%. On the positive side, the Bank of England looks increasingly unlikely to raise interest rates until 2011 and rates should then increase only gradually. At least low mortgage rates should continue to support consumers' purchasing power.
16 Feb - Consumer Price Inflation, January (Month-on-Month): -0.1%
16 Feb - Consumer Price Inflation, January (Year-on-Year): +3.5%
16 Feb - Core Consumer Price Inflation (ex Food, Drink, Tobacco), January (Year-on-Year): +3.4%
16 Feb - Retail Price Inflation, January (Month-on-Month): -0.1%
16 Feb - Retail Price Inflation, January (Year-on-Year): +3.7%
16 Feb - Underlying Retail Price Inflation, January (Month-on-Month): -0.1%
16 Feb - Underlying Retail Price Inflation, January (Year-on-Year): +4.6%
17 Feb - Bank of England Monetary Policy Committee interest-rate vote split, February (Hike-Unchanged-Cut): 0-9-0
17 Feb - Bank of England Monetary Policy Committee Quantitative Easing vote split, February (More-Unchanged-Reduced): 2-7-0
17 Feb - Claimant-Count Unemployment Rate, January (%): 5.0%
17 Feb - Claimant-Count Unemployment Change, January (000s): -8
17 Feb - International Labour Organization Unemployment Rate, December (%): 7.8%
17 Feb - Average Weekly Earnings - total pay, December (3-Month/Year): +0.8%
17 Feb - Average Weekly Earnings regular pay excluding bonus, December (3-Month/Year): +1.1%
18 Feb - CBI Industrial Trends, Total Orders, January: -37%
18 Feb - Public Sector Net Borrowing Requirement, January (GBP/Bln): -3.5
18 Feb - Retail Sales, January (Month-on-Month): -0.7%
18 Feb - Retail Sales, January (Year-on-Year): +0.9%