Bank of England April Policy Meeting
The Bank of England's Monetary Policy Committee (MPC) could probably take an extended Easter break and skip its 7–8 April policy meeting. All nine members voted in favor of unchanged interest rates and quantitative easing at the March meeting, and developments since then suggest there is no need to change tack. Consequently, it looks certain that the MPC will decide next Thursday to keep interest rates down at 0.50% and will not add to the £200 billion already spent on quantitative easing. Indeed, it currently looks highly likely that the MPC will be sitting on its hands for many more months to come.
With GDP growth being revised up to 0.4% quarter-on-quarter (q/q) in the fourth quarter of 2009, most evidence suggesting that economic activity has picked up to a limited extent after a significant weather-related hit at the start of the year, and consumer price inflation falling back more than expected from 3.5% in January to 3.0% in February, the MPC could probably give its April meeting a miss. There seems little, if any, reason for the members to adjust monetary policy and several good reasons for them to stay firmly in "wait and see mode."
The minutes of the March MPC meeting indicated that the committee is firmly in "on hold" mode while it waits for recent distortions to growth and inflation to work through so that it can get a clearer picture of the state of the economy. Significantly, there was a unanimous vote in favor of keeping all aspects of the monetary policy unchanged in March.
There were hints in the minutes that the MPC are a little more worried overall about the inflation outlook, partly due to sterling's recent weakness. There was concern that consumer price inflation could remain well above its 2.0% target level for longer than expected and that this could lead to inflation expectations rising. Even so, there was still general belief within the committee that inflation will fall markedly as temporary upward pressures unwind (January's value-added tax hike—VAT—higher oil prices, and sterling's past depreciation) and underlying price pressures are contained by significant spare capacity.
Moreover, inflation developments since the March meeting should have been largely reassuring for the MPC. Consumer price inflation receded more than expected from 3.5% in January to 3.0% in February, while sterling has climbed off its recent lows. In addition, the recently released Bank of England/GfK NOP quarterly inflation survey for February shows that the public's inflation expectations have only edged up and remain relatively muted.
Meanwhile, the MPC still appears to be far from convinced about the strength and sustainability of the economic recovery, with January's VAT hike and very bad weather further clouding an already-fuzzy outlook. The committee still seems to expect recovery to be bumpy and gradual overall, and this view is unlikely to have been fundamentally changed by GDP growth in the fourth quarter of 2009 being revised up to 0.4% q/q. Significantly, the economy was receiving a lot of help in the fourth quarter of 2009 from monetary and fiscal stimulus and these props are starting to be removed. VAT was lifted up to 17.5% again from 15.0% while the car scrappage scheme has just ended.
Indeed, it is highly possible that GDP growth slowed in the first quarter of 2010 as it was hit significantly by January's freezing conditions (for example, retail sales could very well have contracted appreciably despite some bounce-back in February).
Although the economy should eventually make up the majority of any activity lost to the bad weather, it may very well see only limited growth for some time to come. In particular, the upside for consumer spending is likely to be limited over the coming months by high unemployment, low earnings growth, January's VAT hike, and an ongoing need for/desire of households to improve their balance sheets. Meanwhile, businesses are likely to remain cautious in their capital expenditure because of substantial excess capacity, and still-serious concerns and uncertainties over the outlook. Only slowly easing credit conditions are also likely to hinder business investment in the near term at least. Furthermore, there is still the concern that subdued growth in the Eurozone will limit the upside for exports despite the competitive level of the pound.
We suspect that interest rates will stay at 0.50% through 2010 given probable ongoing concerns within the MPC over the strength and sustainability of the recovery. Furthermore, when interest rates finally do start to rise, the increases are likely to be gradual and limited because of the need to offset the marked tightening in fiscal policy that will start in 2011 at the latest.
Nevertheless, we suspect that the Bank of England would prefer not to engage in further quantitative easing unless the economy suffers a major relapse over the coming months. Nevertheless, we do not expect the Bank of England to reverse quantitative easing until 2011.
Key Economic Releases
Construction Activity in March
The construction purchasing managers' index (PMI; out Tuesday) is likely to show that overall activity continued to contract modestly in March. We expect the PMI to be little changed at 48.7 in March after it dipped to 48.5 in February from a 23-month high of 48.6. This would be close to the 50.0 level that indicates unchanged activity. In fact, the index has been hovering just below the 50.0 level since mid-2009. While still indicating modest contraction, this is a substantial improvement from early 2009 when the index dipped below 30.0.
The overall impression is that the construction sector remains fragile but is broadly stabilizing after enduring a major downturn, and it will be desperately hoping that the economy can develop significant recovery in 2010 after exiting recession in the fourth quarter of 2009.
Nevertheless, the construction sector still faces a very challenging environment, and it is likely to 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. Latest national accounts data show that construction output fell 0.9% q/q in the fourth quarter of 2009 after growing 1.8% q/q in the third quarter and 0.1% q/q in the second quarter. The depth of the contraction in construction output through 2008 and the first quarter of 2009 meant that it was still down 6.0% year-on-year (y/y) in the fourth quarter and contracted 10.8% in 2009.
Service Sector Activity in March
The Markit service sector purchasing managers' index (Wednesday) is forecasted to indicate that activity edged up further in March after rebounding in February from January's weather-related slowdown. Specifically, we expect the business activity index to have climbed to 58.5 in March after spiking to a three-year high of 58.4 in February from a five-month low of 54.5 in January. This would take it further above the 50.0 level that indicates unchanged activity.
There are indications that consumer spending on services has improved to a limited extent recently. For example, the Bank of England's regional agents reported in their March survey of business conditions that "growth in consumer services turnover had picked up slightly in recent months, although it remained weaker than growth in retail spending." In addition, demand for business services has been firmer recently.
Industrial Production in February
We expect manufacturing output (Wednesday) to have expanded 0.5% month-on-month (m/m) and 0.7% y/y in February. Output previously sank by 0.9% m/m in January, as activity was hit markedly by the arctic weather conditions. The Office for National Statistics also indicated that there may have been some corrective element in January's sharp fall in output after production surged 0.9% m/m in December. Overall industrial production is seen rising 0.4% m/m in February after contracting a lesser 0.5% m/m in January when it was helped by higher utilities output. This would leave industrial production at 0.6% y/y.
Certainly, latest survey evidence from the Confederation of British Industry and, especially, the manufacturing purchasing managers has been pretty upbeat. The overall impression coming through is that manufacturers are currently seeing a decent, if unspectacular, pickup in activity after a largely dire 2009 as they benefit from leaner stock levels, improved competitiveness in both domestic and foreign markets stemming from the weak pound, and a limited overall pickup in demand both at home and overseas. Nevertheless, uncertainties persist over the strength of demand for manufactured goods over the medium term, particularly as stimulative measures are withdrawn.
Producer Prices in March
Producer price data (Friday) are likely to show that the annual increase in output pricesclimbed to a 15-month high of 4.3% in March from 4.1% in February. While this is still influenced by unfavorable base effects resulting from the sharp fall in oil and commodity prices in the second half of 2008 and early 2009, there are signs that manufacturers are currently trying to take advantage of the recent overall improvement in activity to push through some price increases and support their margins in the face of recently rising input costs. Core producer output prices are forecasted to have risen 0.3% m/m in March, sending the y/y increase to a one-year high of 3.1% from 2.9% in February.
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 is recovering reasonably well after a largely dismal 2009, it is still far from racing ahead. Meanwhile, the consensus is forproducer input prices to have risen 1.3% m/m in March, thereby causing the annual increase to be 7.1%.
Halifax House Price Index for March
The Halifax lender is expected to report during the week that house prices rose 0.5% m/m in March after falling 1.5% in February. This had been the first fall in house prices reported by the Halifax since last June. A rise of 0.5% in March would cause the y/y rise in house prices to edge up to 4.7% in the three months to March from 4.5% in the three months to February. The y/y increase in house prices would rise to 6.6% in March itself from 4.2% in February, reflecting the fact that house prices fell 1.7% m/m in March 2009.
The Nationwide lender has already reported that house prices rose 0.7% m/m in March after dropping 1.0% in February. Nevertheless, the y/y rise in house prices moderated to 9.0% in March from 9.2% in February.
We suspect that house prices will be erratic through 2010, and will probably be no better than flat over the year. We believe that the overall appreciable house price rises that have been seen since early 2009 have been out of kilter with the overall economic fundamentals. This is even allowing for the support to the housing market coming from low mortgage interest rates and more affordable prices due to the pretty substantial fall in house prices from their October 2007 peak through to their early-2009 trough. Significantly, house prices have been lifted markedly since early 2009 by the shortage of properties for sale, but latest survey evidence suggests that more properties are now coming onto the market and this prop is crumbling.
Although the Bank of England may well hold off from raising interest rates until 2011, the overall economic environment (notably high unemployment and low earnings growth) is still far from supportive for house prices while credit conditions remain pretty tight. In addition, house price/earnings ratios have moved up again in recent months.
Nevertheless, some support for house activity and prices is likely to come from the government announcing in the recent budget that it is bringing in a stamp duty holiday for the next two years for first-time buyers on all properties costing up to £250,000.
6 Apr - Construction Purchasing Managers' Index, March: 48.7
7 Apr - Service Sector Purchasing Managers' Index, March: 58.5
8 Apr - Industrial Production, February (Month-on-Month): +0.4%
8 Apr - Industrial Production, February (Year-on-Year): -0.6%
8 Apr - Manufacturing Output, February (Month-on-Month): +0.5%
8 Apr - Manufacturing Output, February (Year-on-Year): +0.7%
9 Apr - Producer Price Output Inflation, March (Month-on-Month): +0.3%
9 Apr - Producer Price Output Inflation, March (Year-on-Year): +4.3%
9 Apr - Core Producer Price Output Inflation (ex Food, Tobacco etc.) March (Month-on-Month): +0.3%
9 Apr - Core Producer Price Output Inflation (ex Food, Tobacco etc.) March (Month-on-Month): +3.1%
During Week - Halifax House Prices, March (Month-on-Month): +0.5%
During Week - Halifax House Prices, March (Year-on-Year): +4.7%