BANK OF ENGLAND POLICY MEETING
Despite consumer price inflation spiking up to 3.7% in April —nearly double its 2.0% target level—the Bank of England's Monetary Policy Committee (MPC) is still odds-on to keep its key interest rates down at 0.50% for a 16th successive month at the conclusion of their June meeting on Thursday. It is also odds-on that the central bank will leave the stock of Quantitative Easing unchanged at £200 billion, having ended the purchase of assets in February.
Relatively muted recovery following deep recession, the looming major fiscal squeeze, and the risk to U.K. economic activity currently coming from the Eurozone debt crisis make a strong case for the Bank of England to keep its finger off the interest rate trigger in the near term at least. In fact, we still lean towards the view that interest rates will stay down at 0.50% into 2011, despite the OECD suggesting in late May that the Bank of England should start tightening policy no later than the fourth quarter of 2010.
All nine MPC members were in favour of unchanged monetary policy in May; the committee seemed prepared to remain in "wait and see" mode in the near term at least as they look for the uncertainties surrounding U.K fiscal policy and the Eurozone debt crisis to ease.
The minutes of the May MPC meeting acknowledged that the near-term inflation outlook had risen due to higher energy prices and sterling's weakness, as was acknowledged in the Bank of England's May Quarterly Inflation Report. The committee's central view was still that consumer price inflation would fall back below 2.0% in 2011, primarily due to the substantial amount of excess capacity in the economy. There were differing views among the MPC members as to how much spare capacity there is and how much this would hold down inflation over the longer term. There was also a belief among some MPC members that tight credit conditions and the Eurozone crisis posed downside risks to economic growth and inflation.
Indeed, the minutes revealed that the MPC considered that the downside risks to growth in the near term had risen not only due to the Eurozone crisis, but also due to the fact that fiscal policy may have to be tightened more aggressively due to the increased market focus on countries debt positions considering the Eurozone crisis.
Of course, inflation data released since the May MPC meeting have shown consumer price inflation spiking up to a 17-month high of 3.7% in April. This will obviously not have been well received by MPC members, but Bank of England Governor Mervyn King's open letter to Chancellor George Osborne following this latest jump in inflation nevertheless indicated that the Bank of England still expected inflation to fall back below its 2.0% target level in 2011, as temporary factors unwound (January's VAT hike from 15.0% to 17.5%, sterling's past substantial depreciation, and sharply higher year-on-year energy prices) and was still not inclined to raise interest rates in the near term at least.
The fact that consumer price inflation has frequently come in higher than expected in recent months and reached 3.7% in April has led to some questioning of whether the Bank of England can still credibly argue that it will fall back below 2.0% in 2011 and then be close to that level on a two-year horizon. We believe that this is still a defensible forecast given the headwinds facing the U.K. economy, although the inflation profile will be higher if VAT is raised to from 17.5% to 20%—either at the 22 June emergency budget or sometime within the next year—as seems likely as part of the fiscal consolidation measures. It is worth noting that consumer price inflation was 2.0% in April excluding indirect taxes. This was up from a low of 1.2% in February.
The new coalition government has recently revealed its plans to cut public spending by £6.2 billion this fiscal year, but this is only a foretaste of the major fiscal tightening that is on the way. The government's plans will become a lot clearer in the emergency budget to be held on 22 June. This will undoubtedly play a major role in the Bank of England's thinking on how monetary policy pans out over the coming months. Even if the bulk of fiscal tightening does not start until fiscal 2011/12, once people know more details of what is coming, it could very well have a dampening impact on their behaviour.
Meanwhile, the heightened Eurozone debt crisis—and an associated speeding up of fiscal tightening in a number of countries—threatens to dampen U.K. growth not only through limiting exports (the Eurozone accounts for around 50% of U.K. exports), but also through weighing down on confidence, causing market turmoil and increasing pressure for accelerated fiscal tightening in the United Kingdom.
For now at least, we are retaining our view that the MPC will keep interest rates down at 0.50% into 2011. This reflects our belief that recovery will be bumpy and gradual over the coming months. We do acknowledge that there is a very real chance of at least a token interest rate hike before the end of the year if inflation continues to provide upside surprises over the coming months. We still retain the view that whenever interest rates do start to rise, the increases are likely to be gradual and limited due to the need to offset the looming marked tightening in fiscal policy.
Meanwhile, we expect the Bank of England to keep the stock of Quantitative Easing unchanged at £200 billion for the rest of 2010, before starting to gradually reverse the process around mid-2011.
MAIN ECONOMIC RELEASES
British Retail Consortium Retail Sales Monitor for May
The British Retail Consortium (BRC) retail sales monitor for May (out overnight on Monday/Tuesday) is expected to be relatively soft. We forecast the BRC to report that total retail sales rose 2.5% year-on-year in May, while sales are expected to have increased 0.5% on a like-for-like basis (which strips out the effect of additional floor space). The BRC's April monitor was particularly disappointing, showing that total sales fell 0.2% year-on-year and were down 2.3% year-on-year on a like-for-like basis.
The Confederation of British Industry has already released its distributive trades' survey for May, which provided a major downside shock. Indeed, the balance of retailers reporting that sales were up year-on-year weakened to a 14-month low of -18% from +13% in April. The CBI suggested that sales may have been adversely affected in May by bad weather at the start of the month hitting clothing sales in particular, and by recently reduced housing market activity affecting sales of big-ticket items and household goods. It may also be that consumers were deterred from spending by the heightened political uncertainty that surrounded the close-run May 6 general election and the subsequent formation of a coalition government.
We believe that consumer spending will be limited for some time to come as households still face very challenging conditions. These notably include high unemployment and still-falling employment, low underlying earnings growth, elevated debt levels, high fuel prices, and January's Value-Added Tax (VAT) hike from 15.0% back up to 17.5%. Furthermore, overall tax increases are on the way as the coalition government moves to rein in the public finances. This could very well include VAT being raised to 20% (possibly as soon as in the June 22 emergency budget). Meanwhile, still significant uncertainties about the economic outlook and jobs are likely to maintain many consumers' desire to improve their personal finances. There is also growing pressure on the Bank of England to raise interest rates before the end of the year due to heightened inflation concerns, although we believe that they will hold fire for many more months to come.
Trade Deficit in April
The total trade deficit (out Wednesday) is expected to have narrowed to £3.0 billion in April from £3.7 billion in March. Even so, this would still be above the average monthly deficit of £2.7 billion in 2009. Within, this, the visible trade deficit is forecast to have shrunk to £7.0 billion in April from £7.5 billion in March. This would again still be above the average monthly deficit of £6.8 billion in 2009.
We keep looking for net exports to improve and help the economy rebalance, but it is proving to be a frustrating wait. Indeed, net trade was again negative in the first quarter of 2010, as GDP growth was limited to 0.3% quarter-on-quarter. It is to be hoped that the trade deficit will narrow over the coming months as exports benefit increasingly from the combination of sterling's weakness and healthier domestic demand in key overseas markets.
There are at least encouraging signs on export prospects, with latest survey evidence from both the CBI and manufacturing purchasing managers showing robust foreign orders in May. Eurozone economic activity has improved overall in recent months after faltering around the turn of the year and U.K. exporters will be fervently hoping that this continues. The Eurozone debt crisis and an associated earlier and/or more aggressive tightening of fiscal policy in a number of countries are bad news for European growth prospects. Much will also depend to what extent exporters use the more competitive pound to lower prices and try to boost market share in overseas markets and to what extent they keep prices up and use the weaker pound to boost their profit margins. Meanwhile, likely gradually improving U.K. domestic demand will lift imports
Industrial Production in April
We expect manufacturing output (out on Friday) to have expanded 0.4% month-on-month in April after jumping by a very impressive 2.3% in March, thereby pushing the year-on-year growth rate up to 3.7%. Industrial production is forecast to have grown by 0.3% month-on-month in April after a rise of 2.0% in March, which would result in year-on-year expansion of 2.0%. The manufacturing purchasing managers' survey and the Confederation of British Industry's industrial trends survey for April were both very healthy, as they subsequently were for May.
Manufacturers are currently clearly benefiting from healthier demand both at home and, particularly, overseas, improved competitiveness in both domestic and foreign markets stemming from the weak pound, and leaner stock levels. The key question is though can manufacturers sustain healthy growth over the medium term, particularly as stimulative measures are withdrawn? For example, the car scrappage scheme came to an end in March and a major fiscal squeeze is looming ever larger. U.K. manufacturers will certainly be hoping that the Eurozone debt crisis does not derail growth in the region.
Producer Prices in May
Producer price data (also out Friday) are likely to show that output prices rose 0.4% month-on-month in May, which would leave the annual rate of increase unchanged at 5.7%.
While the year-on-year increase is being pushed up by much higher petroleum product prices compared to a year ago and the fact that producer prices were particularly soft a year ago as companies faced sharply reduced demand, it is nevertheless apparent that manufacturers have been looking to take advantage of recently improved activity to push through some price increases and support their margins in the face of increased input costs. Core producer output prices are forecast to have risen 0.4% month-on-month and 4.7% year-on-year in April. Meanwhile, the consensus is for producer input prices to have fallen 0.8% month-on-month in May, helped by the retreat in oil prices. Even so, input prices would still be up 10.7% year-on-year.
8 Jun - British Retail Consortium Monitor Total Sales, May (Year-on-Year): +2.5%
8 Jun - British Retail Consortium Monitor Like-for-Like Sales, May (Year-on-Year): +0.5%
9 Jun - Non-EU Visible Trade Balance, April (GBP/Month): -3.8
9 Jun - Visible Trade Balance, April (GBP/Month): -7.0
9 Jun - Total Trade Balance, April (GBP/Month): -3.0
11 Jun - Industrial Production, April (Month-on-Month): +0.3%
11 Jun - Industrial Production, April (Year-on-Year): +2.0%
11 Jun - Manufacturing Output, April (Month-on-Month): +0.4%
11 Jun - Manufacturing Output, April (Year-on-Year): +3.7%
11 Jun - Producer Price Output Inflation, May (Month-on-Month): +0.4%
11 Jun - Producer Price Output Inflation, May (Year-on-Year): +5.7%
11 Jun - Core Producer Price Output Inflation (ex Food, Tobacco etc.) May (Month-on-Month): +0.4%
11 Jun - Core Producer Price Output Inflation (ex Food, Tobacco etc.) May (Month-on-Month): +4.7%