We expect the preliminary national accounts data for the second quarter (out Friday) to show that GDP growth picked up to 0.5-0.6% quarter-on-quarter in the second quarter. This would be up from expansion of 0.3% quarter-on-quarter in the first quarter and would be the third successive quarter of expansion following the record six successive quarters of contraction through to the third quarter of 2009. It would also cause GDP to be up by 1.1% year-on-year in the second quarter, which would be the first positive annual growth rate since the second quarter of 2008. We assume that there was only a very modest dent to overall economic activity from the week-long flight ban in April resulting from the Icelandic volcanic ash.
The preliminary national accounts estimate is based only on the output side of the economy. Latest available data show that industrial production grew by a healthy 0.7% in May, thereby remaining on course for robust expansion in the second quarter. Even if industrial production was flat in June, it would have risen by 1.3% quarter-on-quarter in the second quarter. It needs to be borne in mind, however, that industrial production only accounts for 17.2% of total output. The dominant services sector is not performing as well as manufacturing and it was hit to a limited extent in April by the flight ban. Nevertheless, it should have achieved reasonable expansion in the second quarter, while survey evidence from the purchasing managers suggests that the construction sector expanded in the second quarter.
There is, however, a very real risk that the second quarter will be as good as it gets for the economy for the time being. Going forward, we expect growth to be relatively muted and bumpy in the face of serious headwinds including the increasing impact of major fiscal tightening, the Eurozone's problems (which could impact negatively on the UK in a number of ways, most notably through limiting exports) and the pressure on consumers coming from high unemployment, muted wage growth, high debt levels, and the fiscal squeeze. Consequently, we expect U.K. GDP growth to be limited to 1.1% in 2010.
Public Finances in June
The public finances data for June (out on Tuesday) are expected to show lower shortfalls compared with a year ago, as has been the case since March. Tax receipts are benefiting from the economy's return to growth since the fourth quarter of 2009 and Value-Added Tax rising back up from 15.0% to 17.5% in January. In addition, unemployment benefit claims have fallen by 167,700 from last October's 12-year high of 1.6278 million. Consequently, we expect the Public Sector Net Borrowing Requirement (PSNBR) to come in at £13.0 billion in June compared with £14.7 billion in June 2009.
Nevertheless, this would still be a worryingly high level and the coalition government is clearly set on returning the public finances to a sustainable state by the end of this parliament. To this end, the emergency 22 June budget contained an extra £40 billion of fiscal tightening, despite the concerns that this could risk derailing already muted and fragile recovery.
CBI Industrial Trends Survey for July
The Confederation of British Industry (CBI) industrial trends survey for July is out on Tuesday, and it is expected to show that the balance of manufacturers reporting that their orders are at normal levels was stable at -23%. The balance slipped back to this level in June, having previously spiked up to a 21-month high of -18% in May from -36% in April.
While the manufacturing survey evidence for June from the CBI, and the purchasing managers, was still pretty healthy, there were hints in both surveys that the rate of growth could be peaking. In both surveys, orders growth dipped in June, with foreign demand faltering.
Manufacturers benefited through the first half of 2010 from healthier demand both at home and overseas, improved competitiveness in both domestic and foreign markets stemming from the weak pound, and leaner stock levels. The key question, however, is can manufacturers sustain healthy growth over the second half of the year and beyond, as inventory adjustment comes to an end, fiscal policy is tightened substantially, the Eurozone faces serious problems, and the pound is firmer against the euro?
Minutes of July Bank of England MPC Meeting
Wednesday sees the release of the minutes of the July meeting of the Bank of England's Monetary Policy Committee (MPC). At the July meeting, the MPC once again kept monetary policy on hold with interest rates staying down at the record-low level of 0.50% and opted not to add to the £200 billion that the Bank of England has already spent on its Quantitative Easing program. The June MPC meeting saw a 7-1 vote in favor of unchanged interest rates, with the one dissenter (Andrew Sentance) wanting a 25 basis point rate hike to 0.75%. We expect this vote to have been repeated in July. In recent speeches, Andrew Sentance has made it very clear that he still favors a modest interest rate hike despite the extra fiscal tightening announced in the June 22 emergency budget, but we seriously doubt that any of the other seven MPC members who participated in the July meeting joined him. All eight MPC members are likely to have voted to keep the stock of Quantitative Easing unchanged at £200 billion at the July meeting. The ninth MPC member, Martin Weale, takes up his new position in time for the August meeting.
Admittedly, all MPC members are likely to be concerned by still sticky, well above-target consumer price inflation and a recent spike up in short-term inflation expectations, but there are currently very serious risks to already-muted recovery coming from the extra fiscal tightening measures that were announced in June's emergency budget, as well as from the Eurozone's problems and heightened fears of a global "double-dip". Although most of the extra fiscal tightening will not kick in before 2011, the emergency budget may lead to increasing consumer and business caution even before some of the measures are imposed or start to bite, something the MPC will probably want to monitor. There are signs in some surveys that confidence has been hit. Furthermore, consumer price inflation has fallen back to 3.2% in June from a 17-month peak of 3.7% in April, and this trend will hopefully continue over the coming months, reflecting significant excess capacity, and the waning of temporary factors (higher energy prices, sterling's past depreciation and VAT effects). Indeed, sterling has firmed recently while oil prices have softened appreciably from April's peak levels.
We maintain the view that the Bank of England is more likely than not to keep interest rates down at 0.50% into 2011, although we do acknowledge that there is a very real possibility of at least a token interest rate hike before the end of the year if inflation continues to be sticky and inflation expectations rise significantly further. Specifically, we forecast the first rise in interest rates to come in the second quarter of 2011, with rates only reaching 1.75% by the end of 2011. Meanwhile, we expect the Bank of England to keep the stock of Quantitative Easing unchanged at £200 billion for the rest of 2010 and at least the first half of 2011 before starting to gradually reverse the process.
Retail Sales in June
Retail sales volumes (out on Thursday) are forecast to have risen by a relatively decent 0.5% month-on-month in June, following an increase of 0.6% in May. Year-on-year growth in retail sales, however, would be limited to 1.0% in June, due to the fact that they spiked up by 1.7% month-on-month in June 2009. Survey evidence for June from the British Retail Consortium (BRC) indicated that retail sales were lifted by the football World Cup, the good weather, and some earlier discounting by retailers in the summer clearance sales. Survey evidence for June from the CBI was softer than the BRC, but was completed earlier in the month.
Despite likely decent retail sales growth in June, it is hard to be optimistic about the prospects for consumer spending. Indeed, we believe that consumer spending will be limited for some time to come, which does not bode well for overall growth prospects given that consumer spending accounts for some 65% of GDP.
Certainly, consumer confidence has been heading south recently, and households face serious headwinds, notably including high unemployment, muted earnings growth, elevated debt levels, high fuel prices, and January's Value-Added Tax hike from 15.0% back up to 17.5%. In addition, the substantial fiscal squeeze will increasingly hit public sector jobs and consumers' pockets. There is also some pressure on the Bank of England to raise interest rates before the end of the year because of heightened inflation concerns, although we still lean towards the view that the bank will hold fire given still-gradual recovery and the serious downside risks to growth.
Longer term, retail sales will be hit by VAT rising up to 20% in January 2011, although this could bring forward some spending later this year as consumers look to make purchases of more expensive items ahead of the increase.
Mortgage Approvals in June
The British Bankers' Association (BBA) is expected to report on Friday that mortgage approvals for house purchases were essentially stable at 37,000 in June. Mortgage approvals amounted to 36,709 in May, which was up modestly from 35,964 in April and a 10-month low of 33,410 in February. Although May's level was the highest so far in 2010, mortgage approvals were still down appreciably from last December's 27-month high of 45,758. They were also well below the average monthly level of 59,543 seen since 1997.
The economic fundamentals are far from ideal for the housing market (in particular, high unemployment and muted wage growth), a major fiscal squeeze is now starting, and house price/earnings ratios have moved back up overall from their early-2009 lows to above their long-term averages.
Furthermore, household confidence has been heading down recently and already deepening concerns over the strength and sustainability of the recovery may be intensified by the extra austerity measures that were announced in June's emergency budget. There are also concerns that the Bank of England will raise interest rates before the end of the year due to sticky, above-target inflation. The more worried consumers are, the less likely they will want to commit to buying a house.
Meanwhile, more properties have been coming on to the market thereby moving the supply/demand balance more in favor of buyers. This is particularly relevant as a shortage of properties has been a key factor in the recovery in house prices from their early-2009 lows. It may well be that the new government's decision to abolish Home Information Packs is now contributing to the rise in houses coming on to the market.
On the positive side, some support for house activity and prices will come from the current stamp duty holiday for first-time buyers on all properties costing up to £250,000. And interest rates are likely to stay low for an extended period to offset the fiscal tightening.
On balance, we believe that house prices are likely to be erratic over the coming months and will probably be flat over the rest of 2010. Furthermore, it is hard at this stage to be optimistic about house prices in 2011 as the fiscal squeeze will increasingly kick in, which will hit people's pockets and lead to serious job losses in the public sector.
20 Jul - Public Sector Net Borrowing Requirement, June (GBP/Bln): 13.0
20 Jul - CBI Industrial Trends, Total Orders, July: -23%
21Jul - Bank of England Monetary Policy Committee interest rate vote split, July (Hike-Unchanged-Cut): 1-7-0
21 Jul - Bank of England Monetary Policy Committee Quantitative Easing vote split, July (More-Unchanged-Reduced): 0-8-0
22 Jul - Retail Sales, June (month-on-month): +0.5%
22 Jul - Retail Sales, June (year-on-year): +1.0%
23 Jul - GDP, Second Quarter 2010 (Quarter-on-Quarter): +0.5%
23 Jul - GDP, Second Quarter 2010 (Year-on-Year): +1.1%
23 Jul - BBA Loans for House Purchases, June: (000s): 37.0