The public finances data for August (out on Tuesday) are expected to show lower shortfalls compared to a year ago, as has been largely the case since March. Tax receipts are benefiting from the economy's return to growth since the fourth quarter of 2009 and from the value-added tax rising back up from 15.0% to 17.5% in January. The marked improvement in growth during the second quarter should have helped matters. In addition, unemployment benefit claims have fallen by 161,800 overall from last October's 12-year high of 1.6278 million, which is helping to limit the rise in public expenditure. Consequently, we expect the Public Sector Net Borrowing Requirement (PSNBR) to come in at £11.5 billion in August, compared with £13.6 billion in August 2009.

Nevertheless, this would still be a worryingly high level and would maintain pressure on the coalition government not to falter in its fiscal consolidation plans.

Minutes of September Bank of England MPC Meeting

Wednesday sees the release of the minutes of the September meeting of the Bank of England's Monetary Policy Committee (MPC). At the September meeting, the MPC once again kept monetary policy on hold, with interest rates staying down at the record-low level of 0.50% and the committee opting not to add to the £200 billion that the Bank of England has already spent on its Quantitative Easing programme. The August MPC meeting saw a 8-1 vote in favour of unchanged interest rates, with the one dissenter (Andrew Sentance) continuing to want a 25-basis-point rate hike to 0.75%. All nine MPC members voted for unchanged Quantitative Easing at the August meeting.

We expect the minutes of the September meeting to reveal that Andrew Sentance maintained his stance that a small rise in interest rates is justified, but that he remained a lone voice within the MPC voting for such a move. We strongly suspect that the other eight MPC members concluded that the serious headwinds facing what is still overall muted recovery from very deep recession (despite GDP spiking up by 1.2% quarter-on-quarter in the second quarter) warranted unchanged interest rates.

These headwinds notably include the major fiscal squeeze that will increasingly kick in, slowing global growth, high unemployment, and persistently tight credit conditions. Indeed, the minutes may well reveal that MPC is becoming increasingly worried about the risk of a double-dip downturn, particularly given the markedly weaker surveys relating to services, manufacturing, and construction activity in August.

Consequently, there may well have been stronger consideration within the MPC at the September meeting about the case for reviving Quantitative Easing, which has been on hold since February. In addition to signs that the recovery may be faltering appreciably, the Bank of England is clearly concerned by the threat to economic activity stemming from persistently tight credit conditions—and latest news on this front remains worrying. Certainly, if the economy continues to falter, the case for reviving Quantitative Easing will become increasingly persuasive.

Nevertheless, the minutes are likely to show that the MPC still has serious inflation concerns, particularly relating to the risk that persistent above-target consumer price inflation could lead to higher inflation expectations becoming entrenched among workers and businesses. This could then increasingly affect wage demands and influence companies' pricing policies. However, we expect the MPC to have stuck to the central view expressed in the August minutes that the "the weight of evidence continued to suggest that the margin of spare capacity (in the economy) was likely to bear down on inflation and bring it back to (the 2.0%) target in the medium term once the impact of temporary factors had worn off." These temporary factors include sterling's past depreciation, value added tax changes, and energy and commodity price movements.

Our view is that Bank of England is most likely to keep interest rates down at 0.50% during the rest of 2010 and much of 2011. We forecast the first interest rate hike to 0.75% to come in the fourth quarter of 2011 and see interest rates still only at 1.00% at the end of next year. Indeed, we would not rule out interest rates staying down at 0.50% until 2012. Whenever interest rates do finally start to rise, they are likely to remain very low compared to past norms, as monetary policy will need to remain loose for an extended period to offset the impact of the major, sustained fiscal squeeze.

Mortgage Approvals in August

The British Bankers' Association (BBA) is expected to report on Thursday that mortgage approvals for house purchases remained very low in August. Specifically, we forecast mortgage approvals to have only edged up to 34,500 in August, from just 33,698 in July, which was the second-lowest level (after 33,059 in February) since April 2009. Mortgage approvals of 34,500 in August would be down 15.1% year-on-year and substantially below the average monthly level of 59,221 seen since 1997.

The economic fundamentals are far from ideal for the housing market (notably high unemployment and muted wage growth), a major fiscal squeeze is getting underway, and house price/earnings ratios have moved up overall from their early-2009 lows and are above their long-term averages. On top of this, credit conditions remain tight with mortgages still hard to get for many people. Meanwhile, more properties have been coming on to the market for some time now, thereby moving the supply/demand balance in favour of buyers. 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, while we believe that a sharp correction in house prices is unlikely, we do expect them to ease back by around 3% over the final months of 2010. Furthermore, house prices look likely to be under pressure 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. Consequently, a further drop of around 5% in house prices looks highly possible in 2011, and the drop could well be steeper still, although much will depend on mortgage availability and the amount of houses coming on to the market. Therefore, we believe that house prices could be some 10% lower by end-2011.

21 Sep - Public Sector Net Borrowing Requirement, August (GBP/Bln): 11.5

22Sep - Bank of England Monetary Policy Committee interest rate vote split, September (Hike-Unchanged-Cut): 1-8-0

22 Sep - Bank of England Monetary Policy Committee Quantitative Easing vote split, September (More-Unchanged-Reduced): 0-9-0