GDP Growth in Fourth Quarter of 2010
We expect the preliminary national-accounts data for the fourth quarter of 2010 (out Tuesday) to show that GDP growth moderated to 0.4% quarter-on-quarter (q/q) from 0.7% in the third quarter and 1.1% in the second quarter. This would cause the annual growth rate to edge back to 2.6% in the fourth quarter from 2.7% in the third quarter. It would also mean that GDP grew 1.6% overall in 2010 after contracting 4.9% in 2009 and 0.1% in 2008. While hardly a spectacular year of growth, especially after such a deep recession, it would nevertheless be a significantly better performance than had seemed likely at the start of 2010.
Considerable uncertainty about just how much December's severe weather hit overall economic activity makes the GDP performance hard to call. The forecasts for fourth-quarter 2010 GDP releases range from 0.2% q/q to 0.6% q/q.
The preliminary national-accounts estimate is based only on the output side of the economy. Hard data for October and November as well as healthy survey evidence for December suggest that industrial production grew by a robust 0.7% q/q in the fourth quarter, which would actually be up from 0.5% expansion in the third quarter. Nevertheless, the service sector appeared to see relatively modest growth in the fourth quarter, and it may well have been hit significantly by December's arctic weather conditions. Indeed, the purchasing managers' survey for the services sector indicated that activity contracted marginally in December.
Meanwhile, it is evident is that construction activity slowed appreciably in the fourth quarter and made nothing like the contribution to overall GDP growth that it had in the third and second quarters. While the construction sector only accounts for 6.3% of GDP, a surge in construction output added 0.4 percentage point to GDP growth in the second quarter of 2010 and a further 0.2 percentage point to growth in the third quarter. Specifically, the national-accounts data show that construction output rose 3.9% q/q in the third quarter of 2010 after surging 7.0% q/q in the second quarter. Nevertheless, hard data and survey evidence suggest that construction activity saw modest expansion at best in the fourth quarter of 2010 and could even have contracted. Construction activity had clearly slowed appreciably even before being hit markedly by December's severe weather.
No details will be released on the expenditure side of GDP in the fourth quarter.Nevertheless, it seems likely that consumer spending was muted, as retail sales volumes rose just 0.2% q/q in the fourth quarter and spending on services appears to have been limited. Investment probably continued to expand, but at a significantly reduced rate from the 3.4% q/q jump seen in the third quarter. It is also likely that stocks rebuilding made a reduced contribution to GDP growth in the fourth quarter after adding 0.3 percentage point to third-quarter growth. Meanwhile, evidence so far suggests that net trade once again struggled to make a positive contribution to GDP growth in the fourth quarter of 2010, as increasing imports countered improved exports.
Minutes of January Bank of England MPC Meeting
The minutes of the January meeting of the Bank of England's MPC will be released on Wednesday. At its January meeting, the MPC kept interest rates down at 0.50% and left the stock of quantitative easing unchanged at £200 billion (where it has been since February).
Of key interest will be whether or not any MPC members joined Andrew Sentance in voting for higher interest rates in January and whether or not the minutes of the meeting are markedly more hawkish. The minutes of the December MPC meeting indicated that the MPC's concerns over upside inflation risks had increased, and the inflation news since then has been largely disappointing. It seems highly unlikely that any MPC member would have joined Adam Posen in voting for more quantitative easing at the January meeting, although we suspect that he continued to favor such a move.
Mounting pressure for an interest-rate hike sooner rather than later is coming from extended above-target and rising consumer price inflation, household's increasing inflation expectations, and a growing questioning of the Bank of England's anti-inflation credibility.
Significantly though, the MPC is very aware that the economy now has to cope with major fiscal tightening increasingly kicking in at a time when unemployment is high and credit conditions are still tight. Furthermore, the Eurozone's problems are a threat to U.K. economic activity. Therefore, there is a very real risk that growth could slow sharply over the coming months.
Importantly, earnings growth remains muted, which indicates that higher inflation and rising household inflation expectations are so far not feeding through to push up wages. With workers' bargaining power likely to remain limited due to high (and very possibly rising) unemployment, the likelihood is that wage growth will remain muted, thereby preventing a damaging wage-price inflationary spiral from developing. Admittedly though, the main test on wages is yet to come, as the early-2011 pay settlements and future pay developments will play a critical role in determining when and how quickly the Bank of England will raise interest rates.
Assuming that wage growth does remain muted, a defensible case can be made for the Bank of England's forecast that consumer price inflation will fall back to 2.0% in 2012, as underlying price pressures are limited by significant spare capacity and the upward effects of value-added tax changes; higher energy, commodity, and food prices; and the waning of sterling's past weakness. The problem for the Bank of England is that it has repeatedly under-forecast consumer price inflation, so its projection that inflation will fall below 2.0% in 2012 is being treated with increasing skepticism.
For now, we are retaining our view that the Bank of England will hold off from raising interest rates until the fourth quarter. This reflects our belief that growth will slow appreciably in the first half of 2011 and that a soft labor market will prevent higher inflation expectations from feeding through to lift wage growth significantly.
Nevertheless, given current mounting inflation risks, there is undeniably a growing likelihood that the MPC will act earlier than the fourth quarter and possibly even before mid-2011. The MPC could well decide that a small near-term interest-rate hike would support its credibility by sending out the message that it is serious about its inflation mandate, but it would not have a major dampening effect on growth. Even if interest rates do rise sooner rather than later, the probability remains that they will move up relatively gradually and remain very low compared with past norms. Monetary policy will need to stay loose for an extended period to offset the effect of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2.00% by end-2012.
Meanwhile, we think further quantitative easing is highly unlikely given the inflation risks.
Public Finances in December
The public-finances data for December (out on Tuesday) are expected to show a slightly smaller shortfall compared with a year ago, partly as a correction to the much worse-than-expected November figures. Specifically, we expect the public sector net borrowing requirement (PSNBR), excluding financial interventions, to have come in at £20.0 billion in December, compared with £21.1 billion in December 2009.
We would also not be surprised if the November PSNBR is revised down. The PSNBR, excluding financial interventions, jumped to £23.3 billion in November, which was a record shortfall for the month and up substantially from £17.4 billion a year earlier. The marked deterioration in the public finances in November was attributed primarily to higher government spending on health and defense as well as a bigger contribution to the European Union.
Tax receipts should benefit from the economy's overall decent growth seen from the second quarter of 2010, while they have also been lifted by value-added tax rising back up from 15.0% to 17.5% in January 2010. In addition, unemployment benefit claims have fallen by 171,200 overall from the October 2009 12-year high of 1.6278 million, which is helping to limit the rise in public expenditure.
A serious problem for the government, however, is that interest payments are increasing markedly. Indeed, the breakdown of central government expenditure shows interest payments were up to £4.5 billion in November from £3.0 billion a year earlier. The government is highlighting this as a key reason as to why there should be no scaling back or delaying of the measures to improve the public finances.
The public finances currently still show marginal overall improvement during fiscal year 2010/11. Specifically, the PSNBR, excluding financial interventions, edged down to £104.4 billion during April–November 2010 from £105.1 billion a year earlier. Nevertheless, if current trends are replicated over the whole fiscal year, the PSNBR would come in around £155 billion, meaning that Chancellor George Osborne would miss his target PSNBR of £149 billion in 2010/11. In late November, the Office for Budget Responsibility lowered the forecast PSNBR in 2010/11 from £149.0 billion to £148.5 billion.
House Prices in January and Mortgage Approvals in December
The British Bankers Association is expected to report on Wednesday that mortgage approvals for house purchases softened further to a 23-month low of 29,000 in December from 29,991 in November and the last peak of 45,740 in December 2009. Furthermore, mortgage approvals would be only half the average monthly level of 58,513 seen since 1997. One thing to bear in mind is that housing-market activity in December, and hence mortgage approvals, could have been hit significantly by the severe weather.
Meanwhile, the Nationwide lender is expected to report during the week that house prices fell 0.3% month-on-month (m/m) in January. This would follow a rise of 0.4% in December, which had been the first monthly increase in house prices on Nationwide's measure since May 2010. There were drops of 0.3% in November and 0.7% in October. A 0.3% m/m decrease in house prices in January would lead to them being down 0.9% year-on-year (y/y).
We maintain the view that house prices will fall around 10% from their peak 2010 levels by the end of 2011. Given that house prices have already fallen 4% on Nationwide's measure, we believe that they will fall around 6% in 2011. We believe that the fundamentals remain largely unfavorable for the housing market, even though signs that fewer houses are now coming on to the market could prove supportive for house prices if sustained.
The housing market is being dogged by high and likely to rise unemployment, muted wage growth, the increasing fiscal squeeze, low consumer confidence, and difficulties in getting a mortgage (particularly for first-time buyers). Further bad news for the housing market is the mounting speculation that the Bank of England could raise interest rates in the first half of 2011 to counter above-target and rising inflation. Any early interest-rate hike would be bad news for the housing market and likely to weigh on prices—not just the rate rise itself, but the effect on potential homebuyers' psychology resulting from the fact that they would be facing rising interest rates.
Meanwhile, affordability measures are mixed. On the favorable side, mortgage payments as a percentage of disposable income are currently very low compared with past norms. Nevertheless, the house price/earnings ratio is above its long-term average.
It is clear that critical to the development of house prices over the coming months will be the amount of houses coming on to the market, mortgage availability, how well the economy and jobs hold up as the fiscal squeeze increasingly kicks in, and what happens with interest rates.
CBI Distributive Trades Survey for January
The Confederation of British Industry (CBI) distributive trades' survey for January (out on Thursday) is expected to be softer, as the value-added tax added to the squeeze on consumers' purchasing power. Nevertheless, it is possible that sales may have been inflated by consumers being very keen to take advantage of genuine bargains in the post-Christmas clearance sales. Consumers generally face serious headwinds and uncertainties, so they will see the sales as a time to make purchases that they could increasingly struggle to make in 2011. There may also have been some catch-up from sales lost to December's severe weather preventing consumers getting to the shops.
On balance, we forecast the survey to show that the balance of retailers reporting that sales were up y/y fell back to 40% in January from 56% in December, which was the highest reading since April 2002.
The suspicion is that consumer spending will be limited in 2011, and we expect it to only rise by around 1% in real terms over the year. Higher inflation (fueled by January's value-added tax hike) and muted earnings growth is increasingly squeezing purchasing power. Meanwhile, consumer confidence is low, unemployment is high and likely to rise further, other elements of the fiscal squeeze will increasingly bite as the year progresses, and debt levels are elevated. On top of this, the weakness of the housing market is not good news for consumer spending.
25 Jan - Public Sector Net Borrowing Requirement, December (GBP/Bil): 20.0
25 Jan - GDP, Fourth-Quarter 2010 (Quarter-on-Quarter): +0.4%
25 Jan - GDP, Fourth-Quarter 2010 (Year-on-Year): +2.6%
26 Jan - Bank of England Monetary Policy Committee interest rate vote split, January (Hike-Unchanged-Cut): 1-8-0
26 Jan - Bank of England Monetary Policy Committee Quantitative Easing vote split, January (More-Unchanged-Reduced): 1-8-0
26 Jan - British Bankers Association Number of Loan Approvals for House Purchase, December (000s): 29
27 Jan - CBI Distributive Trades Reported Volume of Sales, January: +40%
During Week - Nationwide House Prices, January (Month-on-Month): -0.3%
During Week - Nationwide House Prices, January (Year-on-Year): -0.9%