Data out Tuesday are expected to show annual consumer price inflation climbed to a 26-month high of 4.0% in January from 3.7% in December. This would be double the Bank of England's target rate of 2.0% and will trigger yet another "Dear Chancellor" letter from Bank of England Governor Mervyn King to explain why consumer price inflation is more than one percentage point above the target level and what the central bank intends to do about it.Core consumer price inflation is seen climbing to 3.0% in January from 2.9% in December.
We expect higher oil, commodity, and food prices to have significantly boosted consumer price inflation once again in January. In addition, value-added tax (VAT) rose from 17.5% to 20.0% on 4 January. It needs to be borne in mind that VAT also rose in January 2010 (from 15.0% to 17.5%), so much will depend on whether retailers passed on more of the VAT hike at a faster pace in 2011 than in 2010. Meanwhile, there is little evidence that retailers engaged in more aggressive discounting and promotions in the post-Christmas clearance sales in 2011, despite retail sales being hard hit in December by the severe weather. This likely reflects the increased costs that they are facing. Specifically, the British Retail Consortium (BRC) has reported that overall shop price inflation rose to 2.5% in January from 2.1% in December. Food price inflation spiked to 4.6% from 4.0%, while nonfood inflation rose to 1.3% from 1.1%.
Consumer price inflation looks likely to move higher still in the near term due to higher oil and commodity prices. It could well reach 4.5% and seems likely to be above 4.0% through the first half of the year.
Consumer price inflation will hopefully start heading down in the second half of the year and dip below 3.0% before the end of 2011 as the upward impact from VAT developments, higher energy, commodity and food prices, and sterling's past sharp depreciation wanes. Meanwhile, underlying inflationary pressures should be limited by appreciable excess capacity, likely muted growth in 2011, strong competition on the high street as pressurized consumers limit their spending, and high unemployment holding down wage growth. Inflation will hopefully dip below 2.0% early in 2012 as the impact of the January 2011 VAT hike drops out.
Unemployment in January
Data on Wednesday are forecast to show that claimant-count unemployment fell a modest 3,000 in January, to be at a 23-month low of 1.4536 million. Claimant-count unemployment fell 4,100 in December, which was the third successive modest drop in claimant-count unemployment after small increases in September and August. In contrast, there were regular claimant-count unemployment falls around 30,000 during February–May 2010. Theclaimant-count unemployment rate should have remained at 4.5% in January, where it has been since June 2010. This is down from the 12-year high of 5.0% seen in the five months through to January 2010.
Meanwhile, the number of jobless on the International Labour Organization (ILO) measure is seen rising by 45,000 in the three months to December to stand at 2.43 million, thereby keeping the ILO unemployment rate at 7.9%. This would actually be a modest improvement on the 49,000 increase in the three months to November. ILO data are also likely to show that employment fell around 100,000 in the three months to December after a drop of 69,000 in the three months to November. Employment peaked at 29.189 million in the three months to September but was down to 29.089 million in the three months to November.
Labor market data may well be mixed in the near term, but we expect a modest deteriorating trend to emerge as 2011 progresses. We suspect that unemployment is headed up in 2011 as a consequence of slower, below-trend growth, rising business caution and public-sector jobs being increasingly pared. Specifically, we forecast unemployment on the ILO measure to rise to 2.67 million by end-2011 and to peak around 2.75 million around mid-2012. This would see the unemployment rate rise to 8.4% by end-2011 and to a peak of 8.6% in mid-2012.
Major job losses will occur in the public sector as the government slashes spending, and we doubt the private sector will be able to fully compensate. Indeed, we suspect that firms will become increasingly cautious in their employment plans, reflecting slower growth and concerns that the intensified fiscal squeeze will hold back economic activity for an extended period. There are also likely to be significant job losses in private companies supplying services or goods to the public sector. In particular, many firms will likely try to meet any increase in business through greater use of the workers they have already or through part-time staff. They are likely to be reluctant to take on any more permanent staff unless they are convinced sustained improvement in their business is probable.
Meanwhile, earnings growth is expected to have been little changed in January, thereby remaining very low compared with past norms, reflecting relatively high unemployment, workers' job insecurity, and the ongoing need for companies to limit their costs in a challenging environment. Annual underlying average weekly earnings growth (regular pay excluding bonus payments) is seen limited to 2.3% in the three months to December. Meanwhile, annual average weekly earnings (total pay) growth is expected to have risen 2.1% in the three months to December. These are well below the levels around 4.5% that in the past were considered consistent with the Bank of England's inflation target.
Future pay developments will play a critical role in determining just how soon and how quickly the Bank of England will raise interest rates. Households' inflation expectations are rising, but as long as this does not feed through to markedly higher wage growth, the Bank of England could yet hold fire on interest rates for some time to come, despite high, above-target consumer price inflation. We expect wage growth will remain muted because of workers' weak bargaining position, given high and likely-to-rise unemployment.
Bank of England Quarterly Inflation Report for February
Following the Monetary Policy Committee (MPC)'s decision to keep interest rates at 0.50% and the stock of quantitative easing unchanged at GBP200 billion at the conclusion of its 9-10 February meeting, attention will focus on the central bank's Quarterly Inflation Report for February (Wednesday) amid the debate over whether the Bank of England should tighten monetary policy. The bank's new GDP growth and consumer price inflation forecasts contained in the report (which the MPC had access to at its February meeting) will provide important insights into how monetary policy is likely to develop in both the near term and over a two-year horizon.
The Bank of England's new quarterly forecasts will likely show an unappetizing mix of lower GDP growth projections (at least for 2011) and higher consumer price inflation forecasts. Clearly, the bank will lift its near-term inflation forecasts, but if it also raises the longer-term forecasts appreciably, this will be a sign that higher interest rates are on the way in the near term. There is no denying the Bank of England is in a hugely difficult position as it negotiates a tortuous path between high and rising consumer price inflation and relatively fragile economic activity and serious growth headwinds.
With consumer price inflation substantially above its target level and rising, inflation expectations on the up, and significant attacks on its anti-inflation credibility, there is a clear case for the Bank of England to raise interest rates in the very near term.
However, the Bank of England could also hold fire on interest rates for the time beingand see how much the economy is being affected by the major fiscal squeeze that is now only kicking in. While activity seemingly bounced back pretty well in January from the shock GDP contraction in the fourth quarter of 2010, the economy still looks vulnerable in the face of serious headwinds with the consumer sector a particular concern as confidence nose-dived in January. Major fiscal tightening only began with January's VAT hike and will be followed by a rise in employees' national insurance contributions in April as well as increased public spending cuts and job losses. Meanwhile, tight credit conditions remain a handicap to growth.
Critically, households' rising inflation expectations are not feeding through to push up wage growth significantly. Indeed, we expect this to remain the case, given high and likely to rise unemployment. The Bank of England can do little about the current main inflation drivers: elevated oil, commodity, and food prices, the VAT hike, and sterling's past weakness. There is also the belief that there is enough spare capacity in the economy to keep a lid on underlying price pressures.
Consequently, despite the attacks on the Bank of England's credibility, there remains a defensible argument that consumer price inflation will fall below 2.0% in 2012. The key question is will the Bank of England hold to this view in its February Quarterly Inflation Report?
It is highly possible that likely further increases in headline inflation and rising inflation expectations will force the Bank of England to pull the interest rate trigger shortly.
For now, we retain our view that the Bank of England will hold off from raising interest rates until the latter months of the year. This reflects our belief that growth will slow appreciably over the next few months and that a soft labor market will prevent higher inflation expectations feeding through to lift wage growth significantly. The Bank of England is very aware that tighter fiscal policy is going to really kick in over the coming months and will weigh on growth. There are serious concerns over the outlook for consumer spending, which we believe warrants caution on hiking interest rates now. Even a small hike in interest rates risks hitting consumers' psychology hard at a time when confidence is low and falling.
Even if interest rates do rise in the near term, the likelihood is still that they will rise only gradually and remain very low compared with past norms. Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2.00% by end-2012.
Retail Sales in January
Retail sales (Friday) are expected to have seen a decent, if unspectacular rebound in January from December's weather-related sharp fall. Specifically, we forecast retail sales volumes to have risen 0.6% month-on-month (m/m) in January after falling 0.8% in December. As retail sales were very weak in January 2010 (because of the severe weather then), the year-on-year (y/y) increase in volumes is seen spiking to 4.4% in January after they had only been flat y/y in December.
Sales were robust at the start of January as customers rushed to beat the rise in VAT on 4 January (and some shops delayed imposing the rise). This particularly lifted the sales of big-ticket items. In addition, consumers were undoubtedly very keen to take advantage of the genuine bargains in the post-Christmas clearance sales. Given that consumers in general face serious headwinds and uncertainties, many will have seen the sales as a time to make purchases that they could increasingly struggle to make in 2011. The best of the bargains tend to occur early in the sales.
Retail sales seemingly tailed off later on in January following the VAT rise and once the best of the clearance bargains had gone. This was the indication from the BRC. It reported that total retail sales rose 4.2% y/y in January while sales were up 2.3% on a like-for-like basis (which strips out the effect of additional floor space). In addition, weekly sales data from John Lewis was markedly softer toward end-January and the start of February compared with earlier in January.
The suspicion is that consumer spending will be limited in 2011 and hold back overall GDP growth. Higher inflation (fuelled by January's VAT hike) and muted earnings growth is increasingly squeezing purchasing power. Meanwhile, consumer confidence is very 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.
Furthermore, growing speculation that the Bank of England could raise interest rates sooner rather than later is not good news for consumer spending prospects. Even if the Bank of England only edges interest rates up, it will affect consumer psychology as people are bound to see the move as the first in a series of hikes.
CBI Industrial Trends Survey for February
We expect the Confederation of British Industry (CBI) industrial trends survey for January (Thursday) to show that the balance of manufacturers reporting that their orders are at normal levels improved to -14% in February after dipping to -16% in January, from a 30-month high of -3% in December. This would take the balance further above its long-term average of -18%.
Although manufacturing output dipped 0.1% m/m in December, the dip was clearly influenced significantly by the severe weather during the month. Most of the latest evidence suggests that the manufacturing sector is currently still in good shape.Manufacturers have been benefiting from decent demand from both home and overseas, improved competitiveness in both domestic and foreign markets stemming from the relatively weak pound, and a major rebuilding of stocks after they had been slashed during the recession. Manufacturers currently look on course for a very good first quarter of 2011, despite December's dip in output.
Nevertheless, the concern is that manufacturers will find life becoming more difficult as 2011 progresses as stock rebuilding draws to a close and tighter fiscal policy weighs on domestic demand. There is also the risk that problems in the Eurozone could dampen foreign orders.
15 Feb - Consumer Price Inflation, January (Month-on-Month): +0.1%
15 Feb - Consumer Price Inflation, January (Year-on-Year): +4.0%
15 Feb - Core Consumer Price Inflation (ex Food, Drink, Tobacco), January (Year-on-Year): +3.0%
15 Feb - Retail Price Inflation, January (Month-on-Month): +0.2%
15 Feb - Retail Price Inflation, January (Year-on-Year): +5.0%
15 Feb - Underlying Retail Price Inflation, January (Month-on-Month): +0.2%
15 Feb - Underlying Retail Price Inflation, January (Year-on-Year): +5.0%
16 Feb - Claimant-Count Unemployment Rate, January (%): 4.5%
16 Feb - Claimant-Count Unemployment Change, January (000s): -3
16 Feb - International Labor Organization Unemployment Rate, December (%): 7.9%
16 Feb - Average Weekly Earnings - total pay, December (3-Month/Year): +2.1%
16 Feb - Average Weekly Earnings - regular pay excluding bonus, December (3-Month/Year): +2.3%
17 Feb - CBI Industrial Trends, Total Orders, February: -14%
18 Feb - Retail Sales, January (Month-on-Month): +0.6%
18 Feb - Retail Sales, January (Year-on-Year): +4.4%