Inflation in February
Data out on Tuesday are expected to show annual consumer price inflation climbed to a 28-month high of 4.3% in February from 4.0% in December. This would be more than double the Bank of England's target rate of 2.0%. Core consumer price inflation is seen rising to 3.1% in February from 3.0% in January.
We expect higher oil and commodity prices to once again have had a significant upward impact on consumer price inflation in February. Petrol prices climbed appreciably further in February, while some utility bills have risen. In addition, more companies are likely to have passed on the Value-Added Tax (VAT) increase from 17.5% to 20.0% that was enacted on 4 January. While VAT also rose in January 2010 (from 15.0% to 17.5%), we suspect that companies will pass on more of the VAT hike this year than they did a year earlier, reflecting the squeeze on their margins. The British Retail Consortium (BRC) has reported that overall shop price inflation rose to 2.7% in February from 2.5% in January. Non-food inflation rose to 1.6% from 1.3%, while food price inflation edged back to 4.5% from 4.6%.
Consumer price inflation looks likely to move higher still in the near term due to elevated oil and commodity prices. We currently forecast it to reach a peak around 4.6% in the second quarter before starting to head gradually lower in the second half of the year as the upward impact from VAT developments; high energy, commodity, and food prices; and sterling's past sharp depreciation wanes. In addition, below-trend economic activity and ongoing muted wage growth are expected to limit underlying inflationary pressures. Inflation is seen moving back below 4.0% in the fourth quarter of 2011 and dipping to 2.5% early in 2012 as the impact of the January 2011 VAT hike drops out. There is a realistic chance that consumer price inflation will get back down to 2.0% by mid-2012.
Public Finances in January
The public finances data for February (out on Tuesday) are expected to show a reduced shortfall compared to a year earlier, thereby extending the recent improving trend and providing Chancellor George Osborne with some modestly encouraging news on the eve of his 23 March budget. Specifically, we expect the Public Sector Net Borrowing Requirement (PSNBR) excluding financial interventions to have narrowed to £7.0 billion in February, compared to a deficit of £9.5 billion in February 2010.
The economy's improved overall economic performance through the past year should have lifted tax receipts compared to February 2010, while the further increase in VAT from 17.5% to 20.0% will also help matters. Meanwhile, unemployment benefit claims have fallen by 179,200 overall from the October 2009 12-year high of 1.6278 million, which is helping to limit the rise in public expenditure even before the spending cuts really start to bite. In addition, net government investment is now declining compared to a year earlier, reflecting the ending of past stimulus measures.
On current trends, the PSNBR is set to come in around £139 billion in fiscal year 2010/11 (April 2010–March 2011), meaning that Chancellor George Osborne will undershoot his targeted PSNBR of £149 billion. On the face of it, this gives the Chancellor a little "wiggle room" in his 23 March budget for 2011/12; however, he needs to be careful what he does, as his targeted PSNBR of £116 billion in 2011/12 looks challenging, particularly as we expect that GDP growth will be less than Mr. Osborne is looking for.
CBI Industrial Trends Survey for March
We expect the Confederation of British Industry (CBI) industrial trends survey for March(out Tuesday) to show that manufacturing activity extended its healthy start to 2011. We forecast the balance of manufacturers reporting that their orders are at normal levelsedged up to -7% in March. The balance previously bounced back to -8% in February after dipping to -16% in January from a 30-month high of -3% in December. This would keep the balance well above its long-term average of -18%.
Manufacturers are currently benefiting from decent orders both at home and particularly from overseas, the competitive level of the pound, and an ongoing rebuilding of stocks after they had been slashed during the recession.
Manufacturers look likely to have seen robust expansion in the first quarter, but the key question is will they be able to sustain this performance as we get deeper into 2011 as stock rebuilding draws to a close and tighter fiscal policy weighs down on domestic demand. While global economic activity currently looks decent, there is the risk that problems in the Eurozone could escalate and dampen foreign orders. In addition, high oil prices and surging input costs are an increasing threat to manufacturing activity by substantially squeezing companies' margins and putting pressure on them to raise prices and risk losing business.
Minutes of March Bank of England MPC Meeting
Given the ongoing major uncertainty over when exactly the Bank of England is likely to start raising interest rates (and how quickly interest rates are likely to increase), much attention will be focused on Wednesday's release of the minutes of the March meeting of the Bank of England's Monetary Policy Committee (MPC). At its March meeting, the MPC kept interest rates down at 0.50% and left the stock of Quantitative Easing unchanged at £200 billion.
Of key interest from the minutes will be if any of the other six MPC members joined Andrew Sentance, Martin Weale, and Spencer Dale in voting for an interest rate hike in March. Sentance actually favoured a 50-basis-point interest rate hike to 1.00% in February, while Weale and Dale both wanted a 25-basis-point hike to 0.75%. There were also indications from the February minutes that other MPC members had considered voting for a rate hike, as the minutes noted that "Of those members not favouring a rise in Bank Rate, some thought that the case for an increase had nevertheless grown in strength." However, "given the potentially disruptive impact of reversing any immediate change in Bank Rate, there was merit in waiting to see how the economy performed at the start of the year to help assess whether or not the decline in GDP in the fourth quarter presaged sustained economic weakness. A rise at this juncture could damage household and consumer confidence, which remained fragile."
It will also be interesting to see whether Adam Posen, the most-dovish member of the MPC, continued to vote for more Quantitative Easing to be enacted at the March meeting. Regardless, this now looks extremely unlikely to happen.
Whether or not the Bank of England hikes interest rates in the second quarter will depend critically on how well the economy performs over the coming weeks as fiscal tightening really kicks in. Indeed, more fiscal tightening will take effect in April, which is something the MPC will factor into their deliberations and could encourage some committee members to vote to hold off from hiking interest rates in the second quarter. Wage growth, oil price developments, and the impact on the global economy of the tragic events in Japan will also likely be important factors.
While it is very possible interest rates will rise by mid-year, our current expectation is that the Bank of England will delay acting until August, when we see rates rising from 0.50% to 0.75%. We then see interest rates rising to 1.00% in the fourth quarter of 2011 and thereafter increasing gradually to 2.00% by the end of 2012.
Even if interest rates do rise in the near term, the probability remains they will move up relatively gradually and stay very low compared to past norms. Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. In addition, we believe inflation will fall back markedly later on in 2011 and 2012 as relatively modest, below-trend growth and elevated unemployment limits underlying inflationary pressures. In particular, ongoing substantial pressures on consumers are likely to limit both growth and inflation.
Mortgage Approvals in February
The British Bankers Association is expected to report on Wednesday that mortgage approvals for house purchases remained muted in February at 29,500. Mortgage approvals amounted to just 28,932 in January, which was essentially unchanged from the 23-month low of 28,907 suffered in December. A February level of 29,500 would essentially be only half the average monthly level of 58,149 seen since 1997.
We believe housing market activity and house prices will remain under pressure for some time to come from high and likely-to-rise unemployment, negative real income growth, the increasing fiscal squeeze, very low consumer confidence, and ongoing difficulties in getting a mortgage (particularly for first-time buyers). Further bad news for the housing market is the now-strong possibility that the Bank of England will start to raise interest rates within the next few months to counter above-target and rising inflation. Any early interest rate hike would be bad news for the housing market and likely weigh down on prices—not just the rate rise itself, but also the impact on potential house buyers' psychology resulting from the fact they would be facing rising interest rates with the prospect of more to come. Some support to house prices could come if the number of houses coming on to the market is limited over the coming months.
On balance, we expect house prices to continue to trend down gradually in 2011 after losing ground overall in the latter months of 2010. Specifically, we suspect that house prices will fall by around 5% in 2011 and end up losing around 10% from the peak levels seen in the first half of 2010.
Retail Sales in February
Retail sales (out Thursday) are expected to have fallen appreciably after bouncing back in January from December's weather-related sharp drop. Specifically, we forecast retail sales volumes to have fallen by 0.5% month-on-month in February, which would limit the year-on-year increase to 2.4%. Retail sales volumes spiked up 1.9% month-on-month and 5.3% year-on-year in January, after plunging 1.4% month-on-month in December. Survey evidence for retail sales in February from both the British Retail Consortium and the Confederation of British Industry was markedly weaker.
In fact, a softening trend in retail sales had already become apparent in the latter stages of January after a strong start to the month, and February likely saw this trend continue and deepen. Sales had been boosted at the start of January by consumers being keen to take advantage of the best of the post-Christmas clearance sales and to beat the VAT hike from 17.5% to 20.0%. In addition, there was likely a temporary boost to sales in January from consumers looking to make purchases they did not do in December because of the bad weather. However, sales tailed off once these temporary boosting factors waned and shops increasingly enacted the VAT rise.
There are mounting signs that consumers are reining in their spending in the face of serious pressures, most notably the appreciable and increasing squeeze on their purchasing power from high inflation—fuelled by January's VAT hike and soaring petrol prices—and still-muted wage growth overall. Meanwhile, unemployment is high and could very well rise, other elements of the fiscal squeeze will increasingly bite as the year progresses (for example, employees' national insurance contributions will rise in April), and debt levels are elevated. Furthermore, the very real likelihood that the Bank of England will start to raise interest rates sooner 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.
22 Mar - Consumer Price Inflation, February (Month-on-Month): +0.7%
22 Mar - Consumer Price Inflation, February (Year-on-Year): +4.3%
22 Mar - Core Consumer Price Inflation (ex. Food, Drink, Tobacco), February (Year-on-Year): +3.1%
22 Mar - Retail Price Inflation, February (Month-on-Month): +0.7%
22 Mar - Retail Price Inflation, February (Year-on-Year): +5.2%
22 Mar - Underlying Retail Price Inflation, February (Month-on-Month): +0.7%
22 Mar - Underlying Retail Price Inflation, February (Year-on-Year): +5.2%
22 Mar - Public Sector Net Borrowing Requirement, February (GBP/Bln): 7.0
22 Mar - CBI Industrial Trends, Total Orders, March: -7%
23 Mar - Bank of England Monetary Policy Committee Interest Rate Vote Split, March (Hike-Unchanged-Cut): 3-6-0
23 Mar - Bank of England Monetary Policy Committee Quantitative Easing Vote Split, March (More-Unchanged-Reduced): 1-8-0
23 Mar - British Bankers Association Number of Loan Approvals for House Purchase, February (000s): 29.5
24 Mar - Retail Sales, February (Month-on-Month): -0.5%
24 Mar - Retail Sales, February (Year-on-Year): +2.4%