Inflation is expected to have risen further in March, reinforcing pressure on the Bank of England to hike interest rates. Other data and survey evidence are likely to point to muted retail sales and a mixed labor market, thereby maintaining concern about the economy's health.
British Retail Consortium Retail Sales Monitor for March
The British Retail Consortium (BRC) retail sales monitor for March (out overnight Monday/Tuesday) is expected to show muted sales. Certainly, a number of retailers in recent weeks have reported markedly weaker consumer activity in the first quarter of 2011, while John Lewis' weekly sales data for March have been pretty soft. This is significant as John Lewis has been very much an outperformer in the retail sector.
If the BRC's survey is soft as expected, it would further fuel concern that consumers are increasingly reining in their spending. This is a major concern for overall growth prospects, given that consumer spending accounts for some 65% of GDP. The February BRC monitor showed total retail total sales rose just 1.1% year-on-year (y/y) while sales fell 0.4% y/y on a like-for-like basis (which strips out the effect of additional floor space). This was the first such decline for 10 months.
Consumers appear to be reining in their spending appreciably in the face of serious and currently harder-blowing headwinds. In particular, consumers' purchasing power is being squeezed hard by high and rising inflation (fuelled by January's value-added tax—VAT—hike, increasing utility bills, and record-high petrol prices) in tandem with ongoing muted wage growth. Concerns over jobs, the economy, and fiscal tightening increasingly kicking in are also weighing down on consumer confidence and willingness to spend. In addition, the weak housing market is weighing on consumer spending (healthy housing market activity boosts demand for carpets, fittings, and furnishings as well as major household appliances while rising house prices can have a significant wealth effect).
Furthermore, the very real likelihood that the Bank of England will start to 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.
RICS Housing Market Survey for March
The March housing market survey from the Royal Institute of Chartered Surveyors (also overnight Monday/Tuesday) will offer important evidence as to whether or not housing market activity is picking up and also on how many properties are coming on to the market.
The supply-demand metrics in the housing market will be a key determinant in how house prices move over the coming months. The February RICS survey indicated that new buyer enquiries essentially stabilized after falling over the previous six months. Specifically, the balance rose to -1% in February from -7% in January, -12% in December, and -18% in November. Meanwhile, the balance of surveyors reporting an increase in instructions to sell rose for the first time in five months in February. This balance climbed to +5% from -3% in January and -14% in December. Meanwhile, we expect the RICS survey to reveal that the balance of surveyors reporting that house prices increased over the previous three months to have risen to a still-weak -19% in March from -21% in February, -31% in January, and an 18-month low of -49% in October 2002.
We maintain the view that house prices will fall by around 5% overall in 2011 and end up losing around 10% from the peak levels generally seen in the first half of 2010. We suspect that tighter fiscal policy and likely gradually rising interest rates will exert downward pressure on the housing market. On top of that, high and likely-to-rise unemployment, negative real income growth, elevated debt levels, and still-significant difficulties in getting a mortgage (particularly for first-time buyers) do not bode well for house prices. Meanwhile, although there are signs that housing market activity has stabilized recently, it is still at a very low level that historically has been associated with falling house prices. Indeed, current very low consumer confidence will make many people reluctant to risk buying a house.
Some support to house prices could come if the number of houses coming on to the market is limited over the coming months. The modest support provided to first-time buyers in the March budget is too small to provide major support to the housing market.
Inflation in March
Data out Tuesday are expected to show annual consumer price inflation climbed to a 30-month high of 4.6% in March, from 4.4% in February and 4.0% in January. This would take it even further above the Bank of England's target rate of 2.0%. Core consumer price inflation is seen rising to 3.5% in March from 3.4% in February and 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 March. Petrol prices climbed appreciably further in March while some utility bills have risen. In addition, more companies could have passed on the VAT increase from 17.5% to 20.0% that was enacted in early January. While VAT also rose in January 2010 (from 15.0% to 17.5%), we suspect that companies are passing on more of the VAT hike this year than they did a year ago reflecting the squeeze on their margins. This certainly seemed to be the case in the February inflation data, and some companies may still not be done yet with passing on the VAT hike.
We now expect consumer price inflation to reach a peak of 4.9% in the second quarter because of likely sustained high oil prices. Consumer price inflation will hopefully gradually start trending 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 wages 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.
Trade Deficit in February
The total trade deficit (Tuesday) is expected to have widened to £4.0 billion in February, after narrowing sharply to an 11-month low of £3.0 billion in January from a five-year high of £5.5 billion in December. Within, this, the visible trade deficit is forecasted to have widened to £8.4 billion in February after plunging to £7.1 billion in January from £9.7 million in December. High prices for oil, commodities, and food are likely to have pushed up import values.
It is evident that the trade situation was significantly distorted for the worse in December by the severe weather affecting exports more than imports with the result that there was a positive corrective effect in January. So just as December's large trade deficit overstated the weakness of the trade situation, so January's sharp reduction in the deficit overstates the improvement.
Nevertheless, the trade figures for January significantly lifted hopes that net trade will make a decent positive contribution to GDP growth in the first quarter of 2011. So far, hopes that decent global growth and a weak pound will allow exports of goods and services to grow more than imports and help the economy to become more balanced have been repeatedly thwarted. In fact, net trade contributed 0.5 percentage point to the 0.5% quarter-on-quarter (q/q) contraction in GDP in the fourth quarter of 2010, and it also was negative by 1.0 percentage point overall in 2010, which was a major factor limiting UK GDP growth to 1.3%.
On a positive note, latest survey evidence still looks good for near-term export prospects. In particular, the export orders balances in both the March industrial trends survey by the Confederation of British Industry and the March purchasing managers' surveys were still at elevated levels, although they did fall from a respective 15-year high and third-highest level in 15 years in February.
There is a serious risk that global growth could be hit over the coming months by sustained high oil prices while UK exports are also at risk from any sustained problems in the key Eurozone market resulting from recurrent sovereign debt problems.
Unemployment in March
Data on Wednesday are forecasted to show that claimant-count unemployment edged down by 3,000 in March. Latest data show that the number of claimant-count jobless fell 10,200 in February to a 24-month low of 1.486 million. Claimant-count unemployment had previously risen by 1,500 in January after falling a modest 11,800 in the fourth quarter of 2010 and edging up by 4,100 in the third quarter. In contrast, there were regular claimant-count unemployment falls around 30,000 during February–May 2010. The claimant-count unemployment rate is expected to have remained at 4.5% in March, 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.
The number of jobless on the International Labour Organization (ILO) measure is seen rising 27,000 in the three months to February to stand at 2.55 million, thereby keeping the ILO unemployment rate at 8.0%. Within this, it is highly likely that youth unemployment rose to a new record high. ILO data are also likely to show that employment rose 70,000 in the three months to February to stand around 29.16 million. Employment peaked at 29.189 million in the three months to September 2010. The fact that employment and unemployment both likely rose on the ILO measure in the three months to February indicates that the economy is not generating enough jobs to satisfy a growing workforce.
Jobs data may well be mixed in the near term, but we suspect that unemployment will trend up gradually later on in 2011. 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 that the private sector will be able to fully compensate for this.
Indeed, we expect firms to become increasingly cautious in their employment plans over the coming months, reflecting slower, below-trend 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-sector companies supplying services or goods to the public sector. In particular, many firms are likely to try to meet any increase in business through making greater use of the workers they have already or through using part-time staff, and they are likely to be reluctant to take on any more permanent staff unless they are really convinced that sustained improvement in their business is probable.
Average Earnings in February
Underlying average earnings growth is expected to have been little changed in February, so it has remained very low compared with past norms. This is the consequence of relatively high unemployment, workers' job insecurity, and the ongoing need for companies to limit their costs in a challenging environment. Specifically, underlying average weekly earnings growth (regular pay excluding bonus payments) is seen once again limited to 2.2% in the three months to February. Whileannual average weekly earnings (total pay) growth is expected to have climbed to 2.7% in the three months to February from 2.3% in the three months to January and a low of 1.8% in the three months to December, this is seen very much driven by higher bonus payments compared with a year earlier. Furthermore, this rate is still well below the 4.5% level that is generally considered consistent with the Bank of England's 2.0% consumer price 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 current high, above-target consumer price inflation.
We expect wage growth to increase only modestly over the coming months and to remain limited compared with long-term norms due to workers' weak bargaining position, given high and likely-to-rise unemployment. So households' purchasing power will continue to be squeezed markedly.