The public finances data for May (out Tuesday) are expected to show modest improvement compared with a year earlier. Specifically, we expect the Public Sector Net Borrowing Requirement (PSNBR) excluding financial interventions to have narrowed to a still very nasty GBP17.0 billion in May from a shortfall of GBP18.3 billion in May 2010.
The economy's modestly improved overall economic performance through the past year should have lifted tax receipts compared with May 2010, while the further increase in value-added tax (VAT) from 17.5% to 20.0% in January will also have helped matters.Meanwhile, public expenditure cuts are supposed to have increasingly kicked in from April. In addition, net government investment is now declining compared with a year earlier. While the public finances showed deterioration in April compared with a year ago—thereby marking a disappointing start to fiscal year 2011/12—this was influenced by significant distortions. Specifically, the April 2010 figures had been flattered by a one-off bank payroll tax, which raised GBP3.5 billion, and by higher bonuses and share options, which were not repeated in 2011.
Chancellor George Osborne is looking to reduce the PSNBR excluding financial interventions to GBP122 billion in 2011/12 from the 2010/11 outturn of GBP139.4 billion, but this looks increasingly challenging, given the headwinds facing the economy and the current soft patch it is suffering. The chancellor's 2011/12 PSNBR target is based on the economy growing 1.7% in 2011 and 2.5% in 2012. IHS Global Insight believes this is on the optimistic side, as we expect GDP growth to be 1.4% in 2011 and 2.1% in 2012. Furthermore, higher-than-expected inflation is posing a threat to the chancellor's budget targets.
CBI Industrial Trends Survey for June
We expect the Confederation of British Industry (CBI) industrial trends survey for May (Tuesday) to add to the recent evidence that the manufacturing sector is faltering after seeing strong growth through 2010 and the start of 2011. Specifically, we forecast the balance of manufacturers reporting that their orders are at normal levels to have fallen to -8% in June after rebounding to -2% in May from a three-month low of -11% in April. This would be down appreciably from a three-year high of +5% in March, but still above the balance's long-term average of -18%.
Manufacturers now appear to be finding life more challenging as stock rebuilding wanes and tighter fiscal policy weighs on domestic demand. There are also signs that global demand is slowing and dampening export orders. Meanwhile, high oil prices and other elevated input costs have been causing problems for manufacturers by substantially squeezing their margins and putting pressure on them to raise prices and risk losing business. In addition, events in Japan are causing problems for some manufacturing sectors through causing supply-chain disruptions. The Society of Motor Manufacturers and Traders reported that UK car output fell 4.9% month-on-month (m/m) in May after a drop of 12.2% in April as production of vehicles and engines was hit by shortages in parts coming from Japan.
Minutes of May Bank of England MPC Meeting
Wednesday's release of the minutes of the June meeting of the Bank of England's Monetary Policy Committee (MPC) will be closely scanned for clues as to when the central bank is likely to start raising interest rates. At its June meeting, the MPC kept interest rates at 0.50% and left the stock of quantitative easing unchanged at GBP200 billion.
Of particular interest in the June minutes, will be how did MPC new boy Ben Broadbent vote? He has replaced arch-hawk Andrew Sentance in the MPC, and this in itself is likely to have significantly changed the dynamics within the committee as it seems highly improbable that Broadbent will be as hawkish as Sentance was. It is highly possible that this change in MPC personnel will have resulted in the vote in favor of unchanged interest rates widening to 7–2 in June from 6–3 in May.
If this is the case, it will further increase current mounting expectations that the Bank of England will hold off from raising interest rates until 2012. Although consumer price inflation remained up at 4.5% in May—more than double the Bank of England's 2.0% target rate—and seems set to reach 5.0% later this year because of rising utility prices, a flurry of soft recent data and survey evidence (most notably the sharp drop in retail sales in May after April's bounce), after the economy was only flat over the fourth quarter of 2010 and the first quarter of 2011 combined, has heightened concerns over the underlying strength of the economy and its ability to withstand the fiscal tightening that increasingly kicked in from April.
Significantly, the indications are that Bank of England Governor Sir Mervyn King favors keeping interest rates at 0.50% for some time to come to support the economy. In his recent keynote Mansion House speech, King stressed that a mix of tight fiscal policy and loose monetary policy is necessary for the economy to rebalance and recover. He also highlighted subdued wage growth and very low broad money growth as strong reasons to believe that inflation will eventually retreat markedly.
We expect the Bank of England to hold fire on interest rates until at least November, and it is looking ever more likely that the MPC will not act until 2012. We suspect that most MPC members will maintain the view for some time to come that higher interest rates are an extra handicap that the fragile economy can well do without. There is particular concern that any near-term hiking of interest rates could weigh down heavily on already-low and brittle consumer confidence, and further stifle spending.
Furthermore, whenever interest rates do start to rise, the probability is that they will move up relatively gradually and stay very low compared with past norms. We currently see interest rates only rising to 2.00% by the end of 2012, and they may very well not even reach that level. Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. In addition, we do believe that inflation will fall markedly from late 2011/early 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.
CBI Distributive Trades Survey for May
The Confederation of British Industry (CBI) distributive trades survey (Thursday) is expected to show that sales were weak in June as consumers' finances remained under serious pressure and they worried about the economy and jobs. Specifically, we forecast the survey to show that the balance of retailers reporting that sales were up year-on-year have dropped to +10% in June from +18% in May and +21% in April. This is well below the average balance of +42% seen in the second half of 2010.
It is apparent that seriously pressurized and worried consumers have put their hands straight back in their pockets, having been tempted into temporarily loosening their purse strings in April by the royal wedding, later Easter, and very good weather.
The likelihood is that consumer spending will be muted for some time to come as household purchasing power remains under severe pressure from high inflation, low wage growth, and tighter fiscal policy. Furthermore, soaring utility bills will shortly add to the squeeze on consumers. In addition, unemployment is still high and debt levels are elevated. Meanwhile, the weak housing market has adverse repercussions for 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).
On top of this, many consumers are likely worried that the Bank of England could start to raise interest rates before the end of the year. 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.
In fact, weak consumer spending is likely to be a key factor deterring the Bank of England from raising interest rates for some time to come. Significantly, the minutes of the May meeting of the Bank of England's Monetary Policy Committee revealed major ongoing concern and uncertainty over the state of consumer spending and noted that "an increase in Bank Rate in current circumstances could adversely affect consumer confidence, leading to an exaggerated impact on ...spending."