Data Tuesday are expected to show annual consumer price inflation jumped to a three-year high of 4.9% in September from 4.5% in August and 4.4% in July. Very possibly, consumer price inflation reached 5.0% in September. This increase is expected to be driven by the sharp rises in electricity and gas prices that have been enacted by several utility companies. In addition, food prices likely remained elevated in September. Core consumer price inflation is expected to have edged up to 3.1% in September from 3.0% in August. The shop-price deflator produced by the British Retail Consortium indicated that overall shop-price inflation was stable at 2.7% in September as annual food price inflation was unchanged from August at 5.0% while there was a marginal dip in nonfood prices to 1.3% from 1.4%.
While consumer price inflation could well have hit 5.0% in September, this should be close to the peak. Inflation will hopefully start edging down late this year and then fall markedly in 2012 as the upward impact from past value-added tax (VAT) developments, earlier jumps in energy, commodity, and food prices, and sterling's past sharp depreciation wanes. In addition, extended soft economic activity and ongoing muted wage growth amid significant (and growing) labor market slack is expected to weigh on underlying inflationary pressures.
Inflation should dip markedly at the start of 2012 as the influence of the January 2011 VAT hike from 17.5% to 20.0% drops out. We forecast consumer price inflation to be down to the Bank of England’s target level of 2.0% by the end of 2012, and it could very well dip below this level in 2013. Much will obviously depend on oil price developments.
Minutes of October Bank of England MPC Meeting
Wednesday sees the release of the minutes of the October meeting of the Bank of England's Monetary Policy Committee (MPC). The meeting saw the MPC decide to enact a further GBP75 billion of quantitative easing (QE) to take the stock up to GBP275 billion, while keeping interest rates down at 0.50%.
Ahead of the meeting, it had been considered touch and go whether or not the Bank of England would start more QE as soon as October or defer a decision until November when it would have available the first estimate of GDP in the third quarter as well as the Bank of England’s new GDP growth and consumer price inflation forecasts (which are produced for the Quarterly Inflation Report). It was a surprise that the Bank of England announced GBP75 billion of QE rather than GBP50 billion.
A statement accompanying the October relaunching of QE (it had last been increased in November 2009, by GBP50 billion to take the stock to GBP200 billion) set out the reasons behind the MPC’s decision. Essentially, the MPC chose to act immediately and to go for GBP75 billion more QE rather than GBP50 billion because they believed that an already-difficult outlook for the economy has deteriorated amid mounting domestic and global headwinds, notably including squeezed consumer purchasing power, slowing global growth, financial market turmoil, and mounting concerns about the funding conditions facing banks as the Eurozone sovereign debt crisis deepens.
Even though consumer price inflation is still expected to reach 5.0% or even higher in the near term because of soaring utility bills, the MPC saw weakened growth prospects as increasing the likelihood inflation will undershoot its 2.0% target rate over the medium term (as the upward impact of past VAT hikes, sharp rises in oil and commodity prices, and sterling’s past devaluation wanes and underlying price pressures are held down by a significant output gap, below-trend growth, and muted wage growth).
Although the MPC has set out the reasons behind its QE move, the minutes of the October meeting will nevertheless provide further important information on the committee’s views on the UK economy and what it is likely to do on the policy front in the future.
Of particular interest will be how many of the nine MPC members favored more QE in October. There was clearly a huge swing behind QE at the meeting as Adam Posen had still been the sole supporter for more QE at the September meeting (and had been calling for GBP50 billion rather than the GBP75 billion announced in October), although it was evident that a number of MPC members had been close to joining him. Specifically, the minutes of the September MPC meeting had revealed, “for some members, a continuation of the conditions seen over the past month would probably be sufficient to justify an expansion of the asset purchase programme at a subsequent meeting.”
In fact, we would not be at all surprised if all nine MPC members voted for more QE in October. One of the more hawkish MPC members, Spencer Dale (who had been voting for an interest-rate hike as recently as July), has already indicated that he voted for more QE in October. Given the MPC’s clear increased concern over the weakness of the economy, they could well have been keen to present a united front that they are prepared to act decisively to support the economy to try to boost confidence.
The MPC expects the new program of QE to take four months to complete. We suspect further QE will then be extended by GBP50 billion in each of the first and second quarters of 2012, which would take the stock to GBP375 billion by mid-2012.
It will be interesting to see whether or not the Bank of England discussed trimming interest rates from 0.50% at its October meeting (it reviewed this option at its September meeting). We remain highly doubtful it will do this. Notably, even at the height of the 2008/09 recession, the MPC was reluctant to take interest rates below 0.50%, partly because of the negative repercussions this could have on the profitability of banks and on their capacity to lend. There are also serious doubts about just how much benefit even lower interest rates would have.
It is apparent, though, that any interest-rate hike has disappeared into the horizon. We do not expect any increase in interest rates before 2013.
Retail Sales in September
Retail sales volumes (Thursday) are expected to have been flat month-on-month in September after a dip of 0.2% in August and an increase of 0.2% in July. This would see retail sales volumes up just 0.7% year-on-year (y/y) in September. Survey evidence from the British Retail Consortium (BRC) was modestly firmer for September compared with August, indicating the hot weather late in the month lifted food sales, although it hit clothing sales. Nevertheless, the September distributive trades survey from the Confederation of British Industry (CBI) showed the balance of retailers reporting sales were up y/y edged back further to a 16-month low of -15% in September from -14% in August.
It is hard to be optimistic over the prospects for consumer spending in the near term at least. Consumer confidence is very low, with purchasing power under severe pressure from high inflation, muted wage growth, and tighter fiscal policy. Rising utility charges could well see consumer price inflation reach 5.0% in September, while underlying annual average earnings growth slowed further to just 1.6% in August.
Meanwhile, unemployment is now rising markedly and the jobs outlook is looking increasingly worrisome. The current turmoil in financial markets and heightened fears of a renewed serious global economic downturn are unlikely to do much for consumers’ confidence and willingness to spend. Many consumers are being hit by the fall in equity prices. On top of this, the weak housing market has adverse repercussions for consumer spending (a 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).
The only really good news for consumers is that it is very clear the Bank of England is not going to raise interest rates for some considerable time to come. We do not expect a move before 2013.
Further out, inflation is expected to fall markedly in 2012, which will ease the squeeze on consumers’ purchasing power. Nevertheless, unemployment is likely to rise appreciably further and wage growth looks set to remain muted so the overall environment will still be very tough for consumers.
Public Finances in September
The public finances data for September (Wednesday) are expected to show marginal 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 GBP15.0 billion in September from a shortfall of GBP15.4 billion in September 2010.
A modest y/y improvement in the public finances is expected as a result of January’s VAT rise and other fiscal measures increasingly kicking in from April. In particular, the spending cuts should increasingly show up in the public finance figures.
Nevertheless, the improvement in the public finances is likely to have been limited by the economy’s recent extended softness hitting tax revenues and pushing up unemployment benefit claims.
Overall, the PSNBR excluding financial interventions amounted to GBP51.5 billion in the first five months of fiscal 2011/12 (April–August), which was down from GBP55.3 billion in the first five months of fiscal 2010/11.
If the overall performance of the first five months was replicated through the rest of the fiscal year, the PSNBR would come in around GBP127 billion in 2011/12 compared with the targeted GBP122 billion. It is highly likely the public finances will be increasingly pressurized by muted economic activity eating into tax revenues and pushing up unemployment benefit claims, so the shortfall currently looks set to be appreciably more than this.
The chancellor's 2011/12 PSNBR target of GBP122 billion is based on the economy growing 1.7% in 2011 and 2.5% in 2012. It is widely accepted that these growth forecasts are far too optimistic and there is absolutely no chance the 2011 projection will be met. The 2012 growth forecast is looking more fanciful by the day. IHS Global Insight currently expects GDP growth to be 0.9% in 2011 and 1.0% in 2012.
The government continues to argue that its fiscal consolidation plans are the right way forward despite the weakness of the economy, and that it will not ease its fiscal squeeze to give the economy a near-term boost. The government argues that any near-term gains from relaxing the fiscal squeeze would be outweighed by the costs resulting from the loss of market confidence in the UK.
At the very least, though, we expect the chancellor to accept some slippage in his near-term fiscal targets rather than tighten policy further to meet them due to concern that more spending cuts and/or tax hikes will weigh down additionally on already-limited growth prospects. There is, in fact, some leeway for the chancellor on his fiscal targets as he is committed to reducing the structural budget deficit by 2015/16, yet he is actually aiming to achieve this by 2014/15.