Having only acted in July, the Bank of England is unlikely to take further stimulative action in August despite hugely disappointing and worrying GDP contraction of 0.7% quarter-on-quarter in the second quarter. Meanwhile, the July purchasing managers’ surveys will hopefully show some improvement after activity was held back markedly in June by the two days’ public holiday surrounding the Queen’s Diamond Jubilee celebrations.
Bank of England to Sit Tight in August Despite Dismal Second-Quarter GDP Data
In terms of immediate policy changes, August’s meeting of the Bank of England’s Monetary Policy Committee appears to be a non-event despite much-sharper-than-expected GDP contraction of 0.7% quarter-on-quarter in the second quarter. The Bank of England only approved a further GBP50 billion of quantitative easing (QE) in July, and this is due to be enacted through to early November. Furthermore, the MPC will likely want to see what early impact the “Funding for Lending” scheme is having before considering further QE.
Meanwhile, the MPC indicated in the minutes of its July meeting that they had no plans to bring interest rates down from their current level of 0.50% in the near term at least. While the MPC indicated that this stance could change at a later stage, lower interest rates in August appear to be off the Bank of England’s radar.
Nevertheless, the MPC members certainly have a lot to discuss, and it will be interesting to see exactly what they make of the 0.7% q/q plunge in GDP in the second quarter.
Changes in monetary policy at the August meeting of the Bank of England’s MPC are highly unlikely. While the MPC is likely to be perturbed by the 0.7% quarter-on-quarter (q/q) drop in GDP in the second quarter, it is unlikely to prompt an immediate policy response, given that the Bank of England only announced a further GBP50 billion of QE in July (that is due to be enacted through to November) while the “Funding for Lending Scheme” kicks off 1 August.
It is likely also the MPC will assume that the 0.7% q/q GDP contraction in the second quarter significantly overstates the economy’s weakness due to a number of factors (notably the extra day’s public holiday resulting from the Queen’s Diamond Jubilee celebrations and the wet weather hitting retail sales and construction activity). The MPC will also probably want to see how the economy is performing in the third quarter.
Even allowing for special factors, though, the extent of the GDP drop in the second quarter must worry the MPC; and with the Eurozone crisis if anything intensifying at the moment, it currently looks highly likely that the Bank of England will eventually have to act again to support the economy.
The minutes of the July MPC meeting came across as pretty dovish and supported expectations that the Bank of England would be prepared to go for more QE later this year unless the economy shows marked underlying improvement. The July minutes also indicated that the MPC are prepared to revisit the case for lower interest rates at a later stage.
Admittedly, two of the nine MPC members (Spencer Dale and Ben Broadbent) were against more QE in July, but this was countered by news the MPC considered the case for a GBP75-billion extension to QE rather than the GBP50-billion extension that was enacted. Significantly, the minutes revealed that all MPC members judged that further economic stimulus was required, but there was differing views as to whether the launching of the Funding for Lending Scheme and the activation of the Bank of England’s Extended Collateral Term Repo Facility (ECTR) would be sufficient for the time being.
The MPC noted the near-term growth outlook had weakened and GDP was now likely to be only flat over 2012. Events in the Eurozone were seen affecting activity in the United Kingdom and still posing a substantial risk to the outlook. In fact, the subsequent news the economy contracted 0.7% q/q in the second quarter means that it is now highly likely that GDP will fall modestly overall in 2012 (we expect contraction of around 0.3%).
Meanwhile, inflation had fallen faster than had been expected back in May when the last Quarterly Inflation Report was produced. While this was primarily due to lower global energy prices, this was seen reducing the risk that inflation expectations would remain elevated and “become ingrained” in wage- and price-setting behavior.
In July, the MPC discussed for a second successive month the case for lowering interest rates from the current level of 0.50% where they have stood since March 2009. For the time being at least, the MPC stuck to the view that there was not a compelling case that lower interest rates would have an overall beneficial impact, and would not have any advantages over more QE. The MPC is concerned that even lower interest rates would hit banks’ profit margins and constrain their ability to lend. There is also concern that the functioning of money markets would become impaired. In addition, the Bank of England doubts that taking interest rates below 0.50% would significantly help many borrowers, although it acknowledges that the number of people with mortgages contractually linked to the Bank rate has increased since early 2009.
The MPC noted that the “impact of the Funding for Lending Scheme and other policy initiatives might, in time, alter the Committee’s assessment of the effectiveness of such a rate reduction.” The MPC indicated it could review the option of lower interest rates again when the impact of the Funding for Lending Scheme and other policy initiatives was more apparent, but noted that this “was unlikely to be for several months.”
At this stage, more QE looks highly likely in the fourth quarter and we currently expect at least another GBP25-billion dosage. Our expectation is that the UK economy will see an appreciable bounce back in GDP in the third quarter (we expect growth of around 0.7%), helped by the staging of the Olympics, better weather, and the making up of some of the activity that was lost in the second quarter due to public holiday that resulted from the Queen’s Diamond Jubilee celebrations. The reduced squeeze on consumers’ purchasing power coming from lower inflation should also help matters.
However, the underlying economy is likely to remain fragile and prone to relapses, especially if there is not any sustained marked easing in the Eurozone’s problems. So it is very possible that the Bank of England will decide that more support is warranted for the economy, particularly if inflation heads down further as seems likely.
While we would not rule out a future trimming of interest rates from 0.50% to 0.25%, we believe it is more likely they will stay at 0.50% through until at least the second half of 2014.
Main Economic Releases
CBI Distributive Trades Survey for July
The Confederation of British Industry (CBI) distributive trades' survey for July (out Monday) will give an important indication as to how consumer spending has started off the third quarter. The hope is that the Olympic Games, better weather, and lower inflation will provide appreciable support to retail sales in the third quarter and help the economy bounce after hugely disappointing GDP contraction of 0.7% q/q in the second quarter.
Retail sales were poor overall in the second quarter as volumes fell 0.7% q/q. Sales volumes could only edge up 0.1% month-on-month (m/m) in June as they apparently failed to receive a hoped-for significant boost from the Queen’s Diamond Jubilee celebrations. Retail sales were also handicapped in June by the very wet weather dampening sales of summer clothing and outdoor products.
The recent better weather has probably come too late to significantly boost retail sales in July. Lower inflation and recent decent employment growth may have helped matters. In addition, sales may have been supported in July by people increasingly gearing up to enjoy the Olympics.
We expect the CBI survey to show the balance of retailers reporting that sales were up year-on-year was +27% in July.The balance previously jumped to an 18-month high of +42% in June from +21% in May and -6% in April, although this was not ultimately reflected in the hard June retail sales data. A balance of +27% would be above the monthly average of +6% in the first half of 2012.
There are some recent hopeful developments for retailers. In particular, the squeeze on consumers’ purchasing power has eased appreciably recently with inflation coming down to a 31-month low of 2.4% in June, having been as high as 5.2% last September. Meanwhile, latest data show that employment rose 181,000 in the three months to May, while consumer confidence has edged up overall from a low in April.
It seems unrealistic to expect a sustained major pickup in consumer spending in the near term at least. Consumer confidence is still very low, and the worrying economic situation and outlook is likely to fuel caution in spending. Meanwhile, consumer price inflation of 2.4% in June was still above annual earnings growth of 1.8% in May, and tighter fiscal policy is also adding to the squeeze on some consumers. Furthermore, unemployment is still high, with many of the recent job gains being in part-time or low-paid work, or due to a rise in self-employment. On top, there is a need for many consumers to deleverage.
Consumer Confidence in July
The GfK/NOP consumer confidence index (out overnight Monday/Tuesday) is forecast to have been stable at a still very weak level in July. Specifically, we expect the GfK NOP consumer confidence index (which is carried out on behalf of the European Commission) to have remained at -29 in July, having originally risen to this level in May from -31 in both April and March. In fact, with the exception of a brief spike higher in May/June 2011, the consumer confidence index has been locked in a -29 to -33 range since January 2011. This is among the lowest levels since the index started in 1974 and substantially below its lifetime average of -8.
Consumer confidence is expected to have remained under serious pressure in July from major concerns and uncertainties over both the current state and the outlook for the UK economy given the recent largely weakened latest economic data and surveys. In addition, heightened concerns over that the Eurozone’s problems and how the UK economy could be hurt are seen weighing down on confidence.
Confidence may have gained limited support in July from moderating inflation and there may also be some boost from people increasingly looking forward to the Olympics.
Mortgage Approvals in June and House Prices in July
The Bank of England is expected to report Monday that mortgage approvals for house purchases fell to a 13-month low of 47,500 in June. This would be down from 51,098 in May, 51,627 in April, and a 25-month high of 58,572 in January. Mortgage activity is expected to have been held back in June by the two days’ public holiday at the start of the month and by the very wet weather, while it is also evident that underlying housing market activity remains very weak.
The underlying weakness of housing market activity is highlighted by the fact that mortgage approvals have averaged 86,731 a month since 1993, while a level of 70,000-80,000 has in the past been considered consistent with stable house prices.
The Bank of England is also forecast to report that net mortgage lending amounted to just GBP0.5 billion in June. This would be down from GBP0.6 billion in May and would again be very low compared with long-term norms.
We expect July house price data to be released during the week by both the Nationwide and Halifax lenders to add to the weak news on the housing market. Specifically, we expect the Nationwide to report that house prices fell 0.2% m/m in July after a drop of 0.6% m/m in June. This would be the fourth drop in five months reported by the Nationwide and would leave house prices down 2.0% year-on-year (y/y) in July. Meanwhile, the Halifax is also forecast to report that house prices fell 0.2% month-on-month in July, which would leave them down 0.5% y/y in the three months to July. The Halifax house price index has been pretty volatile in recent months, and it showed a 1.0% m/m increase in June, but prices still down 0.3% q/q in the second quarter.
We expect house prices to trend gradually lower over the rest of 2012 and very possibly beyond in the face of limited activity, low and fragile consumer confidence, muted earnings growth, and relatively high unemployment. We expect house prices to end up losing at least 3% from current levels. Furthermore, there is a significant danger that house prices could fall even more than this due to the serious downside risks to the UK economic outlook, both from domestic factors and from the Eurozone crisis.
Housing market activity is persistently low compared with long-term norms and while it may eventually be lifted by more mortgages being granted at decent interest rates under the “Funding for Lending Scheme” to be launched by the Bank of England on 1 August, this is unlikely to be a major factor in the near term at least.
It is possible that house prices will gain some support from a shortage of properties on the market but this tends to vary markedly between regions as a factor. Meanwhile, although mortgage interest payments as a percentage of disposable income are currently very low, other affordability measures are not so favorable with the house price/earnings ratio above its long-term average.
Consumer Credit in June
The Bank of England is also expected to report on Monday that net unsecured consumer credit rose GBP500 million in June. This would be down from an increase of GBP732 million in May, which was the second-highest level (after March) since April 2011. It would also be less than half the average monthly level of GBP1.1 billion in unsecured consumer credit seen since 1993. In May, there was modest net borrowing of GBP70 million on credit cards after a net repayment of GBP60 million in April. Meanwhile, there was a net increase of GBP663 million in other loans and advances in May, which was the largest level since December 2010 and up from an increase of GBP439 million in April.
The overall impression is that consumer appetite for taking on new borrowing remains limited while there is also an ongoing strong desire of many consumers to reduce their debt. Consumer desire to keep a tight grip on their finances is clearly the consequence of serious concern over the current state of the economy and heightened worries and uncertainties over the outlook.
It is possible that some people are having to borrow more as a consequence of the extended squeeze on their purchasing power. Latest data from the Office for National Statistics show that households’ real disposable income fell 0.9% q/q in the first quarter of 2012 after a similar drop in the fourth quarter of 2011.
Manufacturing Purchasing Managers’ Survey for July
The manufacturing purchasing managers' index (PMI; Wednesday) is expected to show that overall activity in the sector achieved moderate growth in July after suffering contraction in both June and May. Specifically, we forecast the PMI to have improved to 50.5 in July from 48.6 in June and a three-year low of 45.9 in May. This would take the index modestly above the critical 50.0 level that indicates flat activity.
The manufacturing sector is expected to have been helped in July by the making up of some of the activity that was lost to the two days’ public holiday in June. The Confederation of British Industry (CBI) has already released its industrial trends survey for July, which showed a pickup in domestic orders and an increase in near-term production expectations. Nevertheless, the CBI’s survey revealed softer export orders in July.
Despite a likely pickup in activity in July, life is clearly challenging for manufacturers at the moment. Domestic demand for manufactured goods is handicapped by current muted investment intentions, still-serious headwinds facing consumers, and tightening public spending. Furthermore, the current uncertain and worrying economic environment is leading to some orders being delayed or cancelled.
Meanwhile, Eurozone economic weakness, in particular, is limiting overall foreign demand for UK manufactured goods. In addition, exporters have had to cope with the hit to their competitiveness from the pound recently trading at a 44-month high against the euro. It is not just weakened demand from the Eurozone that is a concern for UK manufacturers. The manufacturing purchasing managers’ survey for June reported reduced orders from the United States and Asia.
Construction PMI for July
The construction sector has been a major drag on the UK economy so far in 2012. The national accounts data indicate construction output plunged 5.2% q/q in the second quarter following a drop of 4.9% q/q in the first quarter. The magnitude of these drops meant that the construction sector contributed 0.4 percentage point to the GDP contraction of 0.7% q/q in the second quarter, and it also accounted for 0.4 percentage point of the GDP drop of 0.3% q/q in the first quarter.
Not only have the hard data for construction been persistently poor this year, but the survey evidence has taken a marked turn for the worse in recent months after offering some hope earlier in the year. The problems of the construction sector were undoubtedly heightened by the wet weather in May and June, and by the two days’ public holiday in June. The activity index of the construction sector purchasing managers’ survey slumped to a 30-month low of 48.2 in June from 54.4 in May and a 21-month high of 56.7 in March. Furthermore, the more forward-looking elements of the survey also weakened appreciably in June. In particular, the new orders index pointed to demand contracting at the fastest rate since April 2009. In addition, confidence in the sector fell to an eight-month low.
The purchasing managers’ survey (Thursday) will hopefully indicate there was improvement in construction activity in July as the sector made up some of the work that was lost in June to the public holidays and was also helped by better weather. Specifically, we expect the activity index to have picked up to 53.0 in July.
This pickup will not mask the fact that the construction sector is still struggling against serious headwinds. In particular, the government’s spending cuts are limiting overall expenditure on public buildings, schools, and hospitals. For example, the Bank of England’s regional agents revealed in their July business conditions survey that “there had been a further decline in construction output compared with a year earlier, in large part due to weakness in public sector spending.”
On top of this, house building activity is likely to be constrained by persistently weak housing market activity, soft prices, and a still-uncertain outlook. The purchasing managers’ survey showed that housing activity contracted markedly in June.
If the economy continues to struggle to develop sustainable growth over the coming months, there is the danger that construction activity will be hit by some projects being put on hold or cancelled altogether—particularly large ones.
The hope has been that the construction sector will eventually benefit appreciably from various government measures aimed at boosting infrastructure and house-building. There are currently serious doubts about how effective these measures will be and the government is coming under pressure to make further moves in this area.
The latest initiative has seen the government launch a scheme to underwrite risk on large infrastructure projects so as to allow work to go ahead on schemes that are stalled due to market conditions. In order to qualify, projects must be able to have work begin within 12 months, and will be monitored to ensure that the guarantees are necessary and that they would not have been able to go ahead without the government underwriting them, thanks to developers being unable to raise money at an affordable interest rate.
Service Sector Purchasing Managers’ Survey for July
We forecast the business activity index of the service sector purchasing managers' survey (Friday) to have improved to 53.0 in July after sinking to an eight-month low of 51.3 in June from 53.3 in both May and April and 55.3 in March. This would indicate modestly improved expansion given that a level of 50.0 is meant to indicate flat activity.
Once again, the improvement in activity in July is expected to be primarily due to the making up of some of the activity that was lost in June to the two days’ public holiday. However, the signs are that the services sector suffered less than manufacturing and construction from the public holidays, so the rebound effect is likely to have been less in July.
Service sector was essentially flat through the first half of 2012, seeing modest expansion in the first quarter and marginal contraction in the second according to the national accounts data.
The services sector is being hampered by difficult conditions in the private sector as well as by tighter government spending. For example, the Bank of England’s regional agents reported in their June survey of business conditions that some outsourcing companies “had been squeezed as public sector bodies bought work in-house”.
Meanwhile, many consumer-facing services companies are handicapped by the still generally difficult conditions facing consumers and the related inclination/need of many people to limit their discretionary spending.
30 Jul - CBI Distributive Trades Reported Volume of Sales, July: +27
30 Jul - Bank of England Consumer Credit, June (GBP/Billion): 0.5
30 Jul - Bank of England Net Lending Secured on Dwellings, June (GBP/Billion): 0.5
30 Jul - Bank of England Number of Loan Approvals for House Purchase, June (000s): 47.5
31 Jul - GfK Consumer Confidence, July: -29
1 Aug - Manufacturing Purchasing Managers Index, July: 50.5
2 Aug - Construction Purchasing Managers Index, July: 51.5
3 Aug - Service Sector Purchasing Managers Index, July: 53.0
During Week - Nationwide House Prices, July (Month-on-Month): -0.2%
During Week - Nationwide House Prices, July (Year-on-Year): -2.0%
During Week - Halifax House Prices, July (Month-on-Month): -0.2%
During Week - Halifax House Prices, July (Year-on-Year): -0.5%