Having approved a further GBP50 billion of Quantitative Easing in February, the Bank of England’s Monetary Policy Committee is likely to sit tight for the next few months and see how economic growth and consumer price inflation develop. Meanwhile, two major surveys out over the coming week are the British Retail Consortium’s retail sales monitor for February and the purchasing managers’ services survey for February. Given the importance of consumer spending and the services sector to the economy, if they show a continuation of recent improved trends, it will be a significant boost to hopes that the UK will achieve appreciable GDP growth in the first quarter of 2012 following the 0.2% quarter-on-quarter contraction suffered in the fourth quarter of 2011.
BANK OF ENGLAND IN WAIT-AND-SEE MODE
In terms of possible changes to monetary policy, the 7-8 March meeting of the Bank of England’s Monetary Policy Committee is a non-event. The MPC only authorized a further £50 billion of Quantitative Easing (QE) at their February meeting, and this is due to take three months to enact (i.e., will last through to May). Meanwhile, there seems no inclination within the MPC to take interest rates any lower than the current record low level of 0.50%, and there is no likelihood of interest rates being increased for some considerable time to come.
We believe the Bank of England is now firmly in “wait-and-see” mode. Indeed, Sir Mervyn King’s testimony to parliament’s Treasury Select Committee at the end of February strongly indicates this is the case, and that the Bank of England’s future policy actions will be guided by the evidence on the economy before the MPC at the time.
There seems little doubt the MPC will now sit tight through to May while February’s £50 billion QE extension is enacted and the MPC monitors whether the apparent improvement in UK economic activity early in 2012 is continuing and whether consumer price inflation is coming down in line with expectations.
The minutes of the February meeting of the Bank of England’s Monetary Policy Committee revealed increasing divergences of opinion within the MPC over policy, but suggest the door remains open for more Quantitative Easing should the economy struggle for sustained growth over the coming months. Significantly, not one of the nine MPC members favoured less than £50 billion more QE in February, while two of them wanted a £75-billion increase. It is little surprise that Adam Posen wanted even more QE, and it is notable that he was joined by David Miles.
On the other hand, the minutes indicated that further QE was far from certain, as they revealed that among some of the seven MPC members who voted for £50 billion more QE, there was a view that “a case could be made for maintaining the stance of policy at this meeting.” Martin Weale indicated in a speech at the end of February that he is doubtful there will be a case for more QE; however, it needs to be borne in mind that Mr. Weale has been among the more hawkish MPC members, and he voted for an interest rate hike in the early months of 2011.
There are clearly differing opinions within the MPC over the balance of the upside and downside risks to the central forecast that consumer price inflation will be only just below its 2.0% target rate in two years. Some MPC members are clearly worried about the upside risks from possible higher input costs (especially given oil’s current strength) and extended low productivity. The more dovish MPC members are concerned over the possibility of extended weak demand and excess capacity in a difficult domestic and international environment. The pressures on consumers, tighter credit conditions, extended tight fiscal policy, and the problems in the Eurozone remain serious growth risks.
We currently believe that limited additional QE is more likely than not. We anticipate that economic developments will warrant further limited stimulative action despite recent signs of improvement. While we expect the economy will return to growth in the first quarter and avoid recession, we suspect that activity will be erratic and muted overall through the first half of 2012, and then only pick up gradually in the second half. Meanwhile, we think consumer price inflation will trend down appreciably further over the coming months, although clearly inflation may well prove stickier than hoped for due to the strength of oil prices. Even if this is the case, underlying inflationary pressures still seem likely to be limited by extended below-trend economic activity, significant excess capacity, and ongoing wage moderation resulting from high and, likely, rising unemployment.
We lean towards the view that the Bank of England will do £25 billion more QE in May, taking the total up to £350 billion, although this could be delayed until August. Meanwhile, we are sticking to our view that interest rates will not rise until at least late 2013 and could very well stay put at 0.50% until 2014.
MAIN ECONOMIC RELEASES
Service Sector Purchasing Managers’ Survey for February
The performance of the dominant service sector is key to just how much the UK economy can rebound in the first quarter of 2012 after GDP contracted 0.2% quarter-on-quarter in the fourth quarter of 2011. The January purchasing managers’ survey for the services survey provided a major boost to first-quarter growth hopes, as it showed activity in the sector spiking up to a 10-month high and incoming new business at a 6-month high. It also showed business expectations at an 8-month high and employment in the sector rising at the fastest rate since March 2008.
It seems unlikely that the services sector sustained the growth rate apparently achieved in January, but the survey hopefully will at least show that the sector managed to keep expanding at a reasonable pace in February. Specifically, we forecast the business activity index of the service sector purchasing managers' survey (out Tuesday) to have eased back to 54.8 in February, after improving to a 10-month high of 56.0 in January from 54.0 in December and 52.1 in November. This would be well above the 50.0 level that is meant to indicate flat activity and also clearly above the fourth-quarter 2011 average of 52.5.
It must be borne in mind that the survey evidence from the services purchasing managers has recently been healthier than the hard data. Specifically, the national accounts data for the fourth quarter of 2011 indicated that services output was flat quarter-on-quarter as GDP contracted 0.2%. Conversely, the business activity index of the purchasing managers’ survey averaged 52.5 in the fourth quarter, which was clearly above the critical 50.0 level that is meant to indicate unchanged activity.
The services sector still faces difficult conditions in the private sector and cutbacks in government spending. The Bank of England’s regional agents reported in their February summary of business conditions that “businesses services turnover growth continued to slow, reflecting weaker demand and downward pressure on fees, particularly among accountancy and legal firms.” On a positive note, though, the agents also reported that “some contacts recently noted a pickup in activity, as customers had become a little less cautious.”
Meanwhile, many consumer-facing services companies are still being handicapped by the squeeze on consumers’ purchasing power and their need/desire to limit their discretionary spending. The Bank of England’s regional agents reported in their February survey that “the rate of growth of demand for consumer services also continued to slow“. Nevertheless, recently there have been signs that consumers may be perking up a little, although they are still careful in their discretionary spending.
British Retail Consortium Retail Sales Monitor for February
The British Retail Consortium (BRC) retail sales monitor for February (out overnight on Monday/Tuesday) will be of major interest given recent signs that consumers may have more life in them than had been widely thought. Latest hard data show that retail sales volumes rose 0.9% month-on-month in January, while February survey evidence from the Confederation of British Industry (CBI) was reasonably decent, although it indicated that consumers are focusing their spending on food and essentials and are generally reluctant to make purchases of discretionary and big-ticket items. Consumer confidence has also been firmer overall early in 2012, helped by an easing in concerns over the economic outlook.
A relatively decent BRC survey would fuel hopes that consumers really have perked up recently and are helping the economy to achieve clear growth in the first quarter. In contrast, a soft survey would fuel concern that consumers are not yet prepared to step up their spending on an extended basis. One point to bear in mind is that the survey evidence for January from both the BRC and the CBI was considerably weaker than the robust 0.9% month-on-month increase in sales volumes reported by the Office for National Statistics. Specifically, the BRC reported that total retail sales values rose 2.1% year-on-year in January, which was down from growth of 4.1% year-on-year in December. It was also only half the 4.2% year-on-year growth rate achieved in January 2011. When taking shop price inflation into consideration, the indications are that total sales volumes saw little year-on-year growth. Meanwhile, sales values on a like-for-like basis (which strips out the effect of additional floor space) fell 0.3% year-on-year in January, compared to rises of 2.2% year-on-year in December and 2.3% year-on-year in January 2011.
While consumers appear to have genuinely perked up recently, we suspect they will be careful in their spending over the next few months at least. Despite now falling back, consumer price inflation (3.6% in January) is still running at double the rate of earnings growth, thereby continuing to squeeze purchasing power appreciably, while consumers are also having to contend with high and rising unemployment, elevated debt levels, and an extended fiscal squeeze. Additionally, consumer confidence is still low compared to long-term norms despite the recent improvement.
Hopefully, a further marked retreat in consumer price inflation over the coming months will increasingly ease the squeeze on consumers, although there is a growing risk that higher oil prices will limit the drop in inflation. Even if consumer price inflation does fall back appreciably, unemployment is likely to rise further, wage growth looks set to remain muted, tight fiscal policy will continue to bite, and debt levels will still be high, so the overall environment will likely remain tough for consumers.
Manufacturing Output and Industrial Production in January
We expect manufacturing output (out on Friday) to have risen 0.3% month-on-month in January, which would result in a 0.2% year-on-year increase. Manufacturing output spiked up 1.0% month-on-month in December, after falling in each of the previous six months, including drops of 0.1% in November and 0.9% in October. Overall industrial production is seen rising 0.2% month-on-month in January, although this would still leave it down 3.2% year-on-year. Industrial production rose 0.5% month-on-month in December after drops of 0.5% month-on-month in November and 1.0% in October.
Survey evidence on the manufacturing sector so far in 2012 has been improved overall, although the purchasing managers’ survey indicated some loss of momentum in February after activity reached an eight-month high in January, including a slight fall in new orders. However, the CBI’s industrial trends survey was stronger in February than January, with the total orders balance at a six-month high and near-term production expectations relatively elevated.
The manufacturing sector looks set to expand in the first quarter of 2012 after contracting sharply in the fourth quarter of 2011, but it is far from performing as well as it did in 2010 and the start of 2011.
Indeed, manufacturers clearly still face a challenging environment. Domestic demand for manufactured goods is still handicapped by an appreciable squeeze on consumers’ purchasing power, as well as by tighter public spending. Meanwhile, muted global economic activity—particularly in the Eurozone—is limiting export orders while the Eurozone crisis continues to be a source of significant uncertainty for manufacturers. However, the purchasing managers’ survey indicated that export orders are being helped by improved demand from Asia and the United States. In addition, a current spike up in input costs is bad news for manufacturers, as it squeezing their margins and, if sustained, will put pressure on them to raise prices when demand is still fragile.
Producer Prices in February
Producer price data (out Friday) are forecast to show a continued moderation in the year-on-year inflation rate while also indicating that the recent spike up in oil prices is posing an increasing threat to the retreat in inflation. Output prices are forecast to have risen by 0.2% month-on-month in February after an increase of 0.5% in January. This would see the year-on-year increase retreat to a 17-month low of 3.9% in February from 4.1% in January, 4.8% in December, and a near-three-year high of 6.3% in September. Core output pricesare forecast to have increased just 0.1% month-on-month in January, after rising 0.3% in February. This would cause the year-on-year increase to edge back up to 2.5% in February after it dipped to a 23-month low of 2.4% in January from 3.0% in December and a 13-month high of 3.7 % in September.
Meanwhile, the consensus forecast is for producer input prices to have risen 1.0% month-on-month in February after rising 0.5% in January, primarily due to higher crude oil prices. Nevertheless, this would still see the year-on-year increase in input prices dip to a 27-month low of 6.8% in February from 7.0% in January, 8.9% in December, and a peak of 18.5% last July.
The recent rise back up in input prices primarily resulting from higher crude oil prices is exerting increasing pressure on manufacturers to raise their prices in order to protect their margins. At the same time, manufacturers face an ongoing need to price competitively to try and gain, or even retain, business. Even though manufacturing activity has picked up recently after a generally torrid second half of 2011, it is still far from racing ahead and demand is fragile. Significantly, the purchasing managers’ survey for the manufacturing sector showed that input prices spiked up in February after falling over the previous four months. Output prices also picked up to a five-month high in February, having fallen to a 27-month low in January, but the rise was still relatively modest, so manufacturers’ margins were squeezed.
House Prices in February
The Halifax lender is expected to report during the week that house prices rose 0.3% month-on-month in February, which would leave prices down 1.6% year-on-year in the three months to February. The Halifax previously reported that house prices rose 0.6% month-on-month in January, but this followed drops of 1.0% month-on-month in both December and November. The Nationwide lender has already reported that house prices rose/fell 0.6% month-on-month in February after drops of 0.3% month-on-month in January and 0.2% in December. House prices were up 0.9% year-on-year in February on the Nationwide measure.
With housing market activity currently trending up modestly and the economy showing signs of improvement, the downside risks to house prices are abating. It is evident that housing market activity and house prices are currently being lifted by first-time buyers rushing to complete before the stamp duty concession ends in March.
While house prices rise modestly further in the near term due to first-time buyers looking to beat the rise back up in stamp duty, we still suspect that house prices will drift lower over the coming months. Even so, we are trimming our forecast decline in house prices in 2012 to 3% from 5%. We acknowledge there is a growing possibility that house prices may not fall over 2012. Despite the recent pick up, housing market activity is still low compared to long-term norms. Despite current signs of improvement, the economic fundamentals still look far from rosy for the housing market, with unemployment high and likely to rise further, earnings growth muted, debt levels high, and the outlook uncertain. In addition, credit conditions may well tighten, making it harder to get a mortgage. These factors are countering extended very low interest rates.
5 Mar - Service Sector Purchasing Managers Index, February: 54.8
6 Mar - British Retail Consortium Monitor Total Sales, February (Year-on-Year): not forecast
6 Mar - British Retail Consortium Monitor Like-for-Like Sales, February (Year-on-Year): not forecast
9 Mar - Industrial Production, January (Month-on-Month): +0.2%
9 Mar - Industrial Production, January (Year-on-Year): -3.2%
9 Mar - Manufacturing Output, January (Month-on-Month): +0.3%
9 Mar - Manufacturing Output, January (Year-on-Year): +0.2%
9 Mar - Producer Price Input Inflation, February (Month-on-Month): not forecast
9 Mar - Producer Price Input Inflation, February (Year-on-Year): not forecast
9 Mar - Producer Price Output Inflation, February (Month-on-Month): +0.2%
9 Mar - Producer Price Output Inflation, February (Year-on-Year): +3.8%
9 Mar - Core Producer Price Output Inflation (ex Food, Tobacco etc.) February (Month-on-Month): +0.1%
9 Mar - Core Producer Price Output Inflation (ex Food, Tobacco etc.) February (Month-on-Month): +2.5%
During Week - Halifax House Prices, February (Month-on-Month): +0.3%
During Week - Halifax House Prices, February (Year-on-Year): -1.6%