Bank of England Policy Meeting

The September meeting of the Bank of England's Monetary Policy Committee (on Wednesday/Thursday) will undoubtedly see interest rates left at a record low of 0.50%, and it is also unlikely to result in any further increase in the amount of money being spent on quantitative easing (QE). It was last raised by £50 billion to £175 billion at the August MPC meeting.

The fact that three of the nine MPC members, including Bank of England Governor Mervyn King, actually wanted to raise the QE program by £75 billion to £200 billion at the August MPC meeting means that a further increase cannot be completely ruled out at the September meeting. Nevertheless, we suspect that developments over the past month are unlikely to lead to at least two of the other six MPC members changing their mind at this stage and voting for more QE. Furthermore, the current QE spending program by the Bank of England will last until the beginning of November, so there is no pressing need for the MPC to lift the amount next Thursday. By not raising the QE amount in July, the Bank of England set a precedent for not acting, so not too much should be read into a no-change decision at the September meeting.

The Bank of England has repeatedly stressed that it will take many months for the impact of QE (which started in March) to fully feed through and support bank lending; so having raised it by £50 billion last month, most MPC members will probably prefer to wait to see if evidence is mounting that QE is working.

The Bank of England clearly still has major concerns about the strength and sustainability of any recovery, even though it looks very possible that the economy will achieve modest growth in the third quarter. This was evident in the central bank's latest Quarterly Inflation Report that was released in mid-August. While taking some comfort from the recent improved data and survey evidence, the Bank of England remains particularly wary that economic activity could be dampened for an extended period by the ongoing need for financial institutions, households, companies, and the government to adjust their balance sheets. The minutes of the MPC's August meeting also considered that high unemployment and concerns about job security are also likely to "lead to a slow recovery in the level of economic recovery".

Meanwhile, the Bank of England believes that a substantial margin of spare capacity in the economy and likely gradual recovery will mean that consumer price inflation will be limited over the two-year policy horizon. This is despite the fact that consumer price inflation has been relatively sticky in coming down, largely because of sterling's past depreciation. Indeed, inflation defied expectations of a further fall in July, when it was stable at 1.8%.

The overall message that came from the Bank of England's August Quarterly Inflation Report was that interest rates will remain at 0.50% for some considerable time to come and that further QE was a genuine possibility. Critically, on the market assumption prevailing at the time that interest rates will start to rise gradually but steadily from the first quarter of 2010 and QE amounts to £175 billion, the Bank of England's central projection in the report showed consumer price inflation projected to be around 1.5% in two years' time. This is appreciably below the 2.0% target level for inflation. Even on the assumption that interest rates remain at 0.50% over the next two years while QE amounts to £175 billion, consumer price inflation was forecasted to be at its 2.0% target level on a two-year horizon, with the risks balanced as to whether inflation will be above or below this level. Inflation was rising at the end of the two-year period on this basis, however.

The Bank of England's outlook is unlikely to have fundamentally changed over the past month. Latest data and survey evidence relating to service sector activity, manufacturing, retail sales, and the housing market point overall to modest growth in the third quarter, but do little to dilute suspicion that U.K. economic relapses will be highly possible for some time to come and that growth will be limited over the medium term by elevated and rising unemployment, still-serious financial sector problems, and muted bank lending and stretched consumer balance sheets. Furthermore, economic activity will be limited over the longer term by the very pressing need for sustained, major fiscal tightening to rein in the bloated government deficit. Meanwhile, although there were signs in the July data that money-supply growth could be starting to accelerate, there is so far still worryingly little hard evidence that bank lending to businesses is improving.

We suspect that divisions will remain within the MPC on whether or not to extend QE, and to what extent. Although we do not expect any change in QE this month, we certainly would not rule out an eventual further extension. The key factor is likely to be whether or not there are growing signs that bank lending is picking up, as this is vital to sustainable recovery prospects. What is much clearer is that interest rates will remain at 0.50% for some considerable time to come. Indeed, we do not expect any rises until at least the latter months of 2010.

Main Economic Releases

Industrial production and manufacturing output data for July (Tuesday) are expected to show modest growth, thereby suggesting that the sector could expand in the third quarter and help the economy return to growth after five quarters of deep overall contraction. Industrial production is forecasted to have risen by 0.2% month-on-month (m/m) in July after growing 0.5% in June, thereby reducing the year-on-year (y/y) drop to 10.1% from 11.1%. Manufacturing output is similarly seen growing by 0.2% m/m in July after expanding 0.4% in June, which would cut the y/y decline to 11.1% from 11.7%.

The manufacturing sector is currently benefiting markedly from the substantial stock adjustment that has taken place, while the more competitive pound is helping the sector by making U.K. manufacturers more competitive in their domestic markets as well as through helping exporters. On top of this, demand is showing signs of picking up at least temporarily in important overseas markets as well as at home. Nevertheless, manufacturers still face an uncertain future as serious doubts remain about the strength of demand over the medium term.

Producer price data for August (Friday) should provide further evidence of manufacturers' limited pricing power in the face of still relatively muted demand, excess capacity, and intensified competition. Specifically, we expect producer output prices to have edged up by just 0.1% m/m in August. Nevertheless, the y/y decline in prices is likely to have narrowed to 0.5% in August, from 1.3% in July, because of a very sharp m/m fall in producer output prices in August 2008. Core output producer prices are forecasted to have been flat m/m in August, although this would still cause the y/y increase to rise to 0.6%, from 0.2% in July because of unfavourable base effects. Meanwhile, the consensus is for producer input prices to have risen by 1.0% m/m in August, primarily because of higher oil prices. Consequently, the y/y fall in producer input prices is seen narrowing to 8.5% in August, from 12.2% in July. This also reflects the fact that input prices started to fall sharply in August 2008 as oil prices retreated from their July 2008 record-high levels around US$147/barrel.

Housing-market data move very much to the fore over the coming week. The August housing market survey from the Royal Institute of Chartered Surveyors (overnight on Monday/Tuesday) is likely to show that housing-market activity continues to trend up. Meanwhile, the balance of surveyors should be reporting that house prices increased over the previous three months to have risen to -3.0% in August, from -8.1% in July and the 2009 low of -77.8% in February. In addition, the Halifax lender is forecasted to announce during the week that house prices rose by 1.2% m/m in August, following a 1.1% increase in July. This would cause the y/y drop in house price to moderate to 9.9% in the three months to August, from 12.1% in the three months to July and a peak of 17.7% in the three months to April. The Nationwide has already reported that house prices rose by 1.6% m/m in August, which was the fourth successive increase on its measure.

Buyer interest has been lifted substantially by the sharp overall fall in house prices from their autumn 2007 peak levels and markedly reduced mortgage interest rates, and this is gradually but steadily feeding through to lift housing market activity. Furthermore, house prices are currently being supported by a lack of properties for sale. Nevertheless, housing-market activity is still muted compared with long-term norms, while credit conditions remain tight and economic fundamentals are still far from favourable for the housing market. Consequently, we suspect that house prices are likely to suffer relapses over the coming months despite their current firmer tone.

The British Retail Consortium (BRC) retail sales monitor for August (also out overnight on Monday/Tuesday) is expected to show ongoing modestly firmer retail sales compared with their state earlier this year. The last survey showed that total retail sales rose by 3.6% y/y in July, which was up from growth of 3.2% in June and just 0.8% in May. On a like-for-like basis, retail sales rose by 1.8% y/y in July after increasing by 1.4% y/y in June and falling by 0.8% in May. With sharply reduced mortgage payments, lower utility bills, and more moderate inflation-boosting purchasing power, it seems that a good many people are currently more able and more willing to step up their discretionary spending. Nevertheless, a number of factors are likely to limit the upside for consumer spending for some time to come—most notably, sharply higher and rising unemployment, low earnings growth, and heightened debt levels. Furthermore, many consumers are keen to limit their expenditure because of still-serious concerns about the economy and their jobs, as well as a need/desire to improve their personal finances. Meanwhile, credit conditions remain tight.

The trade deficit (Wednesday) is expected to have narrowed to £2.0 billion in July from £2.2 billion in June. This would also be clearly below the average monthly deficit of £2.5 billion in the first half of 2009 and substantially below the average monthly shortfall of £3.2 billion in 2008. The sharp overall depreciation of sterling has boosted the competitiveness of U.K. exporters, while there are hopeful signs that domestic demand is starting to pick up in some key overseas markets, including the United States and Eurozone. Meanwhile, imports are still being limited by muted U.K. domestic demand, while there may also be some import substitution occurring because of the overall marked depreciation of the pound pushing up the price of foreign-produced goods.

8 Sep - British Retail Consortium Monitor Total Sales, August (Year-on-Year): not forecast
8 Sep - British Retail Consortium Monitor Like-for-Like Sales, August (Year-on-Year): not forecast
8 Sep - RICS House Price Balance, August: -3%
8 Sep - Industrial Production, July (Month-on-Month): +0.2%
8 Sep - Industrial Production, July (Year-on-Year): -10.1%
8 Sep - Manufacturing Output, July (Month-on-Month): +0.2%
8 Sep - Manufacturing Output, July (Year-on-Year): -11.1%
9 Sep - Visible Trade Balance, July (GBP/Mn): -6.2
9 Sep - Non-EU Visible Trade Balance, Jul (GBP/Mn): -3.4
9 Sep - Total Trade Balance, Jul (GBP/Mn): -2.0
11 Sep - Producer Price Output Inflation, Aug NSA (Month-on-Month): +0.1%
11 Sep - Producer Price Output Inflation, Aug NSA (Year-on-Year): -0.5%
11 Sep - Core Producer Price Output Inflation (ex Food, Tobacco etc.) Aug SA (Month-on-Month): 0.0%
11 Sep - Core Producer Price Output Inflation (ex Food, Tobacco etc.) Aug SA (Month-on-Month): +0.6%
During Week - Halifax House Prices, Aug (Month-on-Month): +1.2%
During Week - Halifax House Prices, Aug (Year-on-Year): -9.9%