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16/05/2010 | Inflation, Retail Sales, and Public Finances All Featured among U.K. Economic Data for Week Commencing 17 May

Howard Archer

Public finance data will highlight the tough decisions that the new coalition government will have to quickly take on fiscal policy. Meanwhile, inflation is expected to have remained well above the target in April.

 

Inflation in April

Data out on Tuesday are expected to show annual consumer price inflation remained up at 3.4% in April. Indeed, there is a very real possibility that it edged up higher, This will result in Bank of England Governor Mervyn King having to write another open letter to the Chancellor (albeit he will be writing to a new one following the change of government) explaining why consumer price inflation is still more than one percentage point above the central bank's target rate of 2.0% and what the Bank of England is doing about it.

Consumer price inflation is likely to have been pushed up again in April by unfavourable base effects resulting from falling utility bills a year ago, higher fuel costs, VAT rising back up to 17.5% in January, and the lagged impact of sterling's depreciation. Core consumer price inflation is seen remaining up at 3.0% in April. Meanwhile, annual underlying retail price inflation is expected to have remained up at 4.8% in April, while the year-on-year increase in headline retail prices is forecast to have risen to 4.8% in April from 4.4% in March, reflecting the fact that a cut in mortgage interest rates in April 2009 was not repeated this April.

Consumer price inflation is likely to hover around 3.0-3.5% in the near term. Consumer price inflation will hopefully have started on a clear downward path by midyear. Given that oil prices bottomed out in the first quarter of 2010 and then firmed, oil-price related base effects should become more favourable barring a sustained sharp rise in oil prices over the coming months. Meanwhile, underlying price pressures should be contained by substantial excess capacity, likely bumpy and gradual recovery, wage moderation amid high unemployment and job insecurity, and the need for retailers to price competitively in the face of still limited consumer spending. Furthermore, as sterling troughed in late-2008/early-2009, the pound's sharp depreciation should now have largely finished feeding through to push up prices.

CBI Industrial Trends Survey for May

The Confederation of British Industry (CBI) industrial trends survey for May is out on Tuesday, and it is expected to show that the balance of manufacturers reporting that their orders are at normal levels improved to -33% from -36% in April and -37% in March. April's level was the equal highest (with February since) the end of 2008. Recent survey evidence on the manufacturing sector has consistently been more upbeat, while latest hard data from the Office for National Statistics show that manufacturing output surged 2.3% month-on-month in March.

Manufacturers are currently clearly benefiting from a pick up in demand both at home and, particularly, overseas, improved competitiveness in both domestic and foreign markets stemming from the weak pound, and leaner stock levels. The key question is:, can manufacturers sustain healthy growth over the medium term, particularly as stimulative measures are withdrawn? Indeed, the car scrappage scheme came to an end in March. U.K. manufacturers will certainly be hoping that the Eurozone debt crisis does not derail growth in the region, as there have been signs recently that Eurozone growth has been picking up after faltering around the turn of the year.

Minutes of May Bank of England MPC Meeting

Wednesday also sees the release of the minutes of the May meeting of the Bank of England's Monetary Policy Committee (MPC). At the May meeting, the MPC kept monetary policy on hold with interest rates staying down at the record-low level of 0.50% and the committee opting not to add to the £200 billion that the Bank of England has already spent on its Quantitative Easing programme. All nine MPC members voted for unchanged interest rates and Quantitative Easing in April, and we expect this to have remained the case in May.

The thunder of the May MPC minutes has pretty much been stolen by the recent release of the Bank of England's Quarterly Inflation Report for May and by the comments made by bank governor Mervyn King at the accompanying press conference. The minutes of the April MPC meeting had indicated that some committee members are getting a little more worried about the inflation outlook and, subsequently, released inflation data have generally been higher than expected.

Even so, the May Quarterly Inflation Report indicated that the Bank of England is very unlikely to change interest rates for many months to come. Furthermore, King indicated that the Bank of England is keeping open the possibility of further Quantitative Easing should the recovery suffer a significant relapse over the coming months. Significantly, the Bank of England still expects consumer price inflation to be below its 2.0% target level on the two-year policy horizon; not only if interest rates rise in line with market expectations, but also even if interest rates remain at 0.50% through the next two years. Specifically, on market expectations that interest rates will start to edge up in the fourth quarter of 2010 and reach 2.5% around mid-2012, the Bank of England's central forecast shows consumer price inflation close to 1.5% in two years time. On the assumption that interest rates remain at 0.50%, the central forecast for consumer price inflation in two years time is seen around 1.8%. Both these forecasts assume that the stock of Quantitative Easing remains at £200 billion.

Despite ongoing speculation about just how much spare capacity there really is in the economy, the central view of the Bank of England is that there is still enough to limit inflation over the next two years or so, following the sharp overall drop in GDP that occurred during the recession and likely relatively gradual recovery. The Bank of England also expects earnings growth to remain low due to a "sizable degree of slack in the labour market." Meanwhile, temporary upward pressures on inflation from VAT rising back up to 17.5% in January, higher oil prices over the past year and sterling's depreciation are expected to wane.

We retain our long-held belief that the Bank of England will keep interest rates down at 0.50% into 2011. We also retain the view that whenever interest rates do start to rise, the increases are likely to be gradual and limited due to the need to offset the marked tightening in fiscal policy that is on the way. Meanwhile, we expect the Bank of England to keep the stock of Quantitative Easing unchanged at £200 billion for the rest of 2010 before starting to gradually reverse the process in 2011.

Retail Sales in April

Retail sales volumes (out on Thursday) are forecast to have risen by a relatively modest 0.4% month-on-month in April, thereby matching March's growth rate. This would give year-on-year growth of 2.0% in April. Survey evidence from the British Retail Consortium, especially, and the Confederation of British Industry was on the disappointing side overall.

We continue to believe that the upside for consumer spending—and hence overall economic growth—will be limited for some time to come as households still face very challenging conditions. These notably include high unemployment and still-falling employment, low underlying earnings growth, elevated debt levels, and January's Value-Added Tax (VAT) hike from 15.0% back up to 17.5%. Furthermore, overall tax increases are on the way, as the coalition government moves to rein in the public finances. This could very well include VAT rising up to 20%. Meanwhile, still serious uncertainties about the economic outlook and jobs are likely to maintain many consumers' desire to improve their personal finances. It also remains to be seen how consumer confidence will be affected by the formation of the first full coalition government since the Second World War. If consumers believe that the coalition is unlikely to last long, the resultant uncertainty may encourage caution over spending.

At least, the Bank of England has indicated this week that it is unlikely to raise interest rates for many months to come, so low mortgage rates should continue to support consumers' purchasing power.

Public Finances in April

The public finances data for April (out on Friday) are expected to mark a continuation of the recent trend showing that the rate of deterioration is moderating compared to a year ago. Tax receipts are benefiting from the economy's return to growth since the fourth quarter of 2009 and Value-Added Tax rising back up from 15.0% to 17.5% in January. In addition, unemployment benefit claims have fallen by 110,900 from last October's 12-year high of 1.6278 million. Consequently, we expect the Public Sector Net Borrowing Requirement (PSNBR) to come in at £10.0 billion in April compared to £8.8 billion in April 2009.

Nevertheless, even if the rate of deterioration in the public finances did slow further in April, this will not disguise the fact that they are still in a dismal state and that the coalition Conservative-Liberal Democrat government has a major task ahead of them in returning the public finances to a sustainable state over the next five years (if the coalition really does last that long!). The coalition has already indicated that they will enact an extra £6 billion in spending cuts in non-front line services in fiscal 2010/11 while the emergency budget that is due to be held within 50 days of the coalition government taking power is going to have to make very difficult decisions on further spending cuts and tax hikes.

Business Investment in First-quarter 2010

Business investment (out on Friday) is expected to have fallen for a seventh successive quarter in the first quarter, but at a much reduced rate of 0.5% quarter-on-quarter compared to the plunge of 4.3% quarter-on-quarter in the fourth quarter of 2009. This would cut the year-on-year decline in business investment to a still horrible looking 16.5% in the first quarter of 2010 from a record 23.5% in the fourth quarter of 2009.

The worst of the contraction in business investment should now be over, but it is likely to remain limited for some time to come given substantial excess capacity, still relatively limited demand, and ongoing significant uncertainties and concerns among companies over the longer term strength of the recovery. Furthermore, although low interest rates and better functioning markets are helping many companies to raise finance, a lack of credit availability remains a significant problem for a significant number of companies. This is particularly true for smaller companies, and it is still having a dampening impact on their business investment plans.

Recent surveys of investment intentions remain somewhat limited, despite substantial improvement from their early-2009 lows. For example, the Bank of England's regional agents revealed in their April survey that "investment intentions remained subdued…The wide margin of spare capacity, tight credit conditions and uncertainty about future demand and plans for public spending and capital allowances had continued to restrain investment plans." Nevertheless, the agents reported that "there have been tentative signs that some businesses were considering resuming routine maintenance work, or increasing investment to improve productivity and educe costs. And a few contacts had considered investing in new products, in preparation for an upturn in demand."


18 May - Consumer Price Inflation, April (Month-on-Month): +0.3%
18 May - Consumer Price Inflation, April (Year-on-Year): +3.4%
18 May - Core Consumer Price Inflation (ex Food, Drink, Tobacco), April (Year-on-Year): +3.0%
18 May - Retail Price Inflation, April (Month-on-Month): +0.4%
18 May - Retail Price Inflation, April (Year-on-Year): +4.8%
18 May - Underlying Retail Price Inflation, April (Month-on-Month): +0.4%
18 May - Underlying Retail Price Inflation, April (Year-on-Year): +4.8%
18 May - CBI Industrial Trends, Total Orders, May: -33%
19 May - Bank of England Monetary Policy Committee interest rate vote split, May (Hike-Unchanged-Cut): 0-9-0
19 May - Bank of England Monetary Policy Committee Quantitative Easing vote split, May (More-Unchanged-Reduced): 0-9-0
20 May - Retail Sales, April (month-on-month): +0.4%
20 May - Retail Sales, April (year-on-year): +2.0%
21 May - Public Sector Net Borrowing Requirement, April (GBP/Bln): 10.0
21 May - Business Investment, First Quarter 2010 (Quarter-on-Quarter): -0.5%
21 May - Business Investment, First Quarter 2010 (Year-on-Year): -16.5%

Global Insight (Reino Unido)

 


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