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17/07/2011 | Retail Sales, Public Finances, and BoE Minutes Are Key Economic Releases Commencing 18 July

Howard Archer

Of key interest regarding the Bank of England's July meeting will be whether the Monetary Policy Committee is becoming markedly more worried about the economy’s current weakness and is seriously considering re-engaging in quantitative easing as well as delaying any interest-rate hike. Forthcoming data are unlikely to provide much comfort on the economic front with retail sales seen muted in June.

 

Minutes of July Bank of England MPC Meeting

Wednesday's release of the minutes of the July meeting of the Bank of England’s Monetary Policy Committee (MPC) will be closely examined for signs that the MPC may be warming to the idea of re-engaging in quantitative easing (QE) to try to boost the ailing economy. The stock of QE has been unchanged at GBP200 billion since February 2010; until recently, there had seemed little likelihood that the Bank of England could relax monetary policy further by engaging in more QE, even though one MPC member, Adam Posen, has been repeatedly voting for a GBP50-billion rise to GBP250 billion.

Indeed, until the last few weeks, attention had focused exclusively on when the Bank of England would start to tighten monetary policy through raising interest rates from the current record-low level of 0.50%. With consumer price inflation persistently well above its 2.0% target level (it has been in a 4.0-4.5% range through the first half of 2011), there has been serious pressure on the MPC to raise interest rates, despite bumpy and muted overall economic activity and the fact that substantial fiscal tightening is increasingly kicking in.

Nevertheless, a recent extended series of weak data and surveys has significantly intensified concerns over the health of the economy and its ability to withstand the increasing fiscal squeeze. Not only was the economy only flat overall during the first quarter of 2011 and the fourth quarter of 2010 combined, but it is very possible that it failed to grow in the second quarter of this year as well. While the extra public holiday in April resulting from the royal wedding had a negative effect on the second-quarter performance, the current softness of the economy clearly runs deeper than that.

It is notable that within the MPC, the doves currently seem to be on the ascendancy at the expense of the hawks. The voting margin in favor of unchanged interest rates strengthened to 7–2 in June from 6–3 in each of the previous four months as new MPC member Ben Broadbent joined the “no change” camp after replacing arch-hawk Andrew Sentance. Furthermore, there were indications both in the minutes of the June MPC meeting and in recent comments by some MPC members that they could join Posen in favoring further QE if the economy weakens further.

The MPC's growth concerns are likely to have been fuelled by a series of soft data and survey evidence relating to consumer confidence, retail sales, manufacturing and services activity. Furthermore, there are currently significant concerns about global growth. This is bad news for UK exports, which drove what growth there was in the first quarter and it is notable that the net trade performance weakened in April and May.

The MPC obviously has ongoing significant concerns about consumer price inflation which, despite dipping to 4.2% in June from 4.5% in May, still looks likely to reach 5.0% later this year as utility bills jump. There are signs that retailers are feeling increasing pressure to price competitively to get hard-pressed consumers to spend. And crucially, still muted pay growth fuels belief that a damaging wages-prices upward spiral is unlikely to develop, and supports the view that consumer price inflation will fall markedly once the upward pressures from value-added tax (VAT) changes; high oil, commodity, and food prices; and sterling's past weakness wane.

Although a revival of QE is clearly back on the table, we doubt any MPC member joined Adam Posen in voting for such a move at the July meeting. We are dubious more QE will occur unless the economy sees sustained, very weak activity. We believe that given still-significant inflation risks, most MPC members will be reluctant to go back down the quantitative easing road.

Meanwhile, we expect the Bank of England to hold off from raising interest rates until the second quarter of 2012. We suspect that most MPC members will maintain the view for many more months to come that higher interest rates are an extra handicap that the fragile economy can well do without. In particular, there is likely to be serious concern that any hike in interest rates could hit already brittle consumer confidence and further dampen consumer spending.

Furthermore, whenever interest rates do start to rise, the probability is that they will move up only gradually and remain very low compared with past norms. Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. In addition, we do believe that inflation will fall markedly from late 2011/early 2012. Consequently, we suspect that interest rates will only rise to 1.50% by the end of 2012.

Retail Sales in June

Retail sales volumes (out Thursday) are expected to have edged up 0.2% month-on-month (m/m) in June, which would see them down 0.1% year-on-year (y/y). Latest data show that retail sales fell 1.4% m/m in May, which more than outweighed the 1.1% gain in April when sales were lifted by the combination of the royal wedding, later Easter, and particularly good weather.

Survey evidence for retail sales in June from the Confederation of British Industry (especially) and the British Retail Consortium (BRC) was weak overall. Nevertheless, there were signs in the BRC’s survey that there may have been a limited boost to sales coming from some retailers starting their summer clearance sales earlier.

The likelihood is that consumer spending will be muted for some time to come as household purchasing power remains under severe pressure from high inflation, low wage growth, and tighter fiscal policy. The squeeze on purchasing power is highlighted by latest data showing that household disposable income fell 0.8% quarter-on-quarter (q/q) and 2.7% y/y in the first quarter of 2011 and that the savings ratio fell to 4.6% from 5.1% in the fourth quarter of 2010 and 5.6% in the third quarter. Furthermore, soaring utility bills will shortly add to the squeeze on consumers (with British Gas becoming the second utility company to announce sharp gas and electricity price hikes from August). In addition, unemployment is still high and debt levels are elevated. Meanwhile, the weak housing market has adverse repercussions for consumer spending (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).

On top of this, many consumers are likely worried about future Bank of England interest-rate hikes, although these look increasingly unlikely to occur before 2012. Even small interest-rate rises could present serious problems for financially stretched households. Furthermore, even if the Bank of England only edges interest rates up, it will affect consumer psychology as people are bound to see the move as the first in a series of hikes. In fact, weak consumer spending is likely to be a key factor deterring the Bank of England from raising interest rates for many more months to come.

Public Finances in June

The public finances data for June (Thursday) are expected to show modest 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 GBP12.5 billion in June, from a shortfall of GBP13.6 billion in June 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 start to increasingly show up in the public finance figures. Nevertheless, the improvement in the public finances is likely to be limited to the economy’s current softness.

The current weakness of the economy is already casting major doubts as to whether Chancellor George Osborne will be able to achieve his target of reducing the PSNBR excluding financial interventions to GBP122.0 billion in fiscal year 2011/12, from an upwardly revised 2010/11 outturn of GBP143.2 billion. In fact, the PSNBR excluding financial interventions actually rose to GBP27.4 billion in the first two months of fiscal 2011/12 (April and May) from GBP25.9 billion in the first two months of fiscal 2010/11. This was disappointing even allowing for the fact that the April 2011 shortfall was up appreciably from a year earlier because of the April 2010 tax take being flattered by a one-off bank payroll tax, which raised GBP3.5 billion, and by higher bonuses and share options, which were not repeated in 2011.

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. IHS Global Insight believes this is now very much on the optimistic side as we expect GDP growth to be 1.1% in 2011 and 2.0% in 2012. Furthermore, higher-than-expected inflation is posing a threat to the chancellor's budget targets.


20 July - Bank of England Monetary Policy Committee interest-rate vote split, July (Hike-Unchanged-Cut): 2-7-020 July - Bank of England Monetary Policy Committee Quantitative Easing vote split, July (More-Unchanged-Reduced): 1-8-021 July - Public Sector Net Borrowing Requirement, June (GBP/Bln): 12.521 July - Retail Sales, June (Month-on-Month): +0.2%

21 July - Retail Sales, June (Year-on-Year): -0.1%

Global Insight (Reino Unido)

 


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