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02/10/2011 | UK - Bank of England Policy Meeting and Revised GDP Data Head UK Economic Week Commencing 3 October

Howard Archer

The influential purchasing managers’ surveys are likely to show a further overall loss of momentum in services, manufacturing, and construction activity in September. Meanwhile, major methodological and classification changes to the calculation of the national accounts could potentially change the economy’s reported performance during the 2008/09 recession and since significantly. The overall picture is still likely to show only limited recovery from deep contraction.

 

Touch and Go Whether Bank of England Will Enact More Quantitative Easing in October

It now looks very much a question of when will—rather than will—the Bank of England engage in further quantitative easing (QE) to try to help the ailing economy?

We expect the Bank of England to announce a further GBP50 billion of QE by November at the latest, taking the total up to GBP250 billion. We believe it is touch and go whether the Bank of England announces more QE at the October meeting of its Monetary Policy Committee (MPC). While we currently marginally lean towards a move in November, when the MPC will have available the Bank of England’s new GDP growth and consumer price inflation forecasts, it is very possible that a flurry of weak data and surveys over the next few days could prompt the MPC into launching QE2 as soon as Thursday.

Meanwhile, any interest-rate hike has sailed off into the horizon, and is unlikely to reappear before 2013. We doubt the Bank of England will cut interest rates below 0.50%. Notably, it did not take interest rates below 0.50% at the height of the 2008/09 recession amid belief that such a move could actually do more harm than good.

The minutes of the September MPC meeting were appreciably more dovish, opening the door wide to more QE by the Bank of England and likely sooner rather than later. It is evident the MPC is becoming ever more concerned about the current weakness of the economy and the deteriorating domestic and global growth outlook. The MPC is also worried about the weakness and volatility of the markets, and the funding conditions for banks. As a result of the weakened growth situation and outlook, the MPC concluded the downside risks to inflation had “clearly increased further.”

While Adam Posen remained the only one of the nine MPC members currently favoring a further, immediate GBP50-billion dose of QE at the September meeting, he was very near to gaining some supporters. The minutes of the September meeting significantly revealed most other members “thought it was increasingly probable that further asset purchases to loosen monetary conditions would become warranted at some point.” Furthermore, the minutes went on to record that “for some members, a continuation of the conditions seen over the past month would probably be sufficient to justify an expansion of the asset purchase programme at a subsequent meeting.”

Subsequent remarks by Ben Broadbent indicate he was very near to voting for more QE in September, and that it would not take much more of a deterioration in the economic situation to get him to favor it. Similarly, David Miles, another MPC member, was reported in theTimes to have said in late September that the case for QE has become “quite finely balanced.” Furthermore, Spencer Dale, who had voted for an interest-rate hike as recently as July, acknowledged in an interview with the Daily Mail that “if things continue to deteriorate we may need to consider further monetary loosening.” Dale indicated inflation concerns meant further QE was not a done deal.

Barring a marked improvement in the economy over the next few weeks (which is currently hard to see), we expect the MPC to approve a further GBP50 billion in Quantitative Easing by November at the latest. A move as soon as Thursday is entirely possible, although we currently slightly favor November as more likely. Much could depend on just how weak the economic data and surveys are over the next few days—particularly, the influential purchasing managers' surveys for the services and manufacturing sectors in September.

Meanwhile, it is apparent any interest-rate hike has completely disappeared from the Bank of England’s radar. It is unlikely to re-appear for some considerable time to come, given the economy’s softness. There was once again a 9–0 vote in favor of unchanged interest rates in September, and a hike currently looks ever more unlikely before 2013.

In fact, the MPC even discussed trimming interest rates to just 0.25% at its September meeting. Given that the MPC did not do this even at the height of the 2008/09 recession, we very much doubt it will do so now. The MPC has been reluctant in the past to take interest rates down any lower than 0.50% because of the negative repercussions this could have on the banking sector and banks' willingness and ability to lend. The MPC also has serious doubts about just how much benefit even lower interest rates would have.

Main UK Economic Releases

GDP Growth in Second-Quarter 2011

Revised national accounts data (out Wednesday) could potentially see significant revisions to both the recent and more distant GDP history, as there are a number of major methodological and classification changes being made (including: 1. the industrial classification used to provide more detail on the services sector; and 2. the calculation of the deflators). The GDP data are being revised all the way to 1992.

It is impossible to second-guess to what extent history will be rewritten; and it is the current state of the economy and the outlook that is now of prime importance. Nevertheless, if there are major changes to the measured performance of the economy in recent years, it may have significant implications as to what is considered to be the trend growth rate.

Current data show GDP expanded just 0.2% quarter-on-quarter (q/q) and 0.7% year-on-year (y/y) in the second quarter of 2011. This followed growth of 0.5% q/q in the first quarter, which only offset the weather-related contraction of 0.5% q/q in the fourth quarter of 2010. The Office for National Statistics has indicated that special factors could have knocked off up to 0.5 percentage point from second-quarter growth—including the extra public holiday resulting from the royal wedding, manufacturing supply-chain disruptions resulting from the Japanese tsunami earlier this year, maintenance work in the North Sea hitting oil and gas extraction, Olympic ticket sales (that took up people’s spending money but will not be credited to growth until the third quarter of 2012), and warm weather in April and May reducing utilities output.

Even allowing for this, the current indications are that the economy has barely grown since the third quarter of 2010 and latest data and survey evidence point to ongoing serious weakness. Consequently, any technical bounce-back in growth in the third quarter is likely to have been countered by a clear softening in the economy’s underlying performance. The recent stream of weak economic data and survey means it is increasingly questionable whether the economy was able to grow any faster in the third quarter. We have penciled in growth of 0.3% q/q but are increasingly concerned this will prove to be too optimistic. We currently project GDP growth of just 0.1% q/q in the fourth quarter. This would result in overall GDP growth of 0.9% in 2011 (although this forecast will obviously be affected if the revised GDP data show major changes in the past growth profile).

The economy will continue to face serious headwinds in 2012, particularly ongoing tight fiscal policy and likely limited global growth. We think a Greek default is likely to happen in the early months of 2012, which would have significant negative implications for UK growth prospects. On a positive note, moderating inflation should gradually alleviate the squeeze on consumers. In addition, the Olympics is seen providing a modest boost to the economy in the summer.

Given this backdrop, we are likely to trim our 2012 GDP projection to 1.2% in our forthcoming October forecast round.

Manufacturing PMI for September

The manufacturing purchasing managers' index (PMI; Monday) is expected to show that the sector saw further modest overall contraction for a third month running in September. Specifically, we forecast the PMI to have edged back further to a 27-month low of 48.7 in September after falling to 49.0 in August from 49.4 in July and 51.3 in June. This would take the index modestly further below the critical 50.0 level that indicates unchanged activity. In contrast, the manufacturing PMI had been as high as 61.3 in January.

The Confederation of British Industry (CBI) has already released its industrial trends survey for September, which was markedly weaker across the board. While the survey did at least indicate that manufacturers still expect to increase output over the next quarter, markedly slowing domestic and export orders and a sharp rise in stock levels suggest production will come under increasing pressure.

Manufacturers are plainly now finding life much more difficult as domestic demand is withheld by serious headwinds, notably including tightening fiscal policy and the serious squeeze on consumers’ purchasing power, while weaker global growth is hitting export orders hard. Meanwhile, although they have come off their highs, elevated input costs have been an extended problem for manufacturers.

Construction Purchasing Managers' Survey for September

We forecast the construction PMI (Tuesday) to have weakened to a nine-month low of 50.7 in September, from 52.6 in August and 54.0 in June. Given that a reading of 50.0 indicates unchanged expansion, this would point to only marginal expansion.

The August construction purchasing managers’ survey showed output growth slowing, incoming new business at a seven-month low, employment in the sector contracting at an increased rate, squeezed margins, and business expectations deteriorating. Furthermore, data from the Office of National Statistics showed new construction orders down 16.3% q/q and 23.2% y/y in the second quarter, which bodes ill for output prospects in the near term at least.

It is evident the construction sector faces an extremely challenging environment, which threatens to weigh down appreciably on activity over the coming months. In particular, the government's extended pruning of public spending will clearly limit expenditure on public buildings, schools, hospitals, and infrastructure (even though the government is keen to prioritize some infrastructure projects). On top of this, house-building activity is likely to be limited by persistently weak housing market activity, soft prices, and a worrisome outlook. If the economy continues to struggle over the coming months, there is the danger commercial construction activity will be increasingly hit by projects being put on hold or even cancelled.

It has been rumored the government is looking at investing an extra GBP5 billion on capital projects, which could provide a boost to some construction sectors. For now at least though, government ministers will only say that they are sticking to their spending plans.

Service Sector Purchasing Managers Survey for September

The business activity index of the service sector purchasing managers' survey (Wednesday) is expected to indicate that the sector lost further momentum in September and saw very limited expansion. Specifically, we forecast the business activity index to have retreated to a 2011-low of 50.7 in September from 51.1 in August and 55.4 in July, This would be only just above the critical 50.0 level that indicates unchanged activity. The August survey not only revealed a marked slowdown in business activity but showed new business at a six-month low, backlogs of work contracting and business expectations at a 13-month low.

A reading of 50.7 would mean that the services sector business activity index only averaged 52.4 in the third quarter. This would be down from 54.0 in the second quarter; and, given the dominant role of the services sector, would fuel concern that the economy achieved only marginal growth in the third quarter.

There are indications that activity in professional, business and financial services is being limited by more difficult conditions in the private sector as well as the cutbacks in government spending. Meanwhile, consumer-facing services companies are being hit by the serious squeeze on consumer’s purchasing power and their need/desire to limit their discretionary spending.

Producer Prices in September

Producer price data (Friday) are forecast to show that output prices rose by 0.1% month-on-month in September, as they did in August. This is down markedly from the increases seen in the early months of the year. Even so, this would still see the year-on-year increase in output prices edge up to a 35-month high of 6.2% in September from 6.1% in August, reflecting the fact that producer prices were flat month-on-month in September 2010. Core output prices are also forecast to have risen by just 0.1% month-on-month in September after an increase of 0.2% in August which would see the year-on-year increase edge up to 3.7% from 3.6%

Meanwhile, the consensus forecast is for producer input prices to have climbed by 0.7% month-on-month in September, after a drop of 1.9% in August, primarily due to higher oil prices earlier in the month. This would see the year-on-year increase move back up to 16.8% in September after moderating to 16.2% in August and 18.3% in July.

Although the headline year-on-year rate of producer price inflation could well edge up further to a near three-year high of 6.2% in September, latest survey evidence suggests overall that the recent marked slowdown in manufacturing activity is causing manufacturers to become more circumspect in raising their prices. And an easing back in oil and commodity prices from their peak levels earlier this year has reduced the pressure on manufacturers to raise their prices to protect their margins although input prices are still elevated.

Halifax House Price Index for September

The Halifax lender is expected to report during the week that house prices fell by 0.2% month-on-month in September after dropping 1.2% in August. This would result in house prices being down by 2.1% year-on-year in the three months to September (the Halifax prefers to highlight the three-month year-on-year house price rate to smooth out erratic movements). The Nationwide has already reported that house prices edged up 0.1% month-on-month in September after falling 0.6% in August. House prices were down 0.3% year-on-year in September on the Nationwide measure.

While housing market activity has edged up from its lows recently, there remains little sign of any real step up. Indeed, housing market activity remains weak compared to long-term norms and we suspect that house prices will fall by around 5% overall from current levels by mid-2012 as persistently weak economic fundamentals outweigh extended low interest rates. And current heightened concerns over the domestic and global economies, and turmoil in financial markets, are unlikely to do much for consumer confidence and willingness to commit to buying a house in the near term!

Specifically, we suspect that consumers’ squeezed purchasing power, tightening fiscal policy, a softening labor market and worries over the economic outlook will limit potential buyers and weigh down on house prices. On top of that, there still seem to be significant difficulties in getting a mortgage for many people, notably including the need to raise high deposits (particularly for first time buyers). And there is significant concern that banks’ future ability to lend to home buyers could be hit by difficult wholesale funding conditions

These factors are seen outweighing the support to house prices coming from extended very low interest rates. In fact, it currently looks highly likely that the Bank of England will hold off from raising interest rates until 2013.


3 Oct - Manufacturing Purchasing Managers Index, September: 48.74 Oct - Construction Purchasing Managers Index, September: 51.25 Oct - Service Sector Purchasing Managers Index, September : 50.75 Oct - GDP, Second Quarter 2011 (Quarter-on-Quarter): +0.2%5 Oct - GDP, Second Quarter 2011 (Year-on-Year): +0.7%7 Oct - Producer Price Input Inflation, September (Month-on-Month): not forecast7 Oct - Producer Price Input Inflation, September (Year-on-Year): not forecast7 Oct - Producer Price Output Inflation, September (Month-on-Month): +0.1%7 Oct - Producer Price Output Inflation, September (Year-on-Year): +6.2%7 Oct - Core Producer Price Output Inflation (ex Food, Tobacco etc.) September (Month-on-Month): +0.1%7 Oct - Core Producer Price Output Inflation (ex Food, Tobacco etc.) September (Month-on-Month): +3.7%During Week - Halifax House Prices, September (Month-on-Month): -0.2%

During Week - Halifax House Prices, September (Year-on-Year): -2.1%

Global Insight (Reino Unido)

 


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