Consumer Price Inflation in June

Data Tuesday are expected to show consumer price inflation eased to a 31-month low of 2.7% in June after dipping to 2.8% in May from 3.0% in April and 3.5% in March. This would take inflation down further from last September’s three-year high of 5.2% and a little nearer the Bank of England’s 2.0% target rate. The drop in consumer price inflation in June is likely to be limited by challenging base effects reflecting the fact that inflation dipped appreciably in June 2011 (from 4.5% to 4.2%) as many retailers engaged in earlier-than-usual discounting in the summer sales to try to stimulate sales.

Inflation is expected to have fallen modestly in June, primarily due to lower petrol and food prices. Petrol prices should have fallen overall during June as oil prices retreated appreciably further from their March peak levels. Specifically, Brent oil averaged USD95.1/barrel in June, which was down from USD110.2/barrel in May and USD125.3/barrel in March. Apart from their direct impact on the inflation rate, lower petrol prices also reduce the cost of transporting goods, so that should also have helped to limit inflation. It also is likely that annual food price inflation fell in June. The British Retail Consortium (BRC) has reported the year-on-year increase in its shop price deflator moderated to 1.1% in June from 1.5% in May with the annual increase in food prices falling to a near-two-year low of 3.5% in June from 4.3% in May.

Core consumer price inflation (which excludes energy, food, alcohol, and tobacco prices) is seen stable at 2.2% in June. It edged up to 2.2% in May, after falling sharply to 2.1% in April from 2.5% in March. Core inflation is likely to be handicapped in June by the unfavorable base effects resulting from significant early discounting in June 2011.

Consumer price inflation should head down gradually further over the coming months. Future oil price developments will clearly have a key role to play in just how far and how quickly consumer price inflation retreats. IHS Global Insight expects Brent oil to largely trade around USD95–100/barrel through the second half of 2012.

Crucially, underlying price pressures are expected to be held down over the coming months by appreciable excess capacity, extended muted economic activity, and ongoing wage moderation amid substantial labor market slack.

Consequently, we expect consumer price inflation to be down to around 2.2% by the end of 2012 and to dip below 2.0% in 2013. This should provide much-needed help to the economy by easing the squeeze on consumers’ purchasing power. It would also facilitate further quantitative easing by the Bank of England should the economy fail to improve.

Unemployment in June

Labor market data Wednesday are expected to be somewhat mixed, showing some signs of softening after recent overall resilience. Claimant-count unemployment is forecast to have risen 8,000 in June, after an increase of 8,100 in May. Claimant-count unemployment had earlier dipped 12,800 in April and 5,400 in March (which had been the first declines since October 2010). A rise of 8,000 in June would take claimant-count unemployment up to 1.6073 million after it retreated to 1.5912 million in April from a 27-month high of 1.6094 million in February. The claimant-count unemployment rate is seen stable at 4.9% in June, where it has been since September 2011.

The number of jobless on the International Labour Organization (ILO) measure is seen falling by 45,000 in the three months to May to stand at 2.605 million. This would be modestly less than the 51,000 drop seen in the three months to April. The number of jobless on the ILO measure is down from a 17-year high of 2.685 million in the three months to November 2011. Theunemployment rate on the ILO measure is seen stable at 8.2% in the three months to May, which is down from a peak rate of 8.4% in late 2011/early 2012.

Unemployment has been limited in recent months by an increase in people working part time, more people becoming self-employed, and restrained earnings growth.

ILO data are also likely to show employment rose around 128,000 in the three months to May to 29.300 million. This would be down on growth of 166,000 in the three months to April, which took the number of employed up to 29.281 million. This was the highest employment level since the start of 2009, and up from a low of 29.069 million in the three months to September 2011. In the three months to May, there was a rise of 82,000 in full-time workers to 21.32 million, while part-time workers were up by 83,000 to 7.97 million. It is notable, though, that the number of employees working full-time was only up by 27,000 to 18.246 million in the three months to May, while the number of self-employed working either full-time or part-time was up 84,000 to 9.658 million.

The big question is can the labor market remain resilient given the economy’s ongoing weakness and the current very worrying and uncertain outlook? The rise in claimant-count unemployment in May could be a sign that this resilience is starting to wane

We suspect that unemployment is headed higher over the coming months as a consequence of extended soft economic activity, heightened business caution, and public-sector jobs being pared substantially. Unless the economy starts showing sustained decent improvement, pressure will increase on firms to release some of the workers they have been holding on to. Reinforcing concern over the labor market outlook, the June survey from the Recruitment and Employment Confederation (REC) and KPMG showed the number of permanent placements fell at its sharpest rate for nearly three years. It also showed that overall vacancies increased at the slowest rate for five months.

We suspect the number of unemployed on the ILO measure will reach 2.82 million in the second quarter of 2013, which would see the unemployment rate reach 8.8%.

Average Earnings in May

Underlying average earnings growth (Wednesday) is expected to have remained muted in May and substantially below past norms. This is the consequence of relatively high unemployment, workers' job insecurity, and a pressing need for many companies to limit their costs in a very challenging environment. Restrained earnings growth has clearly been an important factor helping to limit unemployment levels.

Specifically, underlying average weekly earnings growth (regular pay excluding bonus payments) is seen remaining at 1.8% in the three months to May, having edged up to this level in the three months to April from 1.6% in the three months to March (which was the equal lowest level since mid-2010). Annual average weekly earnings (total pay) growth is expected to have risen to a still very low 1.5% in the three months to May from 1.4% in the three months to April and just 0.9% in the three months to March, which was the lowest level since December 2009. Total earnings were dragged down in the early months of 2012 by lower bonus payments compared with a year earlier as well as muted underlying earnings growth.

These earnings growth rates are substantially below the 4.5% level that is generally considered consistent with the Bank of England's 2.0% consumer price inflation target. They are also still below current consumer price inflation levels (2.8% in May), so consumers’ purchasing power continues to be squeezed, albeit at a reduced rate.

Minutes of July Bank of England MPC Meeting

Wednesday sees the release of the minutes of the July meeting of the Bank of England's Monetary Policy Committee (MPC) when the committee extended its quantitative easing (QE) program by GBP50 billion, which will take the stock up to GBP375 billion, but kept interest rates unchanged at 0.50% where they have been since March 2009.

The MPC had been widely expected to vote for more QE at its July meeting, having brought the program to a temporary halt in May. The MPC had been on the brink of approving more QE at its June meeting with four of the nine committee members (notably including Bank of England Governor Sir Mervyn King) favoring immediate action then and the minutes of the meeting also revealing that some other MPC members believed “further stimulus was likely to become warranted at some point.” With latest economic data and surveys largely grim, the outlook worrying, and recent inflation developments largely benign, it was always likely that most, if not all, MPC members would take the view at their July meeting that more QE is now warranted and justifiable. Meanwhile, the Eurozone situation is still very worrying and a significant risk to the UK outlook, despite some positive developments at the EU leaders’ summit at the end of June and despite the prospects of a near-term Greek exit from the Eurozone being diluted by the result of the general election in mid-June.

It will be interesting to see if the MPC’s decision to go for more QE in July was unanimous. We would not be surprised if a couple of MPC members were not convinced of the case for more QE at this stage, particularly given that the Bank of England and Treasury have not yet started their “funding for lending” scheme. The Bank of England’s chief economist, Spencer Dale, seems a prime candidate for dissenting against more QE in July.

It will also be interesting to see if the MPC considered again the case for lowering interest rates from 0.50%. The IMF has recommended that the Bank of England should trim interest rates, and the MPC discussed the case for lowering them at its June meeting. This was the first time since last September that the minutes had reported that the MPC had considered the case for lower interest rates.

We suspect the MPC staff were unanimous in retaining the view that there is not a compelling case that lower interest rates would have an overall beneficial impact, and would not have any advantages over more QE. The MPC remains concerned that even lower interest rates would hit banks’ profit margins and constrain their ability to lend. There is also concern that the functioning of money markets would become impaired. In addition, the Bank of England doubts that taking interest rates below 0.50% would significantly help many borrowers, although it acknowledges that the number of people with mortgages contractually linked to the Bank rate has increased since early 2009.

We certainly would not rule out further QE in the fourth quarter. Our expectation is that the UK economy will return to modest growth in the third quarter, helped by the staging of the Olympics and the making up of some of the activity that was lost in the second quarter due to the extra day’s public holiday that resulted from the Queen’s Diamond Jubilee celebrations. The reduced squeeze on consumers’ purchasing power coming from lower inflation should also help matters. Nevertheless, the economy is likely to remain fragile and prone to relapses, especially if there is not any sustained marked easing in the Eurozone’s problems. So, it is very possible the Bank of England will decide more support is warranted for the economy, particularly if inflation heads down further.

While we would not rule out a future trimming of interest rates from 0.50% to 0.25%, we believe it is more likely they will stay at 0.50% through to 2014.

Retail Sales in June

Retail sales volumes (Thursday) are expected to have risen by a relatively decent 0.5% month-on-month (m/m) in June, causing them to be up 2.2% year-on-year. Retail sales volumes rose 1.4% m/m in May after a drop of 2.4% m/m in April and an increase of 2.0% m/m in March.

Retail sales are expected to have been buoyed in June by the Queens’s Diamond Jubilee celebrations. This led to consumers buying food and drink for street parties and other events, purchasing souvenirs, and also taking advantage of the extra day’s public holiday to go to the shops. Survey evidence from the Confederation of British Industry (CBI) and, to a lesser extent, the BRC pointed to reasonable retail sales in June. Significantly, though, the BRC indicated sales were clearly strongest at the start of the month when the Jubilee celebrations occurred and warm weather helped lift clothing and footwear sales. Trading was reported to have been “much more challenging” later in the month, with consumers reluctant to make discretionary and big-ticket purchases.

Retailers will be very much hoping the London Olympics will provide a significant lift to their sales over the coming weeks as people buy related merchandise and souvenirs, and purchase extra drink and food to enjoy watching the Games. The Olympic Games may also lead to more people upgrading their televisions. An extended burst of good weather would also go down well with retailers as it would lift demand for summer clothing and outdoor goods.

There are some recent hopeful developments for retailers. The squeeze on consumers’ purchasing power has eased recently with inflation coming down to a 30-month low of 2.8% in May, having been as high as 5.2% last September. Furthermore, the marked drop in petrol prices and an easing in food price inflation may free up a little more spending power of consumers on discretionary purchases. Meanwhile, latest data show employment rose 166,000 in the three months to April, while consumer confidence has edged up overall from a low in April.

Nevertheless, it seems unrealistic to expect any major pickup in consumer spending in the near term at least. Consumer confidence is still very low, while there is currently still a significant squeeze on consumers’ purchasing power as consumer price inflation of 2.8% in May was still nearly a full percentage point above annual earnings growth of 1.9% in April. Furthermore, tighter fiscal policy is also adding to the squeeze on some consumers. Latest data show households’ real disposable income fell 0.9% quarter-on-quarter (q/q) in the first quarter of 2012 and was down 0.1% year-on-year (y/y). Meanwhile, unemployment is still high, with many of the job gains being in part-time or low-paid work, or due to a rise in self-employment. On top there is a need for many consumers to deleverage.

Public Finances in June

Public finances data for June (Wednesday) are expected to have weakened modestly compared with a year earlier.Specifically, we forecast there to have been a Public Sector Net Borrowing Requirement (PSNBR) excluding financial interventions of GBP13.5 billion in June, which would be up from a shortfall of GBP13.1 billion in June 2011. June is the second month of fiscal year 2012/13 when Chancellor George Osborne is aiming to trim the PSNBR to GBP120 billion from the 2011/12 outturn of GBP127.6 billion (this is stripping out the one-off boost to the public finances this year coming from the transfer of GBP28.0 billion of assets from the Royal Mail’s pension funds).

June’s public finances are expected to have been pressurized by the hit to tax revenues coming from weakened economic activity. This is seen outweighing any beneficial impact of more fiscal tightening starting to kick in.

Data for the first two months of fiscal 2012/13 (April–May) were worrying for the chancellor. The PSNBR (excluding financial interventions) climbed to GBP17.9 billion in May from GBP15.2 billion a year earlier. Tax receipts were disappointing overall in May (particularly income tax). Meanwhile, central government current expenditure was up 7.9% y/y in May. Expenditure can fluctuate appreciably from month to month, but this does suggest the government is having trouble imposing its spending cuts. Stripping out the distorting, one-off impact of the transfer of GBP28.0 billion of assets from the Royal Mail’s pension funds in April, the PSNBR excluding financial interventions amounted to GBP28.4 billion in the first two months of fiscal year 2012/13, which was up from GBP24.5 billion in the first two months of 2011/12.