Bank of England policy meeting features in UK economic week commencing 4 February
Despite the renewed contraction in GDP in the fourth quarter of 2012, the Bank of England’s Monetary Policy Committee is expected to hold off from providing any more stimuli for the economy. Meanwhile, the January British Retail Consortium survey and the purchasing managers’ surveys for the services and construction sectors will offer important insights as to just how great of a hit the economy took from the snow and ice.
Renewed GDP drop in Q4 2012 unlikely to trigger Bank of England action
It looks highly unlikely that the renewed 0.3% quarter-on-quarter drop in GDP in the fourth quarter of 2012 will prompt the Bank of England into further stimulative action at the conclusion of the February meeting of its Monetary Policy Committee (MPC) on Thursday.
The Bank of England will not have been shocked by the fourth-quarter GDP drop, even if it will have hardly been happy with it. The MPC will most likely see the fourth-quarter GDP drop as a continuation of the zigzag pattern that characterized 2012, as a number of distorting factors were present. In particular, GDP was clearly held back in the quarter by a sharp drop in oil and gas production due to maintenance work in the North Sea as well as by some payback from the Olympics’ boost to activity in the second quarter.
Most MPC members are likely to remain opposed to further quantitative easing (QE), at least for now, because of a combination of factors. These factors notably include currently heightened inflation concerns; belief that the downside risks to the economy have been diluted by an improving global environment, including reduced tensions in the Eurozone; and hopeful signs that the Funding for Lending Scheme is poised to increasingly feed through to boost lending to businesses and for house purchases. There is also suspicion within the MPC that further QE will be effective in lifting nominal demand, at least for now.
With economic activity likely to remain fragile and limited, we believe there is still a very real possibility that the Bank of England will ultimately decide to give the economy a further helping hand with another £50 billion of QE, most likely during the second quarter. A desire to see sterling soften further and help export prospects could be a factor eventually supporting more QE.
Meanwhile, the Bank of England will likely retain the view that taking the bank rate any lower than 0.50% could damage bank margins and lending ability, and is unlikely to have net overall beneficial impacts for the economy. We expect interest rates to remain at 0.50% through 2013, and this rate is highly likely through 2014 as well.
The Bank of England’s failure to extend QE since November means that the program was brought to a halt given that July’s £50-billion extension (which took the stock up to £375 billion) was fully utilized by early-November. Meanwhile, interest rates are on the brink of completing a fourth year at 0.50%, having originally been taken down to this level in March 2009.
The minutes of the January MPC meeting point to the committee remaining firmly in wait-and-see mode. Indeed, the indications are that the MPC may well stay on the sidelines for some time to come, barring a marked downturn in economic activity.
Reinforcing belief that further QE is unlikely in the near term at least, David Miles was the once again only one of the nine MPC members who favored more action in January. Furthermore, not only is there little indication from the minutes that any other MPC member is leaning towards more QE at this stage, but the minutes do report that the latest developments “had strengthened the belief of some [of these] members that no further asset purchases were required at the current juncture.”
While the MPC believes that there are ongoing substantial headwinds to recovery and is unsure of the underlying state of the UK economy, it is encouraged by some improved international developments and the strengthening in financial markets. In particular, the United States’ avoidance of the fiscal cliff and the reduced Eurozone sovereign debt tensions are seen helping matters. In addition, the MPC believes that the Funding for Lending Scheme is showing encouraging, early stages of development, with lower bank funding costs beginning to be passed through to lower loan rates.
The 0.3% quarter-on-quarter drop in GDP in the fourth quarter of 2012 is unlikely to have fundamentally changed the MPC’s views, as it had suspected that there could be a modest decline due to some dampening effect from the unwinding of the Olympics’ boost to the economy in the third quarter. The MPC will also note that the sharp drop in oil and gas output due to repair and maintenance work in the North Sea contributed 0.2 percentage point to the fourth-quarter 2012 contraction.
Meanwhile, there is ongoing concern within the MPC over the inflation situation. Some of the factors pushing inflation back up to 2.7% are seen persisting through 2013 and beyond, notably a number of administered and regulated prices (energy tariffs; rail fares; university tuition fees). Consequently, consumer price inflation is seen staying above its 2.0% target through the year, and there is concern within the MPC that the prospect of continued above-target inflation could undermine credibility in the Bank of England’s ability to control inflation, thereby adversely impacting on wage and price setting. There is also uncertainty within the MPC over how much productivity will pick up as the economy improves and limits inflationary pressures.
Finally, there are doubts within the MPC about how effectively more QE would boost nominal demand and real output at this stage, even if it may well bring down yields on government and corporate debt, and support other asset prices.
There was no reported discussion of the case for taking interest rates lower than 0.50% in the January minutes, which maintains belief that this move remains off the radar for the time being at least. The MPC had revisited the case for lower interest rates at their November meeting but concluded that there was a danger that a cut in the bank rate could prove counterproductive for overall aggregate demand, and it notably concluded that “it was unlikely to wish to reduce Bank Rate in the foreseeable future.”
With economic recovery likely to remain fragile and limited, we believe there is still a very real possibility that the Bank of England will ultimately decide to give the economy a further helping hand with another £50 billion of QE sometime during the first half of 2013.
However, unless the news on the economy is really dire over the coming weeks, we suspect that the MPC will prefer to hold fire until at least the second quarter, given that consumer price inflation could well hit 3% because of higher utility charges and higher food prices. The MPC will likely want to make sure that there are no signs that underlying price pressures are picking up given the move back up in the headline consumer price inflation rate. The MPC may also feel that the signs that the Funding for Lending Scheme may be starting to have an increasing impact mean that there is no need for further stimulus for the time being.
Meanwhile, we expect interest rates to remain at 0.50% through 2013 and most likely through 2014 as well. The Bank of England certainly isn't going to raise interest rates anytime soon given the economy's extended weakness and limited recovery prospects. However, we very much doubt that the Bank of England will take interest rates below 0.50% given ongoing doubts within the MPC that such a move would have a net overall beneficial impact for the economy.
Of course, it remains to be seen what type of animal the Bank of England will be under Mark Carney, who takes over as Governor at the start of July. The indications are that if the economy is still struggling for growth then, which seems more likely than not, Mr. Carney could be very active in pushing for further stimulative action by the Bank of England as well as in considering different options. Mr. Carney is floating some interesting ideas ahead of his arrival at the start of July, although it must be remembered that he will have only one vote among nine on the MPC. It is also one thing to float ideas, but another matter completely to adopt any of them.
Major economic releases
Construction purchasing managers’ survey for January
The purchasing managers’ survey (out Monday) is likely to point to increased contraction in construction activity in January, since the snow added to the sector’s already appreciable problems. Specifically, we expect the purchasing managers’ business activity index to have fallen back to a 37-month low of 48.0 in January from 48.7 in December, 49.3 in November, and 50.9 in October. This would take the index further below the critical 50.0 level that is meant to indicate unchanged activity. In addition to the likely hit to construction activity coming from January’s snow, it is very worrying that incoming new orders had contracted in December for a seventh month running—and at the fastest rate since April 2009.
While the latest national accounts data estimate that construction output edged up by 0.3% quarter-on-quarter in the fourth quarter of 2012, this marked ongoing poor performance given that output had previously contracted by 2.5% quarter-on-quarter in the third quarter, 2.8% quarter-on-quarter in the second quarter, and 6.4% quarter-on-quarter in the first quarter. Consequently, construction output was down 11.0% year-on-year in the fourth quarter. It also contracted by 9.3% overall in 2012.
The key concern going forward is whether the construction sector will see any significant improvement in its fortunes in 2013. It certainly continues to face major headwinds, including limited public investment and spending, an extended weak economy, a still-struggling housing sector, and problems in getting funding for large-scale projects.
The construction sector will be fervently hoping that both the economy and the housing market see some improvement, even if only limited, in 2013, and that this improvement stimulates building work. The sector will also be hoping desperately that the government comes up with more support and initiatives to lift activity on top of the limited boost to capital spending and infrastructure projects provided in the autumn statement last December.
Service sector purchasing managers’ survey for January
We forecast the business activity index of the service sector purchasing managers' survey (out Tuesday) to essentially point to stagnation in January after activity seemingly contracted modestly in December for the first time in two years. The bad weather is likely to have had some dampening impact on services’ activity in January. Specifically, we expect the business activity index to have improved modestly to 50.2 in January after falling to a 44-month low of 48.9 in December, from 50.2 in November and a 5-month high of 53.7 in August. This modestly improved level would take the index fractionally back above the 50.0 level that indicates flat activity. However, it is worrying that not only did the December purchasing managers’ survey show services activity contracting modestly for the first time in two years, but also showed incoming new business contracting moderately for a second month running.
The Office for National Statistics estimated that services output was flat quarter-on-quarter in the fourth quarter of 2012, when GDP contracted by 0.3% quarter-on-quarter. Meanwhile, the Bank of England’s regional agents states in their January report (which relates to activity in December) that “professional, financial, and other business services firms’ turnover had continued to grow slowly.” The agents also report that “growth in demand for consumer services remained very modest.”
The worry is that service companies will have their work cut out to achieve anything more than modest growth in the near term at least, because of the still uncertain business outlook and tightening government spending. In addition, there are still significant pressures on consumers; these pressures are likely to limit the upside for consumers’ spending on services for some time to come.
British Retail Consortium’s Retail Sales Monitor for January
The British Retail Consortium (BRC) Retail Sales Monitor (out overnight on Monday/Tuesday) will provide the first tangible evidence of just how much retail sales were hit by January’s snow and ice. The severely bad weather likely resulted in many consumers being unable or unwilling to go to the shops for a time, although it must be kept in mind that some of the lost retail sales will be made up. This recovery will depend critically on the extent consumers just delayed purchases rather than canceled them altogether. Increased internet sales will also have compensated for some of the hit soccer felt from the bad weather.
Evidence already released by the Confederation of British Industry (CBI) indicates that retail sales were reasonable but hardly buoyant in January before the bad weather hit. (The survey was completed prior to the arrival of the bad weather). Specifically, the CBI survey showed that the balance of retailers reporting that sales were up year-on-year fell back to +17% in January from +19% in December. It was also down from the November (+33%) and October (+30%) balances. Nevertheless, the January reading was above the average 2012 balance of +11%. It was exactly in line with the survey’s long-term balance of +17%.
The CBI survey suggests that consumer spending got off to a positive but muted start to 2013 after disappointing in December and through the fourth quarter of 2013. Specifically, retail sales volumes fell 0.1% month-on-month in the key month of December, having been flat in November and dropping 0.9% month-on-month in October. This means that retail sales volumes contracted 0.6% quarter-on-quarter in the fourth quarter of 2012.
The problem that retailers - and the economy in general - face is that consumers’ purchasing power has come under some renewed pressure after seeing appreciable improvement over the first three quarters of 2012. Inflation moved back up in late 2012 while earnings growth faltered. It must also be remembered that many households have faced an extended squeeze on their finances, so are still in a vulnerable position even if they generally saw improvement over the first three quarters of 2012. At least though, employment rose to a new record high in the three months to November.
Consumers benefited from consumer price inflation falling from 5.2% in September 2011 to a low of 2.2% in September 2012 as well as an edging up in earnings growth through to August from the lows seen earlier in 2012. In addition, employment growth was particularly robust through the summer, helped by the Olympics. Indeed, latest data show that households’ real disposable income rose by a further 0.4% quarter-on-quarter in the third quarter of 2012, after jumping 2.3% in the second quarter. This means that it was up 2.8% year-on-year in the third quarter. In contrast, households’ real disposable income fell 1.0% overall in 2011.
However, consumer price inflation rose back up to 2.7% in October–December, while year-on-year growth in earnings growth fell back to 1.3% in both November and October from 2.3% in August. It had previously trended up to 2.3% in August from under 1.0% in the first quarter of 2012. Still, latest data show that employment rose by 90,000 in the 3 months to November, to stand at a record 29.7 million.
Trade deficit in December
The total trade deficit (out on Thursday) is expected to have narrowed to £3.1 billion in December from £3.5 billion in November and £3.7 billion in October. Even so, this would still be in line with the average monthly shortfall of £3.1 billion over the first 11 months of 2012 and substantially above the average monthly deficit of £2.0 billion in 2011. It would also mean that the total trade deficit widened to £10.3 billion in the fourth quarter of 2012 from £8.3 billion in the third quarter.
Within this, the visible trade deficit is forecast to have narrowed to £8.8 billion in December from £9.2 billion in November and £9.5 billion in October. This would be broadly in line with the average monthly deficit of £8.9 billion over the first 11 months of 2012 but markedly above the £8.3 billion monthly average in 2011.
Exports of goods and services grew by 1.7% month-on-month in November, although they were still down by 1.0% on a 3-month-on-3-month basis. Exports were lifted in November by an 8.9% jump in exports of traded goods to EU countries, with sales to Germany seeing a marked rise. Even so, exports of traded goods to EU countries were still down by 5.9% year-on-year in the 3 months to November, highlighting their underlying softness. Meanwhile, imports rose by 1.0% month-on-month in November but were down by 0.9% on a 3-month-on-3-month basis, pointing to muted domestic demand.
While the trade deficit narrowed in November, the improvement was relatively limited, and it looks likely that net trade was negative in the fourth quarter of 2012 and contributed to the 0.3% quarter-on-quarter drop in GDP. Net trade had made a rare positive contribution to GDP in the third quarter following markedly negative contributions in both the second and first quarters.
While it is still hard to be optimistic that net trade can help the UK economy much in the near term given weakened domestic demand in the Eurozone and still moderate global growth, there have been some recent helpful developments. Eurozone economic activity seems to have bottomed out around last October and sovereign debt tensions have eased appreciably, although growth prospects for 2013 still appear limited. In addition, the recent marked retreat of the pound should boost the competitiveness of UK exporters and could also help UK companies gain market share from importers in the domestic market.
Industrial production in December
We expect manufacturing output (out on Thursday) to have expanded 0.4% month-on-month in December after falls of 0.3% month-on-month in November and 1.3% month-on-month in October. This would still leave manufacturing output down by 2.7% year-on-year in December. Survey evidence from the CBI and, particularly, the purchasing managers showed improved manufacturing activity in December.
Overall industrial production is seen expanding 0.7% month-on-month in December, having grown just 0.2% month-on-month in November after very sharp drops of 0.9% month-on-month in October and 2.1% month-on-month in September. This would still result in industrial production being down by 2.2% year-on-year in December. In addition to the modest rise in manufacturing output in November, we expect industrial production to have been lifted by a further increase in oil and gas output as it continued to recover after being hit very hard in October and September by extended repair and maintenance work on the largest North Sea oil field.
Latest survey evidence from the CBI and the purchasing managers suggest overall that manufacturing activity has picked up a little recently.
The overall impression is that the manufacturing sector may be past the worst after a pretty difficult 2012, but it still has its work cut out to return to sustainable growth in the face of ongoing, challenging domestic and international conditions. Domestic demand for manufactured goods is handicapped by current muted investment intentions and tightening public spending. Furthermore, consumers’ purchasing power is coming under renewed pressure from a move back up in inflation and muted earnings growth. On top of this, a still uncertain and difficult economic environment risks some orders being delayed or even canceled. Meanwhile, muted global economic growth—Eurozone economic weakness in particular—is currently still a constraint for foreign demand for UK manufactured goods.
However, signs that Eurozone activity may have bottomed out around October and the recent appreciable easing of the region’s sovereign debt tensions do offer some hope for UK manufacturing exporters. In addition, the sterling’s recent sharp retreat, particularly against the euro, will be largely welcomed by UK manufacturers, since it should boost their competitiveness. The pound traded in late-January at a near 14-month low against the euro, a 5-month low against the US dollar and an 11-month low on a trade-weighted basis.
House prices in January
We expect house price data to be released during the week by the lender Halifax to show that prices rose by 0.3% month-on-month in January. This would cause house prices to be up by 1.9% year-on-year in the 3 months to January. Latest data from Halifax show that house prices rose by 1.3% month-on-month in December after a jump of 1.6% in November. This contrasts with the four months of decline between July and October. Consequently, house prices rose by 0.6% quarter-on-quarter in the fourth quarter of 2012, which followed drops of 0.4% quarter-on-quarter in both the third and second quarters, and a decline of 0.1% quarter-on-quarter in the first quarter.
Nationwide has released its house price index for January, which shows prices rising by 0.5% month-on-month but still flat year-on-year. Nationwide had previously reported that house prices edged down 0.1% month-on-month in December, having been flat in November.
The recent marked divergence in the month-on-month change in house prices reported by Nationwide and Halifax highlights the fact that house prices can vary markedly from month to month and between surveys. Consequently, it is best to try to take an overall view of all the data and surveys when trying to gauge the true state of the housing market.
Recent signs of moderately improving housing market activity and the modest firming of prices in January reported by Nationwide suggest that there is a growing prospect that 2013 could be a slightly better year for the housing market.
For the time being, we are retaining the view that house prices will be essentially flat over the 2013—particularly given the current uncertain and limited economic outlook. However, we acknowledge that the risks to our forecast—that house prices will be flat overall in 2013—may be starting to move to the upside from the downside.
On the negative side, house prices are likely to be held down by still relatively limited market activity (despite the recent modest pick-up), relatively low and fragile consumer confidence, and muted earnings growth. While we believe that the economy will pick up gradually as 2013 progresses, we doubt that growth will be fast enough for some time to come to provide significant support to the housing market.
However, some support for house prices should come from recent decent employment growth and likely extended low interest rates, while mortgages appear to be increasingly available and a little cheaper, helped by the FLS that was launched last August by the Bank of England. The latest Bank of England credit conditions survey indicates that there was a significant increase in the amount of credit made available by lenders for mortgage lending in the fourth quarter of 2012, and that a further appreciable increase is anticipated in the first quarter of 2013. A number of lenders have also been cutting some of their fixed mortgage rates, although mortgage conditions currently remain challenging for many people who are unable to raise large deposits. The Council of Mortgage Lenders and the Royal Institution of Chartered Surveyors both believe that the Funding for Lending Scheme has had a positive impact on the mortgage market, as does Nationwide.
Although mortgage interest payments as a percentage of disposable income are currently very low, other affordability measures are not so favorable, with the house price/earnings ratio above its long-term average. Specifically, data from Halifax show that the ratio of house prices to earnings was 4.52% in December. This is up from a low of 4.39% in September/October and above the 1983–2012 average of 4.06%.
By Howard Archer
4 Feb - Construction Purchasing Managers’ Index, January: 48.0
5 Feb - British Retail Consortium Monitor Total Sales, January (Year-on-Year): not forecast
5 Feb - British Retail Consortium Monitor Like-for-Like Sales, January (Year-on-Year): not forecast
5 Feb - Service Sector Purchasing Managers’ Index, January: 50.2
7 Feb - Non-EU Visible Trade Balance, December (GBP/Month): -4.2
7 Feb - Visible Trade Balance, December (GBP/Month): -8.8
7 Feb - Total Trade Balance, December (GBP/Month): -3.1
7 Feb - Industrial Production, December (Month-on-Month): +0.7%
7 Feb - Industrial Production, December (Year-on-Year): -2.2%
7 Feb - Manufacturing Output, December (Month-on-Month): +0.4%
7 Feb - Manufacturing Output, December (Year-on-Year): -2.7%
During Week - Halifax House Prices, January (Month-on-Month): +0.3%
During Week - Halifax House Prices, January (Year-on-Year): 1.9%
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