Inflation, Retail Sales, and Public Finances among Major UK Economic Releases for the Week Beginning 19 March

Consumer Price Inflation in February

Data out on Tuesday are expected to show that consumer price inflation fell back further to a 15-month low of 3.3% in February, from 3.6% in January, 4.2% in December, and a three-year high of 5.2% in September 2011.

Inflation is expected to have fallen further in February due to favourable base effects reflecting the fact that in February 2011 a number of retailers and companies were still passing on the VAT hike from 17.5% to 20.0% that was enacted at the start of 2011. It is also evident that many retailers are still engaging in significant discounting and promotions to try to get pressurized and worried consumers to part with their cash. Meanwhile, a number of utility providers trimmed their energy tariffs in February; however, February’s dip in inflation is likely to have been limited by higher petrol prices.

Supporting hopes that consumer price inflation dipped further in February, the shop price deflator produced by the British Retail Consortium indicated that overall annual shop price inflation retreated to a 23-month low of 1.2% in February from 1.4% in January. Non-food prices fell 0.7% year-on-year in February, which was the first such deflation since November 2009. This was down from 0.0% in January. The BRC reported that clothing, furniture, and electricals all saw prices lower in February than a year earlier; however, annual food price inflation rose back up to 4.2% in February after dipping to an 18-month low of 3.7% in January from 4.2% in December. The BRC indicated this was influenced by higher transport costs resulting from the recent rise in petrol prices. The BRC also pointed out that the money off total bill vouchers that are being offered by some supermarkets are not reflected in shelf prices.

While inflation should fall back further over the coming months, the very real danger is that it will prove stickier than had been hoped for due to current high oil prices. It had seemed very possible that consumer price inflation would be down to the Bank of England’s target level of 2.0% by the end of 2012 due to the waning impact of sharply rising oil, commodity and food prices in late 2010/early 2011, and by underlying price pressures being diluted by weak economic activity and elevated unemployment. However, this is looking increasingly questionable given current oil prices and the possibility they could go higher still.

If consumer price inflation does prove to be sticky over the coming months, this will have worrying implications for UK growth prospects. Sticky consumer price inflation would maintain an appreciable squeeze on consumers’ purchasing power and dilute hopes that consumers will increasingly step up their spending as 2012 progresses. Sticky inflation would also make it harder for the Bank of England to justify undertaking more Quantitative Easing to support activity if the economy continues to struggle.

CBI Industrial Trends Survey for March

We expect the Confederation of British Industry (CBI) industrial trends survey for March (out Tuesday) to indicate that manufacturing activity is on course for expansion in the first quarter of 2012, after contracting sharply in the fourth quarter of 2012, but it is still far from racing ahead.

Specifically, we forecast the balance of manufacturers reporting that their orders are at normal levels to have fallen back to -6% in March, after climbing to a six-month high of -3% in February from -16% in January and a 14-month low of -23% in December. The balance had deteriorated to December’s low from +1% in August 2011. This compares to a long-term average of -18% for the balance.

We also expect the March CBI survey to reveal that manufacturers generally expect to raise their production over the next three months. Latest hard data show that manufacturing output edged up 0.1% month-on-month in January after jumping 1.1% in December. Manufacturing output had previously fallen or been only flat for the six months prior to December.

Although manufacturing activity has improved after a largely torrid second half of 2011, it still faces a very challenging environment and a battle to develop sustained, decent growth. Domestic demand for manufactured goods continues to be handicapped by an appreciable squeeze on consumers’ purchasing power, as well as by tighter public spending. Meanwhile, muted economic activity in the Eurozone is limiting export orders, although this is being countered by recently improved demand from Asia and the United States. In addition, a current spike up in input costs is bad news for manufacturers, as it squeezing their margins and, if sustained, will put pressure on them to raise prices at a time when demand is still fragile.

Public Finances in February

The public finances data for February (out Wednesday) are expected to show modest improvement compared to a year earlier.

Specifically, we forecast there to have been Public Sector Net Borrowing Requirement (PSNBR) excluding financial interventions of GBP7.5 billion in February, down from GBP8.8 billion in February 2011.

A modest year-on-year improvement in public finances is expected in February as a result of the fiscal measures that increasingly kicked in over the past year. In particular, spending cuts should now be having more of an impact on public finance figures. Conversely, recent weakened economic activity is likely to have limited the improvement, while tax revenues were already being lifted in February 2011 by the VAT rate being increased from 17.5% to 20.0%.

Overall, the PSNBR excluding financial interventions amounted to GBP3.5 billion in the first 10 months of fiscal 2011/12, which was well down from GBP109.1 billion in the corresponding period in 2010/11. If the overall performance of the first 10 months was replicated through the rest of the fiscal year, the PSNBR would come in at GBP116.4 billion in 2011/12, which is appreciably below the latest government forecast of GBP127 billion.

With the economy currently showing signs of improvement and public finances undershooting over the first 10 months of fiscal 2011/12, the chancellor looks like he will comfortably beat his current target of cutting the PSNBR excluding financial interventions to GBP127 billion in 2011/12. It is vitally important for Mr. Osborne that the economy return to growth in the first quarter of 2012 and then build on this if he is to succeed in keeping the PSNBR to GBP120 billion in 2012/13.

Meanwhile, with Fitch in mid-March becoming the second credit rating agency to put the UK’s prized AAA credit rating on negative outlook, the chancellor is highly unlikely to significantly change the overall fiscal stance in his budget on 21 March. The chancellor has been giving every indication he will stick firmly to his fiscal consolidation plans, and Fitch’s move reinforces the belief that he will be true to his word. Indeed, the Treasury already commented that “this is a reminder of why it is essential Britain sticks to its plans to deal with its debts."

Minutes of March Bank of England MPC Meeting

Wednesday sees the release of the minutes of the March meeting of the Bank of England's Monetary Policy Committee (MPC), when the committee made no further changes to policy after deciding to extend Quantitative Easing (QE) by a further GBP50 billion at their February meeting. This takes the stock of QE up to GBP325 billion. Meanwhile, the decision to keep interest rates unchanged in March meant they have completed three years at a record-low level of 0.50%.

There was never going to be any other outcome than unchanged monetary policy at the March meeting of the MPC. Indeed, it will be a major surprise if the Bank of England takes any policy action over the next couple of months at least. With February’s GBP50-billion extension to Quantitative Easing due to take through early May to enact, the Bank of England is now firmly in wait-and-see mode while the MPC monitors whether the UK is returning to sustainable growth and whether consumer price inflation is coming down in line with expectations or is proving stickier than anticipated.

There are signs of an increasing divergence of opinion within the MPC over just how quickly and how far consumer price inflation will come down and whether the economy will need any further help in the form of more QE. Some MPC members are clearly worried about the upside risks to inflation coming from possible higher input costs (especially given oil’s current strength) and extended low productivity. The more dovish MPC members are concerned over the possibility of extended weak demand in a still-difficult domestic and international environment. The pressures on consumers, tighter credit conditions, extended tight fiscal policy, and the problems in the Eurozone remain serious growth risks. The minutes of the March MPC meeting will provide insight into how the balance of opinion is moving within the committee over the relative upside and downside risks to the growth and consumer price inflation outlooks.

We currently believe that limited additional QE is more likely than not. We anticipate that economic developments will warrant further limited stimulative action despite recent signs of improvement. While we expect the economy will return to growth in the first quarter and avoid recession, we suspect that activity will be erratic and muted overall through the first half of 2012 at least, and then only pick up gradually in the second half. Meanwhile, we think consumer price inflation will trend down appreciably further over the coming months, although clearly inflation may prove stickier than hoped for due to the strength of oil prices. Even if this is the case, underlying inflationary pressures still seem likely to be limited by extended below-trend economic activity, significant excess capacity, and ongoing wage moderation resulting from high and, likely, rising unemployment.

We lean towards the view that the Bank of England will do GBP25 billion more QE in May, taking the total up to GBP350 billion, although this could be delayed until August.

Meanwhile, we maintain the view that interest rates will not rise until at least late 2013, and could very well stay put at 0.50% until 2014. There is clearly little interest within the Bank of England for taking interest rates lower than 0.50%. Indeed, it is significant that even at the height of the 2008/9 recession the Bank of England did not take interest rates below 0.50%, which reflected doubts within the MPC that even lower interest rates would have a net beneficial impact.

Retail Sales in February

Retail sales volumes (out Friday) are expected to have fallen back modestly in February after showing surprising vigour in January.

Specifically, we see retail sales volumes retreating 0.3% month-on-month in February after rises of 0.9% in January and 0.6% in December. This would see retail sales up 2.6% year-on-year in February.

It is evident that retail sales were lifted in December and January by people looking to have a good Christmas after a tough year, and also taking advantage of promotions in the run up to Christmas and heavy discounting in the clearance sales.

Survey evidence from the British Retail Consortium (BRC) and the Confederation of British Industry (CBI) pointed overall to muted retail sales in February, although sales did not appear to collapse following January’s surprisingly robust performance. In fact, the CBI’s distributive trades survey showed that the balance of retailers reporting that sales were up year-on-year rebounded to -2% in February after relapsing to a 34-month low of -22% in January from a 7-month high of +9% in December (the January reading was at odds with the actual increase of 0.9% month-on-month). Meanwhile, the BRC’s retail sales monitor for February indicated that total retail sales values rose 2.3% year-on-year in February.

The suspicion is that consumers will be careful in their spending over the next few months at least. Despite now falling back, consumer price inflation (3.6% in January) is still running well ahead of annual earnings growth (which actually slowed to 0.7% in January from 1.7% in December), thereby continuing to squeeze purchasing power appreciably, while consumers are also having to contend with high and rising unemployment, elevated debt levels, and an extended fiscal squeeze. Additionally, consumer confidence is still low compared to long-term norms despite recent improvement. Hopefully a further marked retreat in consumer price inflation over the coming months will increasingly ease the squeeze on consumers, although there is an increasing risk that higher oil prices will limit the drop in inflation. Even if consumer price inflation does fall back appreciably, unemployment is likely to rise further, wage growth looks set to remain muted, tight fiscal policy will continue to bite, and debt levels will still be high, so the overall environment will likely remain tough for consumers.

By Howard Archer

20 Mar - Consumer Price Inflation, February (Month-on-Month): +0.5%
20 Mar - Consumer Price Inflation, February (Year-on-Year): +3.3%
20 Mar - Core Consumer Price Inflation (ex Food, Drink, Tobacco), February (Year-on-Year): +2.4%
20 Mar - Retail Price Inflation, February (Month-on-Month): +0.6%
20 Mar - Retail Price Inflation, February (Year-on-Year): +3.5%
20 Mar - Underlying Retail Price Inflation, February (Month-on-Month): +0.6%
20 Mar - Underlying Retail Price Inflation, February (Year-on-Year): +3.6%
20 Mar - CBI Industrial Trends, Total Orders, March: -6
21 Mar - Public Sector Net Borrowing Requirement, February (GBP/Bln): 7.5
21 Mar - Bank of England Monetary Policy Committee interest rate vote split, March (Hike-Unchanged-Cut): 0-9-0
21 Mar - Bank of England Monetary Policy Committee Quantitative Easing vote split, March (More-Unchanged-Reduced): 0-9-0
22 Mar - Retail Sales, February (Month-on-Month): -0.3%
22 Mar - Retail Sales, February (Year-on-Year): +2.6%