Bank of England Minutes Dominate U.K. Economic Releases for Week Commencing 17 March

We suspect that the March MPC minutes will show that current elevated inflation risks meant that it was too soon for most MPC members to be comfortable about cutting interest rates again despite serious concerns about the growth outlook. Indeed, the minutes are likely to indicate that the MPC will continue to cut interest rates only gradually, as it juggles with the unappetizing combination of slowing growth and significant inflation risks.

We expect the Bank of England to trim interest rates by a further 25 basis points to 5.00% in May. A move in April cannot be ruled out, but it would probably only occur if economic activity data deteriorate markedly over the next two-to-three weeks, credit conditions tighten further, wage growth remains contained, and survey evidence indicates that manufacturers, service sector companies, and retailers are beginning to scale back their pricing plans.

Consumer price inflation (out Tuesday) is forecast to have moved further above the Bank of England's target level of 2.0% in February. We expect consumer price inflation to have climbed to an eight-month high of 2.4% from 2.2% in January, pushed up by rising utility bills and elevated food prices. There is a risk that inflation could have reached 2.5%, with much depending on how quickly and how much retailers raised prices after the post-Christmas sales. It seems highly likely that consumer price inflation will reach 3.0% in the summer, before starting to fall back as softer growth dilutes underlying inflationary pressures. Much will depend on what happens with oil, food, and commodity prices. Meanwhile, underlying retail price inflation is forecast to have risen to 3.6% in February from 3.4% in January, while headline retail price inflation is seen stable at 4.1%. 

The Bank of England will be particularly hoping that average earnings growth (out Wednesday) remained muted in January, given its concern that rising inflation expectations and a currently still-tightening labor market could lead to pay moving up appreciably. The January earnings data are of particular interest to the Bank of England, as they will reflect the first of the 2008 pay settlements. Latest survey evidence generally indicates that pay moderation has continued so far in 2008. We expect underlying average earnings growth (excluding bonus payments) to have only edged up to a still muted 3.8% in the three months to January from 3.7% in the three months to December. Headline average earnings growth is seen modestly higher at 4.0% in the three months to January, pushed up by bonus payments. These levels would both be comfortably below the 4.5% level that the Bank of England considers broadly consistent with its 2.0% inflation target.   

Meanwhile, claimant-count unemployment is expected to have fallen at a reduced rate of 5,000 in February, as slowing growth and weaker business confidence starts to impact. The unemployment rate is seen stable at 2.5% on the claimant count measure in February and at 5.2% on the International Labor Organization measure in January. Unemployment is a lagging indicator and we suspect that slowing growth will take an increasing toll on the labor market as 2008 progresses. Significantly, latest labor hiring surveys are clearly softer. 

Wednesday also sees the release of the CBI industrial trends survey for March. Although latest hard data show that manufacturing output was surprisingly resilient in January, the CBI survey is expected to indicate that the manufacturing sector is gradually losing momentum in the face of slowing domestic demand, tighter lending conditions, and elevated energy and raw material prices. Furthermore, we strongly suspect that recession in the United States and significantly slowing growth in the Eurozone will weigh down markedly on overseas sales, although manufacturers are likely to benefit from an overall weaker pound over the coming months. Specifically, we expect the CBI's survey to show that the balance of manufacturers reporting that their overall orders are at normal, retreated to +1% in March, from +3% in February. With producer output price inflation rising at an alarming 5.7% year-on-year in February as companies looked to pass on their elevated input costs, the Bank of England will be hoping that the CBI survey indicates that manufacturers' pricing power is starting to be diluted by a weakening outlook.

The balance of manufacturers expecting to raise their prices over the next three months stood at +22% in February, which was one of the highest levels on record. Another elevated reading would be a blow to hopes for lower interest rates.

February retail sales data are released on Thursday. Retail sales are notoriously volatile around the turn of the year, being strongly influenced by the amount of discounting going on. Survey evidence for February from the CBI and the British Retail Consortium indicate that retail sales are slowing, but not collapsing, at the moment. On balance, we expect retail sales to have edged up 0.1% in February, after rising 0.8% in January. This would cause year-on-year growth to moderate to 3.9% in February from 5.6% in January.

We continue to believe that spending will be generally muted over the coming months,as consumers are increasingly pressurized by muted real disposable income growth, tighter lending conditions, a substantially softer housing market, lower equity prices, and increased debt levels. Household purchasing power is also being dented by higher utility bills and elevated food prices, while many home owners currently face having to re-fix their mortgages at significantly higher rates. Furthermore, elevated concerns about the economic outlook should encourage consumers to tighten their belts. Finally, we suspect that unemployment will start to rise later in 2008. Probable further gradual Bank of England interest rate reductions will help the consumer, but will only partially offset these major headwinds.

Meanwhile, the Bank of England will be particularly interested in the retail sales price deflator, to see if retailers offered significant discounts in February. A seventh successive fall of 1.0-1.5% year-on-year in the retail sales deflator in January indicated that retailers believe that there is a need to offer incentives for consumers to shop. This was some rare good news for the Bank of England on the inflation front, but was bad news for retailers' margins and profits. 

Also on Thursday, the public finances for February are released. Following the surprisingly strong surplus in January that helped the Chancellor get broadly back on track for 2007/08, we suspect that the February data will show a modestly increased deficit compared to a year earlier. Markedly softer consumer spending and overall growth will take an increasing toll on VAT and corporation tax receipts, while weakening housing market activity and softening prices will hit stamp duty receipts. Although Mr. Darling significantly raised the expected Public Sector Net Borrowing Requirement (PSNBR) and current budget deficit for 2008/09 in last Wednesday's budget, we suspect that they will still prove to be too optimistic given that his growth GDP forecasts look too high for 2008 and 2009.

Finally, mortgage lending and approvals data for February are released by the Building Societies Association and the Council of Mortgage Lenders during the week. We expect this to show that housing market activity continues to be substantially undermined by both stretched affordability and tightening lending practices.

By Howard Archer 

18 Mar - Consumer Price Inflation, February (Month-on-Month): +0.7%
18 Mar - Consumer Price Inflation, February (Year-on-Year): +2.4%
18 Mar - Core Consumer Price Inflation (ex Food, Drink, Tobacco), February (Year-on-Year): +1.5%
18 Mar - Retail Price Inflation, February (Month-on-Month): +0.7%
18 Mar - Retail Price Inflation, February (Year-on-Year): +4.1%
18 Mar - Underlying Retail Price Inflation, February (Month-on-Month): +0.7%
18 Mar - Underlying Retail Price Inflation, February (Year-on-Year): +3.6%