Bank of England March Policy Meeting Headlines U.K Economic Releases Week Commencing 1 March

It is once again a racing certainty that the Bank of England's Monetary Policy Committee will keep interest rates unchanged at 0.50% at their March meeting. Indeed, it is looking evermore likely that interest rates will stay at 0.50% through 2010. The odds also strongly favour the MPC keeping the Quantitative Easing programme on hold on Thursday, although there is an outside chance it could be extended.

The Bank of England clearly still has major concerns about the strength and sustainability of the United Kingdom's economic recovery. This was evident in the minutes of the February MPC meeting, in the February Quarterly Inflation Report, and in the recent testimonies of MPC members to parliament's Treasury Select Committee. While GDP growth in the fourth quarter of 2009 has been revised up to 0.3% quarter-on-quarter from previously reported expansion of just 0.1%, this is not likely to fundamentally ease the Bank of England's concerns about the outlook. Indeed, revisions to earlier GDP data mean the recession was actually even deeper than previously thought. GDP now contracted 6.2% from the peak in the first quarter of 2008 to the trough in the third quarter of 2009.

Bank of England governor Mervyn King's opening statement to the Treasury Select Committee last Tuesday significantly observed that the "risks to the Committee's central view of a gradual recovery of output remain to the downside." In particular, the Bank of England is concerned with the threat to growth prospects coming from the need of banks, the government, and consumers to improve their balance sheets. In addition, the Bank of England is clearly concerned by the apparent stalling recovery in the Eurozone, which is the United Kingdom's main export market. On the positive side, the Bank of England still sees substantial stimulus coming from interest rates at 0.50%, the stock of past asset purchases under the £200-billion Quantitative Easing programme, and sterling past depreciation.

The Bank of England attributes the spike in consumer price inflation—from 1.1% in September to a well-above-target 3.5% in January—to temporary factors, notably Value-Added Tax (VAT) rising back up to 17.5%, higher oil prices, and sterling's past depreciation. Although the Bank of England expects consumer price inflation to remain high for the next few months, the bank still expects it to fall back below the target level of 2.0% during the second half of 2010 as the temporary upward pressures unwind and underlying price pressures are contained by significant spare capacity. Despite recent speculation about just how much spare capacity there really is in the economy, the central view of the Bank of England is clearly that there is still enough to limit inflation over the two-year policy horizon following the sharp overall drop in GDP during the recession and the anticipated relatively gradual recovery.

Given this backdrop, there seems little likelihood that the Bank of England will raise interest rates any time soon. Indeed, if the Bank of England does act in the near term, it will be almost certainly to resuscitate its Quantitative Easing programme, having halted it in February after spending £200 billion mainly on gilts. When halting Quantitative Easing in February, the statement accompanying the MPC's decision commented that "the Committee will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them." In addition, Mr. King told the Treasury Select Committee last Tuesday that "we stand ready to do whatever seems appropriate" on Quantitative Easing, while MPC member David Miles revealed that "for me it was a pretty finely balanced decision" not to raise Quantitative Easing further in February.

Even so, it should not be assumed that a flurry of weak data in the near term will automatically lead to further Quantitative Easing. Significantly, the Bank of England has noted that the data are likely to be particularly volatile over the next few months due to stock developments and January's VAT hike. January's very bad weather will also markedly distort the data for early 2010. The MPC are also very conscious of the danger that inflation could prove sticky after the current spike, and may not fall back as quickly or as far as expected. This is a particular risk if companies and households' inflation expectations rise—something the Bank of England will undoubtedly be keeping an eye on.

We expect the Bank of England to keep interest rates down at 0.50% not only on Thursday but through 2010 given likely persistent concerns about the strength and sustainability of the recovery. Furthermore, when interest rates finally do start to rise, the increases are likely to be gradual and limited due to the need to offset the marked tightening in fiscal policy that will start in 2011 at the latest. Meanwhile, it is apparent that the Bank of England is prepared to engage in further Quantitative Easing if the economy falters markedly over the coming months.

Main Economic Releases

Mortgage Approvals in January and House Prices in December

The Bank of England is expected to report on Monday that mortgage approvals for house purchases fell back appreciably to an eight-month low of 49,000 in January from 59,023 in December and a 21-month high of 60,045 in November. Data already released by the British Bankers Association has already revealed a marked drop in mortgage approvals in January. This was the consequence of both very bad weather and some activity having been brought forward to late 2009 to beat the price threshold for stamp duty on house purchases moving back down from £175,000 to £125,000 at the start of January.

The Bank of England is also forecast to report that net mortgage lending weakened to £0.8 billion in January from £1.2 billion in December and £1.6 billion in November.

Although housing market activity trended up during 2009, as it was lifted by a significant fall in house prices from their 2007 peak levels and low mortgage interest rates, it remained muted compared to long-term norms. Indeed, November's peak level of 60,045 was still substantially below the average monthly level of 92,200 seen between 1993 and 2009. It has also been considered that monthly mortgage approvals of 70,000-80,000 are consistent with stable house prices.

Meanwhile, the Halifax lender is expected to release its house price index for February during the week. It is forecast to show a fall of 0.5% month-on-month, which would be the first drop since last June. House price increases previously moderated to 0.6% in January, 0.8% in December, and 1.3% in November. Nevertheless, the year-on-year rise in house prices is expected to pick up to 4.8% in the three months to February from 3.6% in the three months to January because of the sharp drop in prices a year earlier. The year-on-year increase in house prices would climb to 5.3% in February from 3.6% in January. The Nationwide lender has already reported that house prices fell 1.0% month-on-month on its measure in February after a rise of 1.4% in January.

The marked relapse in mortgage activity in January already reported by the British Bankers Association reinforces our suspicion that house prices are likely to fall in 2010, and they will be essentially only flat over the year—assuming more properties come onto the market, thereby moving the supply/demand balance away from vendors towards buyers. Although the Bank of England may hold off from raising interest rates until 2011, the overall economic environment (notably high and rising unemployment, and low earnings growth) is still far from supportive for house prices, while credit conditions remain pretty tight and the stamp duty threshold has fallen. In addition, house price/earnings ratios are currently moving back up. Indeed, latest Halifax data show that the ratio of house prices to earnings rose to 4.86% in January from 4.68% in December and a low of 4.32% in March 2009. This took it further above the 1983-2009 average of 4.01%.

If properties remain scarce for some considerable time to come, this will support house prices to some extent. It will increase the risk, though, that an eventual correction in house prices will be appreciable.

Consumer Credit in January

The Bank of England is expected to report on Monday that net consumer credit fell £0.2 billion in January. This would be a sixth net repayment in consumer credit in seven months, although there was a marginal increase of £52 million in December. In fact, the Bank of England's data show that there was an overall net repayment of £1.82 billion in unsecured consumer credit in the second half of 2009.

The further net repayment in consumer credit in January is expected to be the consequence of many consumers' desire to reduce their debt in the face of a still-very-worrying economic environment, low consumer appetite for new borrowing, and a lack of availability of unsecured credit from banks. Elevated and rising debt levels mean there is an urgent need for many consumers to improve their balance sheets, while still-serious concerns over jobs and the economic outlook are causing a substantial number of people to want to save more. Meanwhile, still-tight credit conditions continue to make it generally difficult for people to borrow, especially unsecured loans. Significantly, the Bank of England has identified the need for, and desire of, consumers to improve their balance sheets as a major factor that could limit economic growth over the medium and longer term

Manufacturing Activity and Prices in February

The manufacturing purchasing managers' survey (PMI, out on Monday) is expected to show that the sector expanded at an increased rate in February. Specifically, we forecast the PMI to have climbed to 57.0 in February from a 15-year high of 56.7 in January. This would be well above the critical 50.0 level that indicates expanding activity. The Confederation of British Industry (CBI) has already released an upbeat industrial trends survey for February showing improved total orders, export orders, and production expectations for the next three months.

It appears manufacturers are currently benefiting appreciably from leaner stock levels, improved competitiveness in both domestic and foreign markets stemming from the weak pound, and firmer demand in key overseas markets. There are also signs that domestic demand is picking up. Hopefully, the industrial sector can see decent expansion in the first quarter of 2010 and help the economy continue to grow, although it must be borne in mind that the sector only accounts for 17.2% of GDP. Furthermore, serious uncertainties remain about the strength of demand for manufactured goods over the medium term, particularly once stimulative measures start being withdrawn.

Producer price data (out Friday) are likely to show that the year-on-year increase in output prices climbed to a 14-month high of 4.1% in February from 3.8% in January. While this is largely the consequence of unfavourable base effects resulting from the sharp fall in oil and commodity prices in the second half of 2008 and early 2009, there are signs that manufacturers may be trying to take advantage of the recent improvement in activity to push through some price increases and support their margins in the face of recently rising input costs. Core producer output prices are forecast to have risen 0.3% month-on-month in February, sending the year-on-year increase to a 10-month high of 2.8% from 2.5% in January.

We remain dubious that manufacturers will be able to significantly lift their prices over the coming months given substantial excess capacity and elevated competition amid still-challenging conditions. While the manufacturing sector appears to be recovering to some extent after a largely dismal 2009, it is hardly racing ahead. Meanwhile, the consensus is for producer input prices to have risen 0.2% month-on-month in February, causing the year-on-year increase to be 7.8%.

Construction in February

The construction purchasing managers index (PMI, out on Tuesday) is likely to show that overall activity continued to contract modestly in February. We expect the PMI to be little changed at 48.5 in February, after improving to a 23-month high of 48.6 in January from 47.1 in December. This would be close to the 50.0 level that indicates unchanged activity. In fact, the index has been hovering not far below the 50.0 level since mid-2009. While still indicating modest contraction, this is a substantial improvement from early 2009, when the index dipped below 30.0.

The overall impression is that the construction sector is stabilizing after enduring a major downturn, and it will be desperately hoping the economy can develop significant recovery in 2010 after exiting recession in the fourth quarter of 2009. Nevertheless, the construction sector still faces a very challenging environment, and it is likely to be hit by the government's need to significantly rein in its spending for an extended period, as this is bound to hit expenditure on infrastructure and public buildings.

Service Sector in February

The service sector purchasing managers' index (out on Wednesday) is forecast to indicate that activity picked up to a limited extent in February after being hit significantly in January by the very bad weather. Specifically, we expect the business activity index to have risen back up to 55.5 in February, after dipping to fallen to a five-month low of 54.5 in January from 56.8 in December. This would take it further above the 50.0 level that indicates unchanged activity.

There are indications that consumer spending on services has improved to a limited extent recently, while demand for business services has been firmer. Nevertheless, January's VAT increase from 15.0% to 17.5% may well be weighing down modestly on service sector activity. Given the dominant role of the service sector in the economy, if the purchasing managers' survey fails to show a significant rebound in February from January's weather-related dip in activity, it will heighten concern that the economy could suffer a "double dip."

by Howard Archer

1 Mar - Bank of England Consumer Credit, January (GBP/Billion): -0.2

1 Mar - Bank of England Net Lending Secured on Dwellings, January (GBP/Billion): +0.8

1 Mar - Bank of England Number of Loan Approvals for House Purchase, January (000s): 49

1 Mar - Manufacturing Purchasing Managers Index, February: 57.0

2 Mar - Construction Purchasing Managers Index, February: 48.5

3 Mar - Service Sector Purchasing Managers Index, February: 55.5

5 Mar - Producer Price Output Inflation, February NSA (Month-on-Month): +0.3%

5 Mar - Producer Price Output Inflation, February NSA (Year-on-Year): +4.1%

5 Mar - Core Producer Price Output Inflation (ex Food, Tobacco etc.) February SA (Month-on-Month): +0.3%

5 Mar - Core Producer Price Output Inflation (ex Food, Tobacco etc.) February SA (Month-on-Month): +2.8%

During Week - Halifax House Prices, February (Month-on-Month): -0.5%