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MONTHLY ECOMONIC COMMENTARY - JANUARY 2008

Resisting the clamour
The New Year has brought further evidence of an economic slowdown in the UK and heightened fears about a full-blown recession in the US. But while Ben Bernanke, the Chairman of the Federal Reserve in America, made clear in a speech on January 10th that the Fed stands ready to take substantial additional action to sustain growth, the Bank of England’s approach has been rather more measured.

America’s policy interest rate has already been cut by one percentage point since September. Most analysts have taken Mr Bernanke’s recent comments as a virtual guarantee of a further cut of half a percentage point at the next decision meeting on January 30th, with some looking for an extraordinary inter-meeting cut before then.

In the UK, the Bank of England left it until December before announcing its first rate cut, and then resisted calls for further action in January. The cacophony of voices urging another reduction included the usual suspects, such as the British Retail Consortium, but also included words of encouragement (unusual and possibly ill-judged) from the Chancellor of the Exchequer.

Meanwhile, in the euro area, the European Central Bank continues to plough its inflation-fighting furrow. The statement which followed its decision meeting on January 10th (at which its benchmark rate was left unchanged) acknowledged the downside risks to growth, but also made clear that it stood ready to increase rates to bring inflation back under control.
Recent data and surveys from America point to an economy which is slowing sharply. But here in the UK the picture is less clear cut. It seems the Christmas trading period was no bonanza for retailers, yet this evidence is based on the trading statements of individual chains and industry surveys. The official figures, published by the Office for National Statistics, will not be released until 18th January.
Despite the financial markets making much of the trading statement released by Marks & Spencer, the best evidence so far for December having been a poor trading month on the high street was the results of the monthly survey undertaken by the British Retail Consortium. This showed that the total value of sales in December was just 2.3% higher than a year earlier, representing a slowdown from annual increases of around 3% in both October and November. But the jury remains out as to whether Christmas 2007 was just the worst since 2004, or whether it was the worst since the early 1990s.

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As for the housing market, activity continues to weaken, although the impact on prices is less clear. The Bank of England reported that the number of loans approved for house purchase fell again in November, and at 83,000 was about a quarter down from August. But having reported price falls in each month from September to November, the Halifax survey surprisingly observed a rebound of 1.3% in December.
Meanwhile, surveys of Purchasing Managers in the manufacturing and service sectors showed continued expansion in December, albeit at only a modest pace. In particular, the pace of growth appears to have slackened markedly in the service sector. These results suggest that the UK economy grew by around 0.5% in the final quarter of 2007, with a further slowing to 0.3-0.4% likely in the first quarter of 2008.

Given that the coming year is shaping up to be tougher than any since the end of the last recession in 1992, with GDP expected to grow by a subdued 1.5%, the Bank of England will be keen to cut interest rates further, provided that they are comfortable about the prospects for inflation. In this context, the announcement of double-digit increases in gas and electricity prices by npower may have given them pause for thought, since it was swingeing increases in fuel and utility costs during 2006 which eventually led to Mervyn King having to write that embarrassing letter last April. This time around, however, the Bank of England will be hoping that with consumers now embarked on a genuine retrenchment, helped along by tighter availability of credit, increases in some prices will be offset by downward pressure on others.

The extent of price increases for many goods will also be influenced by what happens to the pound.
After briefly breaking above 2.10 to the dollar in early November, sterling is now back in the mid 1.90s. It is also trading at an all-time low against the euro, having finally broken out of the tight trading ranges of the past three years. All other things being equal, a falling pound means that Britain’s goods become more competitive in overseas markets, which could help exports make up for some of the effects of the consumer slowdown. It also means that imported goods become more expensive, so potentially giving a further fillip to inflation.

Unless the retailing and housing data take a marked turn for the better during the next few weeks, another rate cut looks highly likely in February. Thereafter, the MPC will proceed with caution, keeping a wary eye out for signs that inflation isn’t as well-behaved as it should be. A series of well-spaced quarter-point reductions is therefore much more likely than a rapid-fire succession of cuts in the months ahead, while any signs of a re-acceleration of consumer spending could bring the process to a halt. While the economic climate for 2008 is more than usually shrouded in uncertainties, one thing is fairly certain. The Bank of England won’t be embarking on any American-style half-point rate slashing
anytime soon.

Source: HSBC

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ECONOMIC NEWS BRIEFING: WEEK ENDING 7 DECEMBER 2007

It has been another volatile week on financial markets. Amid sizeable day-to-day fluctuations in stockmarket indices, the dollar continued to slide, falling briefly below 1.49 against the euro. The price of oil again came close to the $100 a barrel mark after OPEC decided at its meeting last weekend not to increase output. But news of higher stocks at an important delivery hub in the US then caused prices to fall back a little.

UK industrial sector Those members of the MPC who favour an immediate rate cut were given food for thought by the CBI’s monthly industrial trends survey, which showed a rebound in manufacturers’ pricing intentions. Total order books recovered in November, and firms expect that output will continue to expand at a steady pace. They are therefore in no mood to simply absorb increases in fuel and other raw materials costs. The balance of respondents expecting to raise prices in the coming months was 21%, as against 14% in October, which means that pricing intentions are nearly back to the record level reached earlier this year.

UK growth In its second stab at quantifying growth in the third quarter, the Office for National Statistics scaled back its initial estimate from 0.8% to 0.7%. Spending by households remained brisk, however, increasing by 1% from the previous quarter, while net trade (the difference between exports and imports) was the biggest drag, subtracting 0.5% from growth. Investment spending was also buoyant, rising by 1.6%, with the likelihood that most of this came from the government. Capital spending by businesses was flat in the third quarter, marking a continuation of the weakening trend that has been evident throughout this year. While spending by the services sector fell by 0.7%, that by the production and construction sectors still grew by 2.8%.

UK public finances With seven months of the current fiscal year now behind us, there is little doubt that the Chancellor will overshoot his borrowing forecast by a considerable margin. In October, the public sector made a net repayment of £1 billion. But this compares with a repayment of £3.5 billion in the same month last year. The borrowing trajectory suggests a total for the fiscal year of around £42 billion, against the Chancellor’s forecast of £38 billion.

USA Housing starts recovered by 3% in October, although the number of permits being granted for residential construction fell by a further 6.6% to reach a new low for the cycle. Compared with October last year, starts were down by 16% and permits by 23%.