Until fairly recently, a further rise was widely viewed in the financial markets as pretty much a done deal. This shift in sentiment has also been reflected in the trend in short sterling futures particularly in the longer dated contracts.
It is not difficult to find the reasons for the change of mood. One particularly important factor is the appreciation in sterling which on a trade weighted basis now stands at its highest level since February last year. The November Inflation Report was compiled with the currency index at 100.7. It is now almost two per cent higher on this measure, with the bulk of the advance being achieved against the US dollar. This is significant for the inflation outlook with important ramifications not just for raw material costs but also for high street prices (see below).
A second issue is the somewhat disappointing level of trading on the high street in the run up to Christmas. As ever, there have been winners and losers amongst retailers but we estimate that, in aggregate, the reports from the large stores point to volumes gains of somewhere between two and a half and three per cent. Such an out-turn, while hardly a disaster, casts some doubt on the willingness of the consumer to continue to drive the economy. The British Retail Consortium was rather more downbeat in its assessment suggesting like for like sales (in value terms) were actually lower this December than last.
It is also noteworthy that some big retailers such as Marks & Spencer have already raised the possibility that they will cut prices once again this spring. Intense competition on the high street is one reason for this response but the appreciation of sterling against the dollar is another. With many high street products being manufactured in the Far East, the fact that most Asian currencies remain closely tied to the dollar is helping to lower the cost of purchase for British retailers.
A third point the MPC will have to consider is the fact that the recovery in the manufacturing sector is still fairly embryonic. Indeed, the latest set of official figures (for November) were much weaker than expected. While survey material remains more upbeat, there may be some doubt as to the extent that this will translate into hard data particularly if sterling continues to appreciate.
The MPC is also likely to be concerned by the reluctance of businesses to step up spending. The third quarter showed that capex was still flat on its back despite the recovery in corporate profitability.
Then there is the question of the new measure of inflation. The presentational problem of raising base rates at a time when inflation is so far below the target has been discussed at length. What could be more problematic for the authorities is a further fall in the CPI measure of inflation before the MPC meets. The December number is released on Tuesday and we expect it to show a month-on-month rise of 0.3 per cent. This will, however, translate into a drop in the annual rate of increase from 1.3 to 1.2 per cent.
So, what is left of the case for a tightening? Well, the pre-emptive argument remains in place. The February Inflation Report is likely to show inflation edging up towards the two per cent target over the next couple of years with above trend growth more than offsetting the impact of the strength in sterling.
Meanwhile, the housing market is continuing to bound ahead despite the lack of support from first time buyers. The latest reports from both HBOS and the Nationwide Building Society show property prices accelerating in the final month of last year. In addition, although total household borrowing did slip back in November from the October high, it was still the third largest monthly figure on record.
Finally, next week sees the release of the first estimate of fourth quarter GDP. It is likely to show the economy continued to grow well above trend over this period notwithstanding disappointing high street spending in the run up to Christmas. We are pencilling in a figure of 0.7 per cent which would take the year-on-year rate of growth to 2.3 per cent. This would be the highest growth rate recorded since the first quarter of 2001.
To conclude, we would accept the arguments for another tightening in policy are reasonably finely balanced but believe little would be lost by refraining from raising rates in February. Crucially, all the evidence suggests that private sector companies are having precious little success in pushing up prices, whatever part of the economy they operate in. In view of this, the MPC can certainly afford to wait a few more months before putting its foot on the brake pedal.
