Steven Andrew turns his attention back to the UK and the economic indicators coming out of the Bank of England
The Bank of England’s quarterly Inflation Report probably came as a slight disappointment to those expecting the Bank to signal a shift to a more hawkish tone. Most recent data provided reassurance on domestic consumption growth, and a greater level of resilience has been shown by Euro Area leading indicators over the turn of the year.
It was understandable then to expect the Bank to express somewhat reduced fears for the UK growth outlook than it did in November. At that time the risks to both the growth and inflation projection were seen as being on the downside, and the probability that CPI inflation would exceed the Bank’s forecast on a two-year horizon was placed at 42 per cent - close to record lows for that series. This time, contrary to expectations, the Bank retained its description of the risks to growth and inflation as being on the downside; though it did lift the probability of an overshoot to 49 per cent - so less dovish but still below this series’ long-term average of 53 per cent.
Subsequent to the publication some forecasters have raised their expectation for UK interest rates to now expect a final 25bps rate increase at the May Monetary Policy Committee (MPC) meeting. We are surprised that the content of this Inflation Report has been sufficient to provoke such a change in view in its own right and suspect that stronger fundamental newsflow had upward revisions to interest rate expectations waiting in the wings anyway, with the Inflation Report seen as providing convenient timing.
Retail sales
UK retail sales data for January showed a 0.9 per cent month-on-month rebound from December’s sharp fall in sales (1.1 per cent month-on-month, revised down from -1.0 per cent), leaving high-street spending broadly flat for the turn of the year period. The impact of this data on the MPC’s rate decision is likely to be minimal. Governor King reiterated in the Inflation Report press conference that “drawing strong conclusions about spending over the Christmas period is something we should all give up for Lent”.
This is taking things a bit far but we get the point – the Bank will continue to look at the wide range of indicators of consumer activity and will not be overly swayed by the month-to-month volatility of one series. A deceleration in retail spending growth has been underway for around the past six months. In terms of the risks going forward, the Bank highlighted in the Inflation Report that softer consumption growth combined with external demand were the two key downside fears for the outlook. But with the employment market still very supportive, we think it unlikely that it all ends in tears for the UK consumer. With the past year’s change in monetary policy still exerting downward pressure on activity, we continue to expect retail sales growth to slow to around the 2-3 per cent year-on-year mark by the middle months of this year.
On the continent
Just when we thought it was safe to expect no further disappointment from Euroland economic data, fourth quarter GDP statistics fell far short of expectations, coming in at just 0.2 per cent quarter-on-quarter compared with the consensus forecast of 0.4 per cent. Of the five largest economies only France and Spain managed any growth at all – both registering a positively booming 0.8 per cent quarter-on-quarter in Q4 on the back of buoyant consumer spending.
It is these areas to which the ECB refers when it warns of excessive liquidity fueling rapid credit growth, so the degree of concern at the ECB will be undiminished by this gloomy GDP report. But as long as aggregate Euroland activity remains so weak – thanks to dire German and Italian domestic demand – the ECB will find it very difficult to raise interest rates. As we have said recently most German economic newsflow has shown signs of improvement and it is worth remembering that the GDP data is backward-looking, so while the disappointment is undeniable, it remains our view that domestic demand across Euroland is on a gradually improving path.
