Economic Data Roundup

Wednesday, 14th February to Friday, 16th February 2007

United Kingdom

14/2 Labour market (Jan/Dec)

In the wake of January’s surprise rate hike, economic commentators were finding signs of economic strength everywhere. This was certainly how most view last month’s labour market report. Yes, unemployment (on both measures) declined again, but the fall in the claimant count was tiny and still left the total some 35,200 up on year ago levels. Similarly, the Labour Force Survey measure showed a larger 28,000 fall in the three months to November, but this was due primarily to a sudden decline (after many months of gains) in the labour force. Consequently, the key story for us was the extremely modest (14,000) increase in employment. Moreover, within this, the number of people working full time in employee jobs - the highest earning cohort within the jobs market - fell (yes fell) by 105,000. Instead, the new jobs were concentrated in part-time employee positions (53,000) and in self employment (50,000), with the balance explained by a sudden jump (22,000) in the number of people on government training schemes. This pattern of employment growth simply doesn’t tie in with an economy that is growing strongly. Nor for that matter does the fact that all of the jobs were filled by people above the state retirement age (men aged 60+/women aged 59+ up 18,000, workers aged 16-64(59) down 4,000).

This in turn helps explain why, despite such historically low rates of unemployment, wage growth should remain so subdued. Headline average earnings growth was again lower than expected at 4.1% year-on-year in the latest three-months, whilst excluding bonuses it was even lower at 3.7%. The MPC is worried that it may accelerate over the coming few months, but with the pattern of jobs growth showing that the balance of power remains very much with employers, we suspect that it won’t. Financial markets are looking for the claimant count to have edged down a further 5,000 in January, whilst average earnings growth is projected to be unchanged in the three-months to December.

14/2 Bank of England Quarterly Inflation Report

The implication of the MPC’s decision to leave interest rates at 5.25% is that the new central projection, which assumes interest rates move in line with market expectations, will show inflation at 2% in two years’ time. The real interest though will be whether, on the basis of the alternative assumption of no change in interest rates, it is also around its target rate. If it is, speculation will mount that interest rates have peaked. This in turn will send sterling sharply lower.

15/2 Retail Sales Volumes (Jan)

Why is everyone so worried about consumer spending being too strong? True, retail sales surprised on the upside in December - volumes jumped 1.1% against a central expectation of 0.6% - but things are not quite what they seem. For one thing, spending was heavily concentrated in the non-food sector (up 1.4%), and in particular amongst household goods stores, where volumes surged 5.2%. But they also apparently leapt 6.2% in December 2005 (so the annual rate actually declined) only to be followed by a 4.4% slump in January. This strongly suggests that the ONS hasn’t got its seasonal adjustment programme running correctly. It also implies a big pull back is likely in January. However, what we found really interesting was that prices in the household goods sector fell a massive 3.9% on the month. Similarly, in the non-food sector a whole, prices fell 1%, leaving the value of sales up a paltry 0.4%. Thus, spending on the high street is only as strong as it is because retailers are cutting prices. Does this really sound like an inflation problem? For January, the consensus expects retail sales volumes to have increased by 0.2%.

United States

14/2 Retail Sales (Jan)

US retail spending was stronger than expected in December. However, with November’s initially reported 1.0% increase revised down to 0.6%, December’s 0.9% advance left the level of nominal retail sales broadly in line with market expectations. With car sales down on the month, underlying retail sales were up even more than this at a full 1.0%. True, part of this apparent strength can be attributed to “forced” spending at gasoline stations, which bounced 3.8% reflecting the recovery in gasoline prices. But even excluding this, spending was up a buoyant 0.7%. Despite this, overall nominal spending rose just 0.3% during the fourth quarter, a pronounced deceleration on Q3’s 3.6%. However, this has been due entirely to the sharp fall in energy prices during the period. Consequently, in real terms, we find that retail sales actually accelerated during the final quarter, advancing 3.2% compared with just 0.7% in Q3 and a decline of 1.6% in Q2. A more modest 0.3% increase is the central market expectation for January.

Wednesday, 7th February to Tuesday, 13th February 2007

United Kingdom

7/2 Industrial Production (Dec)

The industrial sector ended 2006 on an extremely weak note. Although manufacturing output rose 0.2% in December, for the final quarter as a whole, activity was flat. This compares with gains of 0.7% and 0.9% in the previous two quarters. And with the output of the extraction industries down a further 3.6% on the month, overall industrial production contracted 0.1%. This left activity in the industrial sector down 0.2% in the final quarter as a whole. This is broadly in line with the contraction already factored by the ONS into the preliminary Q4 GDP estimate. Looking ahead, with sterling having strengthened and growth slowing in the US, it is tempting to conclude that industrial activity will remain soft in early 2007. But with the CBI output expectations balance having rebounded over the last couple of months (see chart) we believe activity in the industrial sector is likely to pick up, albeit modestly, in Q1.

8/2 MPC interest rate decision

As expected - by most commentators anyway - the MPC left interest rates unchanged this month. Given that the decision was taken in the light of revised growth and inflation forecasts, we have to conclude that the central projection must show inflation falling back to 2% over the Committee’s two-year time horizon. However, we cannot conclude from this by itself that interest rates have now peaked. The November Inflation Report forecasts also showed such a profile and yet interest rates were increased in January. The reason for this of course was that in the interim actual inflation spiked higher in December (to 3%) than had previously been assumed. In the view of the MPC, without higher interest rates inflation was unlikely to fall back to 2%. But the MPC also knew this month that inflation in January had fallen back to 2.7%, with the core rate easing to 1.6%. The chances of a final rate hike now depend on the behaviour of inflation over the next couple of months. If it rebounds again in February or March - thereby driving it significantly away from the new central projection - the MPC may surprise again in March or April. But even if it does, with inflation in our view set to fall sharply during the course of the year, we would expect to see interest rates on their way down again before the year-end.

9/2 International Trade (Dec)

The UK’s external trade deficit unexpectedly widened in December - the shortfall on the goods account increased from £6.9bn to £7.1bn. And with the surplus on services declining, the overall goods and services deficit increased to £4.9bn, the largest since May. For the final quarter as a whole, the deficit widened from £12.7bn to £13.5bn, suggesting that net trade, after boosting GDP in Q3, will have acted as a drag on growth in Q4. At the margin, this may in fact be sufficient to cause the ONS to revise down its 0.8% growth estimate. Most striking within the figures is the weakness of export demand. Export volumes were down 0.4% in December, but were a chunky 2.7% lower over the quarter as a whole. Part of this may reflect the strength of sterling over the past 12 months, but it can also be attributed to the deceleration in economic growth in the US - the Q4 GDP figures revealed US imports declined 0.8% during the period. In contrast to what the Treasury expects, net trade is likely to remain a constraint on growth throughout 2007.

12/2 Producer Prices (Jan)

Sharply lower oil prices, together with a drop in the cost of imported materials, meant that producer input prices fell a larger than expected 2.0% in January. As a result, the annual rate of change slumped to -1.7%, the lowest since November 2002. Meanwhile, the prices manufacturers charge for their finished products rose 0.3%. However, this was due mainly to higher prices for alcohol and tobacco. Consequently, excluding these and other volatile components (food and energy) and adjusting for normal seasonal variations, core output prices rose 0.2%. Whilst this was more than the 0.1% seen in December, it was broadly in line with the average seen over the last 12 months. Indeed, the annual change in the core measure actually eased slightly from 2.4% to 2.3%. Within the figures we can find little evidence to suggest that manufacturers are using falling energy prices to expand their margins. True, output prices are increasing faster than input prices, but it should be remembered that the vast majority of manufacturers’ costs are in fact labour costs (70%), and these are growing more quickly than output prices. Consequently, according to our calculations manufacturers’ margins contracted slightly in both October and November (the last two months for which data is available).

13/2 Consumer Prices (Jan)

Financial markets breathed a collective sigh of relief this morning as the inflation figures for January came in much better than expected. After spiking up to a decade high of 3.0% in December, some fall back had been anticipated. However, not even the most optimistic of forecasters had expected the headline rate to drop to 2.7%, effectively taking us back to where we were in November. The largest downward effect on the annual rate came from transport costs, with petrol prices having fallen this year in contrast to a rise 12 months earlier. In addition, food and nonalcoholic drinks prices fell by more than last year. However, there was also an easing in underlying inflationary pressures, with the core rate (ex energy, food, tobacco and alcohol), which climbed to 1.8% in December, falling back to 1.6%. Meanwhile, the headline RPI annual rate eased to 4.2%, whilst the RPIX rate fell to 3.3%.

Looking ahead, the forecasting community remains divided on where inflation will be in 12 months time. Everyone agrees that everything else being equal, it should fall sharply as last year’s increases in energy prices drop out of the annual comparison. The increases in gas and electricity tariffs for example by themselves accounted for a full 1% of the 3% increase in consumer prices in the year to December. Even if they were to remain flat in 2007 (and remember several providers have already announced cuts) by December 2007 inflation should have fallen back to 2.0%. However, the uncertainty lies in what is going to happen to underlying inflation in the months ahead. The pessimists worry that high rates of retail price inflation over the past 12 months will push up pay settlements and this in turn will stoke a further round of price increases. By contrast, the optimists (who include us) maintain that there is sufficient spare capacity within the economy that even if wages do accelerate, producers and retailers will not be able to pass this through in the form of higher prices. Our guess now is that inflation will drop like a stone over the next six months, and will end the year at around 1.5%. If we are right, interest rates will be heading south again before the year is out.

Eurozone

8/2 ECB Interest Rate Decision

As expected the ECB left interest unchanged at 3.5%. However, equally as expected, the central bank president, Jean-Claude Trichet, effectively confirmed that rates would rise in March by emphasising that the ECB would exercise “strong vigilance” against inflation. More of a surprise for the markets was a clear steer from Trichet that this was unlikely to be the last hike of this cycle, by arguing that policy remained “accommodative” and interest rates were still at “low levels”. In addition, whilst recognising that inflation should fall later this year, the central bank saw upside risks to inflation over the medium term. We expect rates to rise to 4% in June - the ECB is back on a once-aquarter tightening pattern - where they are likely to remain through to the end of the year.

13/2 Eurozone GDP (q4 prov)

Growth in the Eurozone was significantly stronger than expected in Q4, with activity expanding by 0.9% compared with a central expectation of 0.6%. What’s more the acceleration was pretty much enjoyed by all of the member states - the Netherlands being the sole exception. After a flat Q3, growth has resumed in France. Meanwhile, at 0.9% growth in Germany was much stronger than expected, and what’s more growth in Q3 was revised up from 0.6% to 0.8%. This leaves growth for 2006 as a whole at 2.9%, with the prospect of 3.1% to follow this year. With the recovery now firmly underpinned, the ECB will press on with at least two more quarter-point increases in interest rates.

John Clarke
Economic Adviser

ODL Securities

http://www.actionforex.com