WISE MONEY

The newest member of the Bank of England’s interest rate setting Monetary Policy Committee hit the headlines this morning.Britain faces “significant” risk of a fresh slump into recession according to Dr Martin Weale, who said it would be “foolish” to rule out the possibility of a double-dip downturn. He also thought the Banks central outlook on growth could be too optimistic in light of the fiscal cuts currently being implemented.

The BoE forecast is for growth of about 2.8% in 2011 and 3.2% in 2012. Sterling has dropped over a cent against the dollar following the news and has traded as low as 1.5371.

M&A activity in the US, helped lift sentiment yesterday, unfortunately this did not last for long and both main stock indexes closed marginally down on the day.

There is little economic news again today so focus is likely to remain on the existing home sales in the US which is out this afternoon at 15:00. Figures are expected to show that sales of existing US homes fell to an annual rate of 4.67million in July from 5.37 million in June.

Sterling is trading up 50 points after the release of the Bank of England minutes showed one member, Andrew Sentance, voted to start the withdrawal of the exceptional monetary stimulus. This is the third straight meeting that Sentance has been the lone dissenting voice calling for a 25 basis point increase in the banks base rate.

He argued that the economic recovery is gaining momentum and the Bank needed to act to make sure inflation expectations are not allowed to deviate from current levels due to the current inflation rate stuck stubbornly above target.

Traders have taken this as a positive sign for the UK economy and the Pound now has just broken through 1.56 against the Dollar and 1.21 against the Euro.

The Euro regained ground against the US Dollar as Ireland’s 2014 and 2020 bond auctions largely passed without incident.

Spreads were already tightening ahead of the auction, and final bid-to-cover ratios of 5.4 and 2.4 respectively showed that demand remains firm.

Spain also sold 5.5 billion euros of 12- and 18- month bills at lower yields than in previous auctions in July. We wait to see if ECB intervention was the main reason for the strong demand.

The European data picture was less rosy, however, as the ZEW Economic Sentiment survey was much lower than expected at 14.0 (consensus. 20.0), though the current situation index was firm at 44.3 (cons. 24.0).

UK inflation eased to 3.1% in July from 3.2% in June, the third month in a row that prices have risen more slowly than expected.
However, the Consumer Price Index (CPI) is still well above the Bank of England’s 2% target rate.

The Retail Prices Index (RPI) slowed to 4.8% from 5% in June, the Office for National Statistics said.  Sales signs Summer sales helped to push down prices, analysts said

The governor of the Bank of England will now have to write to the chancellor of the exchequer explaining why inflation is still above target.

The July inflation figures are watched particularly closely as they are used to set rail fare increases for the following year.

The changes affect regulated rail fares, which include long-distance off-peak journeys. This comes after some fares fell at the start of 2010, because RPI last July was -1.4%.

The main factor behind the drop in the inflation rate in July was a fall in transport costs, and in particular the prices of second hand cars and fuel.

Other factors included falls in the price of clothing and footwear.  These offset rises in cost of food and non alcoholic drinks.

Core inflation – which ignores volatile energy and food prices and is closely watched by economists – fell to 2.6% to 3.1%.

Last week, the Bank said it expected inflation to remain higher than forecast in the coming months, largely due to the rise in VAT to 20% in January.

The Bank’s governor, Mervyn King, said inflation was likely to fall back below the Bank’s 2% target in 2012.

China is now officially the second largest economy in the world, after the US.The Japanese GDP data out overnight reflected that China has moved into the lead and a number of economists are forecasting that China will take over as Number One by 2027.

Friday was a busy day on the economic data front. First up, we saw figures released showing that the Eurozone economy expanded in the second quarter at the fastest pace in nearly four-years.

The eurozone’s seasonally adjusted preliminary second quarter GDP showed an expansion of 1.0%, compared with the previous 0.2% and the expected 0.7%. The biggest jump in the figures came from Germany’s GDP, with a preliminary reading of Q2 GDP showing extremely robust 2.2% q/q growth, well above expectations of 1.3%.

This was the fastest pace of growth in nearly 20 years since German reunification. Global demand and a weaker Euro helped boost exports during the period, sustaining growth in the area.

Whilst the UK can take comfort from the fact that they can control their own currency, there are still issues. House prices in the UK have taken a bit of a knock for the month of July according to figures posted by Rightmove, the property website.

The figures reflect that people wanting to sell their homes are having to cut prices faster than at any time this year following a flood of properties hitting the market. On a national basis house prices have come in by 1.7% from July to August.

Following the Bank of England cutting its growth forecast on Wednesday and raising its estimate of inflation this housing data has not helped the continued fear around the risk of a double dip recession.

The Governor of the Bank of England Mervyn King presented a very down beat assessment of the UK’s growth prospects this week.For the first time he mentioned there was an outside chance of a double dip recession during his inflationary report.

This sent the FTSE down 2.4% to 5245.21 and the pound fell for a third straight day against the Dollar down to a low of 1.5626 giving back all of last week’s gains.

In his Quarterly Inflation Report King highlighted that they are nowhere near considering an exit strategy, nowhere close to increasing interest rates and have now left the option open for renewed quantitative easing should the need arise.

This negative sentiment overshadowed the positive UK unemployment data which fell as the economy added workers at the fastest pace since 1989.

Unemployment as measured by the International Labour Organization fell 49,000 to 2.46 million in the three months up to and inclusive of June.

Employment jumped 184,000 to 29 million. Overnight sterling has shown relative strength versus the euro, moving over 1.5% against the single European currency and hit a high of 1.2182.

The Bank of England has announced it is to overhaul its macroeconomic model (the excitingly titled- The Bank of England Quarterly Model) after a glut of large revisions to GDP and inflation figures.
In addition to the GDP forecasts it’s inflation forecasts haves been above target for 42 of the 51 months, triggering seven letters from BOE Governor Mervyn King to the Chancellor over the same period.

A chat over a few pints of beer and a packet of crisps are no longer deemed an acceptable method of assessing the health of the UK economy and the Bank plans to spend £3.5 million (or 350,000 magic eight balls) on overhauling and improving their forecasting model.

The announcement has led some commentators to suggest the markets may start to lose credibility in the Bank’s ability to forecast inflation and this could feed into Sterling weakness.

But since the story broke Sterling has hardly budged and along with us at Wise Money, the market probably sees the announcement as good rather than bad news.

The Financial Times yesterday also reviewed the BoE forecasts and discovered that the most reliable method of predicting future UK inflation and growth was to look at what happened in the previous quarter and copy those figures forward to the next quarter. Simples.

The Bank of England has kept its economic stimulus programme and record low interest rate of 0.5pc in place yesterday amid lingering doubts among rate setters over a sustained recovery for the fragile UK economy.The nine strong Monetary Policy Committee (MPC) was not swayed by the UK economy’s rapid 1.1pc advance between April and June, with growth expected to fade in the second half of 2010 as the biggest Budget cuts since the Second World War take hold.

Mervyn King, the Governor of the Bank of England, has repeatedly emphasised that there is no guarantee that the recovery which began in the fourth quarter of 2009 is sustainable.

The MPC held rates at the historic low of 0.5pc – where they have been since March 2009 –and maintained its target for bond holdings at £200bn, when it announced its monthly decision at noon.

The MPC maintained the ultra loose policy stance it established when the crisis took hold, despite a return to economic growth and a persistent failure to meet its 2pc inflation target.

The consumer prices index – the official measure of inflation – has been above 3pc since the beginning of the year. The Bank is expected to raise its inflation forecasts when it publishes the August Inflation Report next week, to reflect above-target inflation for most of 2011.

Mr King has stated that a failure of banks to lend, as well as weakness in Britain’s key export markets, could hamper growth in the UK.

Fears that Britain’s recovery will slow were reinforced by a snapshot of the UK services sector in July on Wednesday.

Economists had expected a slight improvement to 54.5, and the disappointing news for the economy helped to drive sterling pound down almost a cent lower against the dollar, to close at $1.5877.

Today is all about monetary policy meetings with the UK and the Eurozone committees all deciding on levels for interest rates for the next month.
As with previous months it is a fairly common view that both the MPC and the ECB will decide to leave their respective rates on hold, resolving to also leave the levels of QE unchanged as well.

For the MPC, that will be it for a week or so until the minutes of the meeting are released.

I would expect Andrew Sentance to once again prove to be the lone dissenter for leaving rates unchanged although it would be a shock if there was not evidence of protracted discussion amongst the members over the stubbornly high level of inflation and its effect on the UK economic outlook.

This is also the first meeting attended by Martin Weale therefore the minutes will also be awaited to discover his thoughts and voting intentions.

The Governor of the Bank of England, Mervin King, warned yesterday that a continued economic recovery was still unsure and that inflation is likely to remain above the 2% target for the next year.  King delivered a rather frank message to banks saying that their harsh treatment of corporate clients was leading to a “heartbreaking” situation in Britain’s small and medium sized business sector.

He said “It is a very tough job to build up these businesses and I do think that we need a pattern of finance that respects the need for these longer-term relationships.”

Mervyn added “They [small and medium-sized companies] may have had the same banking relationship for 60, 80 years and then suddenly out of the blue, comes a letter churned out by a computer which says that the terms of our relationship have changed.”

The bearish comments tempered Sterling slightly but that didn’t stop the Great British Pound hitting a fresh 5 month high against the USD following recent robust economic indicators and we are now trading at 1.5639 on cable.

Sterling received another boost this morning after a leading think tank announced that Britain will avoid a double dip recession and its economy will expand at trend growth rates as early as 2012. In the latest forecast from the National Institute for Economic and Social Research (Niesr), it predicts GDP growth of 1.3% this year, 1.7% next year and 2.2% in 2012.

The news follows recent strong economic data over the past week where GDP and retail sales figures shocked the market on the upside.

The pound has surged to 5 month highs against the dollar and the general consensus is Sterling will continue on a long term rise against the Greenback.

Merv “the swerve” King will be speaking today and as usual, I’d expect “doom and gloom” comments from the BoE chief.

Most likely on his radar will be the GDP figures from Q2 which showed a rise of 1.1% QoQ (0.6% forecast).