WISE MONEY

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.

On Friday, US Employment fell for a second straight month in July as more temporary census jobs ended, as private hiring rose less than expected, pointing to an stunted economic recovery and a potential requirement for further quantitative easing. The main points were as follows: Non-farm payrolls fell 131,000 the Labor Department said on Friday, as temporary jobs to conduct the decennial census dropped by 143,000. Private employment, considered a better gauge of labor market health, rose 71,000 after increasing 31,000 in June.

The government revised payrolls for May and June to show 97,000 fewer jobs than previously reported. Analysts polled by Reuters had forecast overall employment falling 65,000 and private-sector hiring increasing 90,000.

The unemployment rate was unchanged at 9.5 percent in July for a second straight month, just below market expectations for a rise to 9.6 percent.

It was a similar sentiment in the UK as both consumer and business confidence dipped again.

The most recent purchasing managers’ index from the services sector indicates that, while growth continues business expectations have suffered a fall of about 10% since Spring. Friday’s PMI data showed a rise in cost of 5% which is rather high and pulls inflationary pressures into focus.

The other area of alarm for most is the idea that whilst interest rates remain low and are expected to stay as such until 2011 there seems to be greater comment around the fact that when they start to move they are likely to move quickly.

It is still a very fine balance to control inflation, implement spending cuts and tax hikes whilst in the meantime not cause a double dip.

The general market view seems to be that interest rate rises back towards more ‘normal’ levels can only be implemented if the economy grows confidently the idea of pushing an already fragile economy back into recession is simply not palatable.

Whilst recent UK economic data has been extremely positive yesterday this trend was broken. Overnight GfK Consumer Confidence fell by more than expected to -22 (consensus -20, previous -19). This follows yesterday’s news that house prices fell by more than expected in July, coming in at -0.5% m/m (consensus -0.3%, previous 0%).

It appears that concerns about the medium-term impact of fiscal austerity measures on personal finances is outweighing any potential optimism about the recent recovery’s momentum, thus keeping demand low.

In other data, both mortgage approvals and mortgage lending in June fell more than expected and M4 money supply was unchanged for June.

Despite this negative development, Sterling continued its recent surge against the US Dollar and managed to close at levels not seen since February of this year.

Significantly, sterling is well supported ahead of a key technical level, the 200 day moving average of 1.5543.

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).

The Euro rose significantly yesterday rising up to 1.2991 against the dollar and breaking, although briefly 1.30, a ten week high.The gains were owed to more weak data from the US where home-builder sentiment fell more than expected in July to the lowest level in over a year and comments from many of the EU countries stating their most important banks had passed the stress tests.

Germany, whose sources said Deutsche Bank and Commerzbank passed the tests look set to see Hypo Real Estate, a small nationalised mortgage lender fail, and it could be the first of many banks who specify in that market.

With the housing market across Europe still struggling, banks who exclusively work in that sector could have overly exposed balance sheets and be the next to require a takeover or even a bailout.

The Euro has also gained massively against Sterling falling well back from the high of 1.2380 3 weeks ago to 1.1750.

The BoE will be releasing the MPC Meeting minutes from the July rate decision tomorrow where we will find out more details to the divide growing in the committee.

Record price cutting in the Summer sales on the high street and falling petrol sales helped to push down inflation to its lowest rate since December.
The annual Consumer Prices Index inflation rate fell from 3.4 per cent to 3.2 per cent in June, the Office for National Statistics said.

Clothing and footwear prices fell by 2.1 per cent – the biggest reduction seen in June since the ONS began collecting monthly figures 14 years ago.

Petrol prices fell by an average 2.6p a litre to 117.9p – in contrast with a 4.4p hike a year earlier – dragging down the rate of inflation.

The ONS said clothing sales were more widespread this year, particularly for categories such as womenswear.

Offsetting this were other factors such as the soaring cost of air fares – ticket prices to South Africa doubled for the World Cup – as well as higher insurance premiums.

The figures also showed a rise in “core” inflation – excluding volatile factors such as food and petrol – over the month from 2.9 per cent to 3.1 per cent.

The CPI rate of inflation remains well above the Monetary Policy Committee’s 2 per cent target and has stayed at 3 per cent or higher throughout this year.

The Bank has already predicted that CPI will gradually fall back later this year as the economic slack built up by a record recession drags down prices.

The committee has left monetary policy unchanged since last November, with interest rates at a record low of 0.5 per cent.

The retail price inflation measure – which includes mortgages costs – fell less than expected to 5 per cent from 5.1 per cent.

Factory gate prices from manufacturers fell last month for the first time since November 2008.