RBS Weekly Economic Update: 2nd August A waiting game

  • After a flurry of surprisingly strong economic indicators for the UK, the Bank of England added a dose of necessary realism about the outlook for the UK economy.
  • Uncertainty over the prospects for economic growth is affecting interest rate expectations. The UK’s Monetary Policy Committee (MPC) will meet this week to set interest rates. Although no one is expecting an immediate change in rates or to the asset purchase scheme (QE), there is increasingly fierce debate over where rates should move. On the rate-hiking side, inflation prospects are the major concern, with CPI sticking stubbornly high at 3.2% in June. Indeed, some MPC members are concerned that inflation expectations are on the rise. Moreover, the UK notched up a surprisingly robust 1.1% q/q growth rate in Q2, which might also suggest that it is time to reduce the pedal-pressure on ultra-stimulative monetary policy.
  • Yet on balance, we believe rates are likely to remain on hold for some time yet. There are still ongoing concerns about the strength of the recovery. UK firms have plenty of spare capacity and high rates of unemployment are holding down domestic demand, while signs of a slowdown in the global recovery suggest exports are unlikely to come to the rescue just yet. Indeed, last week Governor of the Bank of England, Mervyn King, expressed concerns that problems in the world economy threaten the UK’s recovery. Speaking to MPs at the UK Treasury Select Committee, he said that imbalances in global demand, where the growth prospects of exporter countries rely heavily on spending by deficit ones, remain unresolved. One manifestation of those imbalances is the UK’s continued reliance on consumption, rather than exports, to maintain growth.
  • In addition, there is further evidence that the UK housing market recovery has run out of steam. The Nationwide index finally joined the pack showing price declines, reporting that prices fell by 0.5% between June and July. This takes the annual rate of house price inflation from 8.7% to 6.6%. The mortgage lender cited weak buyer demand as a factor driving prices lower.
  • According to the Bank of England, the number of approvals for purchase mortgages fell (again) in June, to 47.6K. This is below the six-month average of 50K and almost half the longer 10-year average of 93K. Remortgage approvals fell too, albeit slightly. It seems borrowers remain reluctant to commit to new mortgages while lenders' standard variable rates are so low, i.e., most homeowners are willing to take the chance that attractive fixed rate deals will last for a while yet.
  • Net lending to individuals dropped by almost half in June, compared with May, falling from £1.1bn to £0.6bn. Total debt held by UK individuals also fell, for the fifth consecutive month – UK households now owe £1.457tn. Although the drop from peak amounts to just £5bn, total debt levels seldom fall and any decline marks a significant shift in UK household behaviour.
  • Better news for a continent concerned with deflation is that inflation in the euro area jumped to 1.7% in July, the highest rate since November 2008. Yet with inflation still below the 2% target ceiling and an economic recovery far from secure, the ECB is unlikely to alter rates this week. For starters, there is still plenty of slack in euro area labour markets. The unemployment rate remained at 10% in June, meaning that 15.7m people are willing to work but could not find a job. This masks significant regional variation though. Austria and the Netherlands have the lowest unemployment rates (3.9% and 4.4% respectively) while the highest rates are in Spain (20%), Slovakia (15%) and Ireland (13.3%).
  • On the other side of the Atlantic, US GDP growth slowed to 2.4% on an annual basis in Q2 2010. Estimates of Q1 growth were revised up to 3.7%, indicating a loss of momentum in the recovery of the world’s largest economy. Global imbalances were in the spotlight again, as imports grew at nearly three times the pace of exports (29% and 10% annualised for imports and exports respectively). The US, however, does appear to be weaning itself off its reliance on consumer spending. Consumption rose at an annual rate of 1.6% whereas private investment expanded by 29% (annualised).
  • Some comfort too came from the US housing market, which showed some signs of improvement in June. New home sales rose by more than expected, up at an annual rate of 330K in June, a 24% improvement from previous month. Meanwhile, US house prices continue their upward slog. The Case-Shiller index showed that the prices in the 20 biggest US cities climbed 4.6% y/y in May, the biggest year-on-year increase since 2006.
     

Paul W Turton
Business Development Director