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Economics Weekly

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UK data will keep focus on recession risk

Tue, Oct 28 2008, 08:03 GMT
by Nichola James

Lloyds TSB Financial Markets

The preliminary estimate last week showed that the UK economy contracted by 0.5% in Q3 compared with the previous quarter. This represents the first contraction in output since Q2 1992 and the biggest quarterly fall since Q4 1990. The market consensus view was for a smaller decline of 0.2%. Looking ahead, a further modest fall in Q4 is possible, though so is flat growth. Should the Q4 outcome be negative (published in January), then the UK economy will be in technical recession. Given the latest figures, our weaker case scenario for growth (as published earlier in the year), where the UK economy contracts by up to 1% in 2009, now seems more likely. What does this mean for UK base rates? We forecast a base rate cut of one percentage point to 3.5% - probably a 0.5% cut at the BoE's 6th November meeting and an additional 0.5% cut - which may take the form of another round of co-ordinated central bank cuts- before year end. Confirmation of a contraction in Q3 US GDP may provide further justification for the Fed to cut its funding rate by up to 0.5% to 1% at this week's meeting. Moreover, should the German IFO survey and EC confidence indices for October weaken further and the flash CPI October inflation figure fall to around 3.4% as expected, the chance of up to a 0.5% cut in rates to 3.25% by the ECB will significantly increase. The Norwegian central bank is expected to cut interest rates by 0.5% to 4.75% on Wednesday.

• UK data will keep the focus on recession as housing market-related figures and consumer confidence and retail sales surveys stay weak. The consensus forecast is for mortgage approvals to stay around last month's record low level of 32,000 in September. Net mortgage advances could rise to £1bn in September from a very weak figure of £143m in August, but still sharply lower than last year's levels. GfK consumer confidence for October may ease from September's low level of -32, which should be reflected in a drop in the CBI distributive trades' survey from -27 in September to possibly -35 this month, as high street businesses perceive households as either reluctant and/or unable to increase spending.

• US economic data due this week are likely to provide justification for another Fed interest rate cut. The extent of the deterioration in the figures, and equity market turmoil, will dictate whether the Fed goes for a 0.25% or a 0.5% reduction. Practically all data releases are expected to show a worsening economic backdrop. Starting with weaker new home sales and consumer confidence figures before the Fed's decision, then the Q3 GDP first estimate on Thursday after the meeting (although the Fed will almost certainly have seen the number in advance). The market consensus forecast is for a contraction of 0.5% on an annualised basis, compared with 2.8% growth in Q2 when $180bn of tax rebates in that quarter may have helped prop up consumer spending. Friday's official data releases may show a modest increase in personal spending in September, while growth in the core PCE deflator, the Fed's preferred measure of inflation, may slow to 0.1% on the month, representing 2.5% on the year, which would mark the first drop in the annual rate since last February.

• In the run up to the ECB interest rate meeting on the 6th November, speeches by President Trichet and other ECB members will be scrutinised for hints of the likelihood and magnitude of additional interest rate cuts. This week, we expect the key German IFO survey to weaken and consumer & industrial survey confidence levels to fall. Should weak data be accompanied by a decline in CPI inflation last month from 3.6% in September to 3.4% in October as expected, the likelihood of an ECB rate cut will be increased.

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Published on  Tue, Oct 28 2008, 08:07 GMT