Economics Weekly

Focus on BoE and ECB Interest Rate Decisions

In the UK, the outcome of the April services PMI, published Tuesday, will play a part in the Bank of England's decision whether to immediately cut interest rates by 0.25% to 4.75% on Thursday, or to delay the move until June, with the possibility that there will be no further cuts at all. Our view is that unless there is a significant fall in the index, to a level below 50, which suggests contraction, the majority of MPC members will vote to hold rates, with David Blanchflower and possibly one other member dissenting. Another 0.25% cut in June or later, is entirely dependent on the depth of economic slowdown from incoming economic data. By contrast, the ECB's stance to hold interest rates at 4%, also on Thursday, is far more clear cut. Whereas there are some signs that the region's economy is slowing, data this week on services growth and retail sales may present a mixed picture, while inflation pressures are evidently rising. US data is likely to provide further indication that the economy is close to, or in recession, providing justification for last week's 0.25% cut to 2% in the Fed funds rate. But there are early indications that financial markets may be over the worst of the credit crunch and evidence that the US economic downturn is finally bottoming out, suggesting that the Fed may also be close to or at the end of its interest rate cutting cycle.

UK data this week will show that despite the deepening slump in the housing market and weak consumer confidence, the service sector is still expanding, albeit at a slower rate. However, should the PMI services index fall below the market median forecast of 51.9, fears of more significant economic slowdown may influence more members of the MPC to vote for an immediate cut, although this is not our central view. In addition, the rising trend of PMI services input and output price indices will highlight the Bank of England's growing challenge on the inflation front, and probable reluctance to lower rates again this month. The April PMI manufacturing survey was stronger than expected, helped by the weaker pound boosting exports to overseas markets. This highlights opportunities for UK high value-added and/ or commodities-based exports this year. Official industrial production figures for March, published Wednesday, are expected to show modest annual expansion.

The EU-15 April PMI services data should be confirmed above the key level of 50, indicating that the sector is growing, although as with the UK, at a slower pace than in March. EU-15 retail sales may rebound on a monthly basis, but the annual figures are likely to remain in negative territory, which suggests that the consumer sector remains weak as higher energy and foodstuffs prices reduce households' discretionary spending. German official industrial output may have fallen in March, although growth on an annual basis may have remained strong, while new orders may have risen on the month, despite the strong euro. With eurozone inflation running at 3.6% pa, well above the ECB's target rate of 'below, but close to 2%', EU-15 March producer price growth of 0.5% on the month and 5.6% on an annual basis, due Tuesday, will add to the ECB's inflation worries. With this set of figures in mind, a signal from the ECB that interest rates will be cut is very unlikely and, in our opinion, the biggest risk may lie with the possibility of a hike next year, or sooner if the credit crisis suddenly abates.

Recent indications from minutes and speeches suggest that the US Fed, having lowered interest rates by 3.25% to 2% in a series of rate cuts since last September, now seems likely to pause. There are early indications that the worst of the credit crisis is over and that the downturn in the economy is bottoming out, as highlighted by the better than expected April NFP jobs number and fall in the unemployment rate to 5%. Today's release of the April ISM non-manufacturing index may also surprise on the upside; there is a real possibility that the index was at/ or above 50, indicating expansion. Consumer credit growth and weekly initial claims figures may also show improvement. In terms of the US trade deficit, the soaring cost of commodity and foodstuffs imports may have kept the US trade deficit around the $62bn level in March, annualised at $744bn. Although representing a 10% improvement compared with 2007, it is clearly still reflecting a massive overseas funding requirement.

Chart 1: Is the downturn in services bottoming out?

Chart 2: Have the Fed and the BoE come to the end of their respective interest rate cutting cycles?

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