Economics Weekly

Market Events to Overshadow Data

The European Central Bank (ECB) meets to discuss interest rates on Thursday, amid intensifying financial market stress and growing signs of weakening euro zone economic activity. However, these concerns will have to be balanced with the still unfavourable inflationary backdrop, despite signs that the annual rate may have peaked. Although we expect interest rates to remain on hold at 4.25%, the press conference from ECB president Trichet could contain surprises. The US September employment report, on Friday, is forecast to show that the US economy lost jobs for a 9th successive month. We look for a 90,000 decline, with the risk of a sharper fall. The unemployment rate will also attract attention, after rising to a five-year high of 6.1% in August. A disappointing report will raise speculation of a cut in US interest rates. However, we believe interest rates are already low at just 2% and a further reduction will have only a limited impact on the credit crisis and current slowdown.

UK data his week will provide further clues to whether the economy has entered recession. We forecast the UK will skirt recession this year, with any quarterly contraction likely to be relatively modest should it occur. The final estimate of Q2 UK gdp, on Tuesday, may provide a surprise, if growth is revised from unchanged over the quarter. While we believe there is a risk on either side, given recent economic data, the most likely outcome is for no change. But a large scale revision of the method of calculating gdp has been underway and the results of this could lead to a surprise. Any contraction would be the first since 1992 and will raise market speculation of interest rate cuts, possibly as soon as next week. However, we remain of the view that the majority of the MPC will want to wait for clearer signs that inflation has peaked though the worsening credit market conditions will raise the risk of a cut in rates. A sharp slowdown in economic growth is ultimately required to increase spare capacity and bring inflation to target over the Bank's two-year horizon. However, the destabilisation of money markets and generalised tightening in credit conditions - UK 3- month Libor is up more than 50bps since the September MPC meeting. A further deterioration in credit conditions ahead of the next MPC meeting could shift the balance of risks to growth from inflation.

We expect the PMI data this week to show both services and manufacturing activity contracted in September. However, the headline indices should remain close to levels broadly consistent with slow to stagnant economic growth. The retail sector, which has been surprisingly buoyant of late, is also not covered by these indices. We remain of the view that UK Q3 gdp growth could be slightly positive. Lending figures published by the BoE this morning are likely to show a further fall in mortgage approvals and net mortgage lending in August. This should come as no surprise given the significant tightening of household credit conditions and weakening sentiment about the housing market, and suggests that further falls in house prices are likely in the months ahead. However, net consumer credit may have picked up, possibly to a six month high of £1.3bn, from 1.1bn in July.

The economic landscape in the US continues to be dominated at present by bank failures and the much publicised $700bn rescue package to remove illiquid mortgage backed assets off banks' balance sheets. However, with Congress close to agreeing a compromise over the weekend, attention should soon return to the real economy. Economic data last week highlighted the risk of a relapse in Q3 gdp growth, with business investment and housing markets registering weak demand. The rise in weekly unemployment claims last week to 492,000 suggests that the labour market picture is also darkening. The September employment report is due this week and may add to market perceptions that the Fed will cut interest rates, possibly as soon as October 29th. We are not convinced. The US consumer confidence index, ISM surveys and personal income and spending data are also published this week.

The ECB finds itself in a very similar position like the BoE, with monetary policy currently being dictated by high inflation and rising fears about economic growth. However, challenging credit markets, worsening forward-looking indicators and signs that inflation has peaked, suggest that the ECB could soon switch its stance on interest rates towards an easing bias. The main data highlights this week are the 'flash' estimate of September CPI and EU-15 retail sales in August.

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Lloyds TSB Bank
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