Weekly Economic Data Preview

We Expect the ECB to Cut Interest Rates by 0.50%

A very quiet week in terms of UK economic data lies ahead and this will put the focus on the ECB interest rate meeting on Thursday and a busy US economic schedule. The only statistics this week in the UK will be published on Tuesday and include the BRC retail sales and RICS house price surveys for December, and foreign trade data for November. US retail sales are due on Tuesday and CPI will be published on Friday. The Fed Beige Book, a summary of US regional economic trends ahead of the January 30/31 FOMC meeting, will be released on Wednesday. A speech by Fed chairman Bernanke at the LSE on ‘Policy Responses to the Financial Crisis' and the confirmation hearing of Treasury Secretary nominee Geithner will also attract interest.

The decision by the Bank of England (BoE) last week to cut base rate by 0.50% to 1.50% was based on the view that there remains a significant risk that inflation will undershoot the 2% CPI target in the medium term. Three-month Libor settled at 2.38% on Friday and the Ois/3-month Libor spread stabilised around 160bps, pointing to some alleviation of tensions in the inter-bank market. But despite the record low Bank rate and falling Libor rate, the scarcity of credit lending to businesses and households remains a considerable hurdle for the economy. More unconventional policy measures may be required to restore the flow of lending to the non-financial sector. Business surveys and official data point to a worsening rate of contraction in gdp growth in the final quarter of 2008, and with demand overseas also still deteriorating, we are turning increasingly sceptical that activity can stabilise even in the second half of 2009. A sharp 2.9% monthly drop in UK industrial output in November was reported last Friday and does in our view set the tone for the next few weeks. As the economy contracts and generates excess spare capacity, we believe the BoE faces no other option but to cut interest rates again in February by another 0.50% to 1%. This week's data releases are forecast to show a marginal reduction in the UK global trade deficit in November to £7.55bn and a small improvement in the RICS balance of agents reporting falling vs rising house prices to -75. The BRC survey may show disappointing retail sales for December.

The ECB in theory should not face a dilemma of what to do with interest rates on Thursday. Economic data released since the December meeting has continued to worsen to the downside of expectations, and CPI inflation fell below the ECB target in December to 1.6%. With the economic backdrop still deteriorating into the New Year, chances are that CPI could undershoot the 2% target by a full percentage point by March. However, official central bank rhetoric suggests that Thursday's meeting could be on a knife edge. Some members, including president Trichet, appear to be favouring a pause and would prefer for the Bank to bide its time following the 75bps rate cut to 2.50% in December. The common view is that the ECB has no other option but to keep cutting interest rates. It may choose to wait until next month, but the magnitude of the latest declines in output, new industry orders and overall economic confidence argue in favour of more timely monetary action. Even though inter-bank rates in the euro zone have declined - the 26bps spread for 3-month euribor over the refi rate is considerably lower compared to spreads in the UK (88bps) and the US (101bps) - confidence is still low. Last week, banks were on average depositing more than €260bn overnight with the ECB.

Retail sales data on Wednesday are the highlight of a packed US schedule. The downward revised guidance for Q4 earnings by US retail giants Wal-Mart and Nordstrom last week suggest that consumer spending ended 2008 on a disappointing note. We expect headline retail sales to have dropped 1% m/m and sales ex-cars to have fallen 1.2% in December. Lower oil prices and weak domestic demand should have contributed to a fall in the trade deficit in November to $50bn. The data will be published on Tuesday. CPI data is released on Friday and may show a fall in annual CPI to -0.2% in December. Core CPI is forecast to have slowed to 1.8%. Treasury Secretary nominee Geithner testifies on Thursday and may offer some detail on how he plans to use what's left of the $700bn financial rescue fund. More details should also emerge how President-elect Obama plans to implement a mammoth fiscal package to stimulate the economy.

Lloyds TSB Bank
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