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Economics Weekly - Business surveys hold important news about the direction of the economy; Weekly economic data preview - Central banks launch cash auctions & BoE MPC minutes may show strong support

Economics Weekly  17 December 2007

Business surveys hold important news about the direction
of the economy

It appears to have been the case that the decision to cut UK interest rates by ¼% to 5.5% in December, the first cut since August 2005, was influenced by the second consecutive monthly fall in the services PMI. At a time when the central bank has become more worried about the quality of some of the official figures for economic growth, it has been paying more attention to surveys of economic activity as a lead indicator when setting policy. So what does our own Business Barometer survey, released each month, tell us about the state of the UK economy and the likely direction it will take in the months ahead?

Our survey shows that business confidence is falling…
Our latest Business Barometer survey shows that the pace of weakening in UK business confidence accelerated in November. This outcome supports our view that the UK economy may already be slowing, albeit modestly and gradually, and suggests that the Bank of England was right to cut official interest rates in December. Although one cut will not be enough to halt the slowdown, and more reductions will be required. These cuts may not come as quickly as firms would like, however, as the MPC will likely continue to be mindful about its key target of stable and low inflation. Economic growth is important, but principally only insofar as its impact on the evolution of price inflation in the medium term, see chart c.

‘Business confidence’ - the balance of companies in our survey expecting higher rather than lower business activity over the next 12-months - plunged by ten percentage points to 47% in November from 57% in October, the biggest drop since June. The breakdown shows 57% of companies expected business activity to rise over the next 12-months and 10% expected it to fall, see chart a. This compares with 64% and 7%, in the October survey.

...led by a reduction in confidence amongst services firms…
Weaker expectations of business activity among services firms was the key factor in the overall decline. The survey suggests that after several years of strong growth, around 4% per annum, the service industry overall is expecting weaker activity in coming months. Business confidence in the South region, which is more service-dominated, fell to its weakest level since July 2005. But in other regions - where manufacturing is traditionally more important – confidence rose, suggesting the fall in November was services-led.

Companies’ confidence in the economy as a whole - current economic optimism – weakened further in November. The fall of one percentage point to a balance of 16% compares with 17% in October, see chart b. The detail showed that in November 44% of firms were more confident, with 28% less confident. In October, 46% were more confident and 29% were less confident.

…but the slowdown is far from recession territory
The latest Business Barometer survey result adds to a weight of evidence, including weaker house price growth and slower retail sales growth that the UK economy is slowing. As chart d shows, services activity has been the key driver of UK economic growth, and the sharp slowdown in this sector will account for close to a 1% fall in annual gdp growth next year. Our forecasts show UK economic growth slows from 3.1% this year to 2.3% in 2008.

Business confidence has now declined for the second consecutive month. Some perspective is needed however, although it is entirely feasible that confidence levels may fall further before they recover, as the fact is that the underlying state of the UK economy in terms of jobs and productivity growth is still favourable, offering support for economic prospects in the year ahead. For instance in November, the unemployment rate fell to its lowest level since 1975 on the claimant count basis, to just 2.5%, with a fall in the wider labour force measure to 5.3%, the lowest since 2006. These are not the sort of figures that suggest the economy is about to head into recession. Neither are they the sort of figures that suggest short term official interest rates will be slashed to well under 5%. However, slower economic growth will justify some modest easing in interest rates in 2008, depending on how price inflation evolves.

Trevor Williams, Chief Economist

Weekly economic data preview

Central banks launch cash auctions & BoE MPC minutes may show strong support for a cut
Central banks launch their series of Term Auction Facilities (TAF) and swap arrangements to ease cash pressures in the financial system this week. The
US Fed auctions $20bn on Monday and another $20bn on Thursday. Also on Monday, the ECB and the Swiss National Bank auction up to $24bn in swap arrangements with the Fed. On Tuesday, the Bank of England auctions a share of the total amount of £11.35bn offered to boost liquidity and the Bank of Canada sells C$1bn.

Also this week, the minutes of the December BoE interest rate meeting may not show unanimous support for a 0.25% cut to 5.5%. Financial market expectations are that the decision was a close one - 6-3 or 5-4. In terms of individual members' decisions, our view is that Andrew Sentance and Tim Besley may have voted to keep rates on hold, as may Governor Mervyn King, given his stated concerns about inflation. On the other hand, he may not want to have been outvoted by other members and, therefore, opted to cut rates as well, leading to a voting pattern of 7-2. The Swedish central bank may raise interest rates by 0.25% to 4.25% on Wednesday, whereas the Bank of Japan will probably leave interest rates unchanged at 0.5% on Thursday.

• Growth concerns may have been at the forefront of MPC thinking in deciding to cut official interest rates, given that they were aware of the results of the latest BoE quarterly inflation expectations survey when they voted on rates. The survey showed median expectations of 3% annual inflation over the next 12 months, from 2.7% in August and the highest since the survey began in 1999. November's inflation data is published on Tuesday, and we forecast a rise in CPI to 2.2% in November from 2.1% in October. RPI growth may hold at 4.2%, excluding mortgage interest payments, it could rise a hefty 1.6% on the month (up from 0.4% in October), but remain at 3.1% on the year. There may be a case for arguing that slower growth will reduce inflation pressure in the economy, taking the heat off inflation in the months to come, but for now, companies in manufacturing and services sectors are feeling the pinch from rising raw-materials, foods and energy costs and there is an upside risk that they may pass these on to customers. Published Thursday, UK money supply growth may have weakened in November, falling 0.2% on the month and rising 11% on the year, down from 11.8% in October. M4 sterling lending in November may have slumped to £10bn from £19.5bn in October. November retail sales, due Friday, may have risen 4.6% on the year, up from 4.4% a month earlier.

US data features the Q3 current account, TICS international capital data for October, housing market data, final Q3 gdp and the core PCE deflator for November. The Q3 current account deficit may have risen to $196bn, so TICS capital outflows of $24.7bn failed to fill this gap. In October, TICs capital inflows may have risen to $50bn, up from $26.4bn in September, but still below funding levels required. Housing starts and building permits are expected to have fallen further in November suggesting that the housing market has further to fall before bottoming out. Q3 gdp should be confirmed at 4.9% annualised on Thursday, highlighting the fact that the economic slowdown is largely restricted to the housing sector. The core PCE deflator, the Fed's preferred inflation measure, may have risen 0.3% on the month, 2.1% in the year.

• The performance of the eurozone economy in December will come into focus on Monday with the publication of possibly stronger PMI manufacturing and services data. The German IFO survey for December may consolidate around the 104.4 level, due to firm industrial orders.

Nichola James, Senior Economist

Economic Research,
Lloyds TSB Corporate
Markets,
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London EC2V 7AE
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