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FX Blog - Economics Weekly - ECB steps up fight against inflation

Economics Weekly 9 June 2008

ECB steps up fight against inflation

Financial markets will still be reacting this week to the strong hint by the ECB that it will raise interest rates at its next meeting in July. Even if the rise does not occur in July, and it looks like it will, the monthly inflation profile suggests that there could be two, not one rise this year. We suggest July and October, depending on the inflation data. In the US and the UK, there will be no further rate cuts this year, or next, in our view. With the important caveat for the UK and US that any rate rise is also highly unlikely until 2009, we think rates in both will rise in the first half. Data this week will, however, show that growth is still at or below trend in the US and UK and weaker than in Q1 in the euro zone economies. But, at the same time, inflation pressures are worryingly high and likely to be further reflected in rising actual inflation rates.

• In the UK, producer price figures will highlight the fact that oil prices are still pushing up firms input prices to 20 year highs and increasingly being reflected in the output prices that firms charge. We suspect that there was a rise in input prices of well over 2% in May, taking them up to nearly 25% higher than in the year before. Output prices are heading higher as well, possibly up some 0.7% in May to nearly 8% in the year. This has yet to be reflected in the consumer price data, but will push CPI up towards 4% in the months ahead. But industrial production has not collapsed, and is likely to register a small rise, or a small fall, in the month. Although export orders are up, there is not yet a strong output response to a weaker pound (it may boost output for up to 2 years) and domestic orders are weakening, so only a modest year on year rise is likely in manufacturing output. The good news is that the labour market is still well behaved, with only a modest rise in average earnings expected, to 4.2% including bonuses. With economic growth close to or just below the 2-2.5% trend rate, claimant count unemployment may show a modest rise. The trade deficit may be down, but with exports not rising strongly, it may not shrink by much. The NIESR’s estimate of gdp growth in the quarter to May, on Wednesday, should also attract interest, and is likely to be 0.4%.

• In the US, the trade balance, on Tuesday, is likely to widen, driven by higher oil prices. However, the non oil component is likely to shrink further, as exports rise from a weaker US$. Retail spending may have risen in May, as government cheques start arriving and there is a rebound from a weak April. Import and consumer price inflation are expected to show a big jump in May - data due on Thursday and Friday - with core annual CPI up to 2.4%. Also, headline annual CPI inflation may go back up to 4%. But with confidence weak and the credit markets still fragile, rate rises by the Fed this year are still off the agenda.

• In the euro area, the focus will be on whether the data between now and the July meeting will allow the ECB to raise rates by an expected 0.25%. Figures this week will confirm that CPI is rising but that activity is positive though stalled. However, German and French trade figures will suggest that growth overseas is healthy enough to support exports. EU-15 industrial production, on Thursday, is expected to be positive, up 0.3% after a 0.2% drop in April. French manufacturing output for April, on Tuesday, may show a rise but only at a modest annual rate. However, the industrial and retail sales data this month are unlikely to prevent a rate rise, as they are still consistent with growth of close to 2% a year and so not enough to prevent inflation rising, as in our forecast to well over 4%, as opposed to the fall back expect by the ECB, see charts.

Trevor Williams
Chief Economist, Corporate Markets

Economic Research,
Lloyds TSB Corporate
10 Gresham Street,
London EC2V 7AE
0207 626 - 1500


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