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Monday March 2, 2009 - 10:39:34 GMT
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Economics Weekly - BoE and ECB to cut interest rates, weak US jobs data expected

Economics Weekly 2 March 2009

BoE and ECB to cut interest rates, weak US jobs data expected


A busy week lies ahead for central bank events and economic data releases. Central banks in the UK, the euro zone, Canada and Australia are all forecast to cut interest rates this week in response to the weak economic backdrop and sharp falls in inflation. We expect the BoE and ECB to cut key rates by 0.50% to 0.50% and 1.50%, respectively. February surveys of manufacturing and services activity are due in the UK, the euro zone and the US and should offer some indication about the rate of contraction in output growth in Q1. Focus in the US will also be on the February employment report. A sharp rise in unemployment claims points to a step up in the pace of monthly job losses to above 600,000.


The projections for UK gdp growth and CPI inflation published in the February Inflation Report and comments since then by a number of MPC policymakers leave very little doubt that UK base rates will be cut below 1% on Thursday. Markets still hesitate over the exact magnitude of the cut - our forecast is for a 0.50% move - but it will be accompanied by a possible announcement on quantitative easing. Whilst this is not certain, the minutes of the February MPC meeting made clear that in the current environment where credit markets are not functioning normally and money supply growth (excluding lending between financial institutions) is weakening, it is appropriate to consider increasing the supply of money by more unconventional types of asset purchases ‘in due course’. The rise last week in the UK 3-month Libor/Ois spread to 163bps, a two-month high, suggests that money and credit markets are again deteriorating and that further action may be required sooner rather than later. With the BoE running out of conventional monetary policy tools as base rates approach zero, a decision to make purchases of government gilts to raise private sector spending may not be far away. The outcomes of the UK February services and manufacturing PMI’s on Monday and Wednesday will give a good indication of the rate of contraction in output growth in Q1, and are likely to make the case for quantitative easing more pressing as credit rationing helps keep the economy in a negative spiral. We expect the services PMI to have declined to 41.5 from 42.5 in January. The manufacturing PMI released earlier this morning dropped to 34.7 from 35.8, weaker than the market anticipated.


The reports last week of a rise in US continuing unemployment claims above 5m and a sharp fall in February household employment confidence do not bode well for this week’s monthly US employment report. The February non-farm payrolls data may on Friday show a rise in layoffs of more than 600,000, with some participants putting the number closer to 700,000. This would take the unemployment rate to about 8%. The positive correlation between weekly claims and unemployment show that the unemployment rate may reach 10% (see chart below). Worse than expected outcomes last week for durable goods orders, house prices and home sales suggest the US economy is still under severe strain, making another quarter of negative growth inevitable in Q1. The two ISM surveys are due today (manufacturing) and Wednesday (services). The Fed will publish its latest summary of economic conditions in the Beige Book on Wednesday.


Worse than expected outcomes for leading euro zone activity indicators in February and a sharp fall in inflation to only 1.1% leave the ECB with no alternative but to revise down its 2009 gdp growth and inflation forecasts and cut interest rates at the governing council meeting on Thursday. Our forecast is for a 0.50% move to 1.50%, but with the ECB careful to avoid falling into a liquidity trap, we are keen to hear from president Trichet whether interest rates are approaching a nominal floor. This may also help to clarify whether the ECB considers deploying new tools to bolster liquidity growth. Euro zone M3 growth figures last week showed sharp falls in credit and loan growth at the start of the year. The ECB’s December gdp growth forecast of -0.5% for 2009 faces a substantial downward revision. So does the 2009 CPI forecast of 1.2%. Our forecast is that the euro zone economy will contract by about 3% this year and inflation will average below 0.5%. Weak manufacturing PMI data this morning make this more likely.

Kenneth Broux, Economist, Corporate Markets


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


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