Economics Weekly - BoE and ECB to cut interest rates, weak US jobs data expected
Economics Weekly 2
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 â€˜in due courseâ€™. 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 PMIâ€™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 weekâ€™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
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 ECBâ€™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.
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