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Economics Weekly - Will QE become QE2? Weekly economic data preview - Focus on activity as central banks deliberate next steps

Economics Weekly 27 September 2010


Will QE become QE2?


Signs of a weakening in the UK economy are Chart a: QE has helped economic recovery... becoming more widespread. Since GDP growth of 1.2% in Q2, UK purchasing managers’ indices have turned lower, volume retail sales has shown the first fall in four months and business and consumer confidence is turning down. With interest rates pretty much as low as they can go at 0.5%, the only real monetary option left is quantitative easing – directly injecting liquidity into the economy via the central bank buying securities from the financial markets. Our own Business Barometer - a better lead indicator of economic activity in the next three months than the PMI survey - is suggesting that economic growth could be flat by the end of the year. In this weekly, we look at the prospects for a resumption of QE - or QE2.


Normally, a loosening of fiscal policy would also be an option for the authorities at a time of economic stress, but of course that is ruled out by the size of the UK’s budget deficit. Instead, fiscal policy is being tightened in order to ensure that the UK avoids being tainted with the funding concerns associated with the sovereign risk crisis facing a number of the smaller members of the eurozone, like Greece and Ireland. Latest figures (for August) suggest that annual borrowing this year could be closer to £155bn rather than the Office for Budget Responsibility forecast of £149bn. Not least, this prospect makes further spending cuts or tax rises more likely if the government is to meet its June Budget forecasts.


With fiscal policy ruled out and interest rates already low, the only viable option for loosening policy falls to QE. Whilst the MPC predictably left interest rates at 0.5% in September, the minutes of the meeting suggest that the debate was dominated by the fact that data suggested the economy was likely to be weak in the second half of the year. Bearing in mind that the Bank’s forecast of growth for 2011 is at the high end of expectations, close to 3%, weaker growth would leave the economy with more spare capacity, and so lower inflation, than expected previously by the MPC. Some MPC members thought that this could mean a need for further stimulus to ensure that inflation hits the 2% target in the forecast period. Of course, one member, Andrew Sentance, still voted for a rate hike at the September meeting.


Admittedly, not all of the economic news on the UK has been negative in the last month. Manufacturing activity seems to be holding up well. Reports from the Bank of England’s own officials suggested that consumer demand was still rising and that services activity and company exports were up in September. In addition, surveys of sales activity by the CBI showed that retailers’ expectations were still fairly robust. Unfortunately, the overall bias of the data in the last month still points to a slowdown being underway. One bit of good news is that the economic data do not suggest a double-dip, or a return to falling output.


To help assess the usefulness of further QE, the question that has to be asked is: what has it achieved in the time that it has been in operation? Chart a shows that QE has been followed by a sharp rise in money GDP - one of the originally stated aims of QE was to get nominal GDP growth into a 4- 6% range. This has been achieved. Of course, the fear about a renewed slowdown is that it will fall back. Other charts show that government and corporate bond yields have fallen and that equity prices are higher. However, annual money supply growth is still falling and the velocity of circulation, the number of times money changes hands in the economy is also declining, though more recently at a slower pace.


Our analysis of the effects of QE on bond yields shows that without it, yields would still have fallen but are around 100 basis points lower with QE. In other words, QE does make a difference. Interest rates not only seem likely to stay low well into 2011 but, as the fiscal squeeze in 2011 takes effect, some further offset on the monetary side seems to be becoming inevitable. We estimate that, given the amount that has been spent so far on QE (£200bn), a further £50bn or so will be required to have a significant impact. Nor would concerns about inflation seem to stand in the way of further QE: in the September meeting, the majority view on the MPC was quite explicitly that the upside risks to inflation had not materially changed in the last month. Since this was despite the fact that CPI inflation remained at 3.1% in August - well above the 2% target - there seems relatively little concern about its history but plenty about its future path. This further cements the likelihood of a second round of QE or QE2 - either later in 2010 or in early 2011.


Trevor Williams, Chief Economist,

Corporate Markets



Weekly economic data preview 27 September 2010


Focus on activity as central banks deliberate next steps



After the September Bank of England MPC minutes placed the possibility of additional QE firmly back on the agenda, the focus in the UK this week is on the hard data releases which will help decide whether the Bank ultimately ends up expanding its asset purchase program. We believe that the decision is finely balanced and, as in the US, data-dependent. However, unlike the US where data will probably need to improve in order to prevent further QE, in the UK, there will likely need to be a further deterioration in monthly indicators for the MPC to pull the trigger. Recent data on the labour market, housing and retail sales, as well as the key leading indicators of activity, are all flagging up downside risks to growth in the coming months, however, as things stand, do not suggest a contraction in output which would almost certainly leave the MPC with no choice but to act. The key data this week relate to the housing market, where we expect to see little change in the pattern of general weakness seen in recent months, with August net mortgage lending close to flat and approvals remaining below 50k – some 60% below the levels seen in 2007. We look for the Nationwide house price index to post a third consecutive monthly decline, pushing the annual rate close to zero. Other data to watch are the final reading of Q2 GDP – expected to remain unchanged on the previous 1.2% q-o-q estimate, and more importantly, the manufacturing PMI for September. The PMI hit a 9-month low in August, and with the new orders index falling to its lowest level since June 2009, we expect the headline figure to drop further towards the key 50-level which would signal that the recovery in the sector has all but stalled.


This week the focus in the US will remain on monthly activity indicators to assess the extent of the current slowdown. After posting a solid 0.4% gain in July, we forecast personal spending rose by a further 0.3% in August, providing encouragement that consumer spending should help underpin GDP growth in the third quarter. However, with disposable incomes under pressure and continuing slow jobs growth, the pace of recovery is likely to remain modest. Outturns for consumer confidence, on Tuesday and Friday, are also expected to disappoint. The manufacturing ISM provided a positive surprise last month after rising to 56.3 but looks poised to fall in September based on anecdotal evidence. Both the Empire and Philadelphia Fed manufacturing surveys disappointed expectations in September. We look for a fall in the manufacturing ISM to 55, with the risk of a sharper drop. However, the Chicago PMI, published a day earlier on Thursday, could prove better than expectations – although reflecting in large part some retracement after a steep drop last month. The third estimate of Q2 GDP is also

published on Thursday. Also this week, there are a series of Fed speakers and the Treasury will sell $100bn of notes.


It is a relatively quiet week for prominent data releases in the eurozone. Attention will primarily be focused on August EZ M3 money supply today, where we expect a further improvement in the underlying trend. However, a host of surveys on Wednesday are likely to show some easing in confidence from recent highs, while, on Friday, the unemployment rate is forecast to remain at a decade-high of 10% in August. There are a host of ECB speakers this week, including President Trichet.


In emerging markets, the official and HSBC China PMI manufacturing surveys provide the highlights. We look for both to point to continued expansion in September, albeit below the pace recorded earlier in the year. The official survey is forecast to rise to 53.8 in September, from 51.7 in August. The HSBC survey is forecast to rebound to a 3-month high of 52.5, from 51.9.


Economic Research team


Lloyds TSB Corporate Markets Economic Research, 10 Gresham Street, London, EC2V 7AE, Switchboard: 0207 626 1500. Bloomberg: LLOY<GO>



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