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Monday December 13, 2010 - 09:49:19 GMT
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ECONOMIC DATA ANALYSIS - FOMC, global inflation data to dominate the week

ECONOMIC DATA ANALYSIS Monday, 13th December 2010


FOMC, global inflation data to dominate the week


With global bond markets showing signs of capitulation, markets are likely to be pouring over the veritable feast of economic releases and events this week for confirmation, or otherwise, of the growing bearish sentiment. From a global perspective, the calendar headlines with the US FOMC announcement (Tuesday). The Swiss Central Bank and the Central Bank of India are also due to pronounce on interest rates this week. Datawise, the main theme is inflation, with key consumer price readings in the US, UK and eurozone – further highlighting the striking differential between the three regions.


In the UK, key consumer price inflation, labour market and retail sales data headline a busy week. It is difficult to say which of these carry the greatest impact - from an economic perspective, it is probably the labour market figures, although the markets will almost certainly be watching the inflation and retail sales readings closely (and probably end up reading too much into both of them). As we noted in our last weekly, views on the inflation outlook are becoming polarized between those who think the UK is on a precipice of a sustained reflation, and those that believe a Japanese-style deflation poses the biggest risk once some of the temporary factors keeping inflation high at the moment begin to dissipate. For now, those arguing the former appear to be gaining momentum. The headline CPI rate has been above 3% - the threshold which triggers an exchange of letters between the BoE Governor and the Chancellor of the Exchequer - for 8 consecutive months and looks set to remain so in November, household surveys of inflation expectations have risen and so too have market breakeven inflation rates.


Overall, we expect the annual CPI and RPI to have remained unchanged at 3.2% and 4.5%, respectively, with food and energy prices (petrol prices reportedly rose 1.5% last month) forecast to have continued their upward swing. More generally, some of the consumer-facing businesses we speak to have indicated that they have already sought to reprice ahead of the VAT increase - or are looking to do so over the coming months given mounting input cost pressures (particularly in the food and leisure sector). Add in the planned rises in gas and electricity prices over the coming months and the close to 10 per cent rise in rail fares in the new year and there is a clear risk that inflation surprises on the high side as we move into 2011.


While this has the capacity to spook the bond markets, we expect the MPC to continue to hold its nerve. Given the degree of spare capacity, it is difficult to see domestic price pressures becoming entrenched. For this to happen, inflation expectations and wages would need to start rising far more aggressively and for now, at least, there is little evidence of the latter taking place. Certainly we look for this recent pattern in the data to have been repeated in October when we expect the headline earnings rate of growth to have remained at 2.1% and the ex-bonus measure to tick up only slightly to 2.4% from 2.2% in September. If so, the annual rate of growth on the ex-bonus figure will hit the highest level since early 2009 – certainly good news as far as household incomes are concerned. However, as a useful point of reference it is worth highlighting that in the five years between 2004 and 2008 earnings growth averaged 4.0% on the same measure, which suggests that labour market conditions remain far from normal (see chart b).


That being said, however, the relative resiliency in consumer spending in the face of weak incomes growth has been an interesting UK theme to follow over the past year, and we look for the latest retail sales data (covering the month of November), to give an early steer on whether this pattern is set for a repeat in Q4. We look for a decent 0.3% rise in monthly retailing volumes - consistent with the fairly upbeat recent CBI distributive trades survey. However, retail sales outturns have confounded expectations in recent months and heading into the holiday season, which brings with it the usual problem of how to correctly seasonally adjust the data, markets may end up with yet another surprise on their hands. Elsewhere, for the moment at least, volatility in eurozone government bond markets has given way to a potentially stronger-than-anticipated US economic recovery as the current theme of choice. The latter reflects the combination of a second phase of the Fed’s quantitative easing programme and the recent extension of the Bushera tax cuts.


Following the ECB’s purchases of ‘peripheral’ eurozone government debt earlier this month, spreads have narrowed in countries such as Ireland, Portugal and Spain. By contrast, US Treasury yields have risen precipitously over the past month or so, particularly in the 5- to 10-year sector of the curve, where they have moved by around 65bp on average during the period. However, with the supply of bank credit still impaired and a weak US housing market preventing the movement of labour to ease the problem of high unemployment (through skills matching), there is no guarantee that these measures will boost activity as quickly as markets seem to think. Indeed, with so much attention on fiscal issues at the moment, it may be that the cost of extending the fiscal stimulus is the real issue occupying markets’ minds at the moment.


The dynamics of the US economy will be discussed at length during this week’s FOMC meeting. As recently as last week, Fed Chairman Bernanke flagged the possibility that if US growth did not move above its trend rate in order to reduce the unemployment rate, then an extension to its asset purchase programme may be necessary. But following November’s $600bn QE2 announcement, we think that further Fed action this week is unlikely notwithstanding some market reports going into the FOMC meeting. This week also sees a number of key US economic data releases with the themes of inflation and the housing market dominant. We look for “core” CPI to register growth of 0.6% in the year to November while for ‘headline’ CPI, our forecast stands at 1.3%. Producer price data are also published this week, alongside November retail sales, housing starts and building permits (see forecast table).


In the eurozone, the economic data calendar is no less busy. With considerable uncertainty still surrounding eurozone government bond markets given the fiscal challenges for all euro area countries, the region continues to be reliant on robust activity in Germany. This week sees the release of eurozone industrial production data for October, where we think Germany’s robust 2.9% m/m increase will yield a 1.5% m/m rise. Furthermore, the main business surveys for Germany are also scheduled including December’s Ifo, purchasing managers’ and ZEW reports. Here, however, we look for a modest pullback in the business climate index to 109, from 109.3 previously, with both current conditions and expectations components slipping back. Similarly, we expect a moderation in the pace of growth in purchasing managers surveys of both the manufacturing and services sectors. This reflects the potential for the recent volatility in financial markets to drag on sentiment.



This document, its contents and any related communication (altogether, the 'Communication') does not constitute or form part of any offer to sell or an invitation to subscribe for, hold or purchase any securities or any other investment. This Communication shall not form the basis of or be relied on in connection with any contract or commitment whatsoever. This Communication is not intended to form, and should not form, the basis of any investment decision. This Communication is not and should not be treated as investment research, a research recommendation, an opinion or advice. Recipients should conduct their own independent enquiries and obtain their own professional legal, regulatory, tax or accounting advice as appropriate. Any transaction which a recipient of this Communication may subsequently enter into may only be on the basis of such enquiries and advice, and that recipient’s own knowledge and experience. This Communication has been prepared by, and is subject to the copyright of, Lloyds. This Communication may not, in whole or in part, be reproduced, transmitted, stored in a retrieval system or translated in any other language in any form, by any means without the prior written consent of Lloyds. This Communication is provided for information purposes only, and is confidential and may not be referred to, disclosed, reproduced or redistributed, in whole or in part, to any other person. This Communication is based on current public information.


Whilst Lloyds TSB Bank plc (“Lloyds TSB”) and Bank of Scotland plc ("Bank of Scotland") have exercised reasonable care in preparing this material and any views or information expressed or presented are based on sources it believes to be accurate and reliable, no representation or warranty, express or implied, is made as to the accuracy, reliability or completeness of the facts and data contained herein.


This material has been prepared for information purposes only and Lloyds TSB, Bank of Scotland, their directors, officers and employees are not responsible for any consequences arising from any reliance upon such information. Under no circumstances should this material be treated as an offer or solicitation to offer, to buy or sell any product or enter into any transaction. If you receive information from us which is inconsistent with other information which you have received from us, you should refer this to your Lloyds TSB or Bank of Scotland Relationship Manager for clarification.


Lloyds Bank Corporate Markets, Lloyds TSB Corporate Markets and Lloyds TSB are trading names of Lloyds TSB Bank plc, Lloyds TSB Scotland plc and Bank of Scotland plc. Lloyds TSB Bank plc. Registered Office: 25 Gresham Street, London EC2V 7HN. Registered in England and Wales no. 2065. Lloyds TSB Scotland plc. Registered Office: Henry Duncan House, 120 George Street, Edinburgh EH2 4LH. Registered in Scotland no. 95237. Authorised and regulated by the Financial Services Authority under registration numbers 119278, 191240 and 169628 respectively





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