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Monday May 8, 2006 - 10:17:40 GMT
Lloyds TSB Financial Markets - www.lloydstsb.com/corporatemarkets

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Economics Weekly: How good is the Financial Markets Consumer Barometer?

Survey
Average Apr Mar Feb

Q1 - Over the last 12 months, did prices rise/fall? 48 60 60 57
Q2 - Over the next 12 months, will prices rise/fall? 67 76 77 79
Q3 - Is your job more/less secure than 12 months ago? -1 -5 -5 -2
Q4 - Are employment prospects better/worse than 12 months ago? -13 -27 -22 -18
Q5 - Will interest rates be higher/lower in 12 months time? 49 50 50 49

FMD consumer survey helps to spot economic trends
In November 2004, Lloyds TSB Financial Markets started a monthly consumer survey, made up of five questions, about inflation, backward and forward looking expectations; job security and job prospects, and interest rate expectations. With the UK economy seemingly undergoing a turning point in the last few weeks, it is perhaps a good time to assess whether the survey is able to offer any insights into the changing pattern of economic performance in the UK, at least as far as consumer trends are concerned. Our analysis of the results of the survey since it started suggests that it is a useful guide to trends in consumer confidence and unemployment, through its focus on sentiment about the jobs market, and trends in inflation and interest rate expectations.

What areas does the consumer survey cover?
The Lloyds TSB Financial Markets (FM) Consumer Barometer is a monthly survey of UK consumer opinion. The survey is completed around the middle of each month and is intended to provide an early indicator of expectations and so of key economic trends from a consumer perspective. Since consumer spending makes up 70% of the expenditure measure of UK economic growth, getting a view on this aspect of the economy could therefore be very useful in spotting turning points in the level of activity.

Survey participants are asked a series of key questions, the answers to which are either an increase/improvement, no change or a decrease/worsening compared with the previous month. The balance between increase/ improvement and decrease/worsening responses is used to provide the summary headline indicator for each question. The survey typically has a sample size of over 2000; however, for questions relating to employment conditions, only responses from employed survey participants are reported.

Two questions are focused on the labour market, partly because it is a good guide to changes in consumer confidence, which is mainly driven by changes in unemployment. One of these labour market questions is backward looking and the other is forward looking. There are also two questions about price changes, which are not necessarily the same as inflation, as people, typically, have a view about prices but are less sure about what is meant by inflation. This question also has a backward looking and forward looking element. Finally, there is a question about the likely direction of interest rates.

The LTSB Financial Markets Consumer Barometer is a good lead indicator of UK economic trends
How does the trend of these responses map out to the recent shift in the UK economy, in particular the areas covered in the survey? In the last few weeks, the UK economic data flow has strengthened – retail sales activity seems to be getting firmer, both the services and the manufacturing surveys are showing highs, 4½% and 2½% years respectively, and house price inflation is gathering pace. These have led the financial markets to turn away from the view that interest rates will be cut this year to the view that they will be raised instead.

Table 1, page 1, shows the three month trend of the FM Consumer Barometer against the average score since November 2004. All of the latest survey results are above their long run average for the series. For prices, this means that past prices have trended higher and price expectations have also risen. Job security has worsened, implying weaker consumer confidence, higher unemployment and lower employment (something already clearly evident in official data). But with interest rate expectations also above the survey average, there is a belief in the survey that interest rates will head higher. How do these survey results map out to what the data for these variables are actually showing for the economy?

The short answer is that they are remarkably accurate in their depiction of relevant trends in the UK economy. Currently, for example, the Bank of England’s NOP price survey is showing that there is a rise in consumer price expectations, something our own survey is showing. More remarkable is that if we map our survey results for this question out to inflation expectations in the financial markets, as measured by the two year bond rate, we find that our survey is a very good lead indicator, see chart a. Indeed, the FM Consumer Barometer shows that when the financial markets became less worried about prices in the second half of 2005, respondents to our survey remained concerned. In the last few months, it is the financial markets that have become more worried, and moved back into line with FM’s survey results.

What about interest rate expectations? This too dovetails very well with the bond rate, as shown in chart b, and as one would expect given the price expectations balances shown in chart a. The price expectations survey responses from consumers also tracks consumer price inflation (CPI) trends very well, or at least so far in the surveys’ existence, see chart c. As can be seen in the chart, the recent breakdown in the trend either implies that the survey will turn sharply lower in the months ahead or that consumer price inflation will pick up. Given the trend in prices of gas, water, electricity and petrol, to name a few, we tend to believe that it is the CPI that will accelerate. Such an outcome would conform with the current view being expressed in bond yields and in financial market predictions of where base rates are likely to be at the end of the year.

What about labour market indicators? Chart d shows that this question in our survey is also useful, tracking the falling trend of employment. But unemployment is a lagging indicator of economic activity, so as the economy recovers unemployment will recover as well. We shall be watching this survey question carefully in the months ahead to see when it turns up and whether this is then followed by a rise in the official series. In conclusion, it does appear as if the Lloyds TSB FM Consumer Barometer can add real value in the analysis and tracking of changes taking place in the UK economy.

Trevor Williams, Chief Economist
trevor.williams@lloydstsb.co.uk
www.lloydstsbfinancialmarkets.com
Lloyds TSB Bank,
Financial Markets
Division,
Faryners House,
25 Monument,
London EC3R 8BQ
Switchboard:
0207 283 - 1000

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