Monday October 23, 2006 - 11:20:21 GMT
Share This Story
Lloyds TSB Financial Markets - www.lloydstsb.com/corporatemarkets
Economics Weekly: Prospects for UK economy in 2007 β challenging but better than in last 2 years
Economics Weekly: Prospects for UK economy in 2007 β challenging but better than in last 2 years
Economy recovered in 2006
At the start of this year, there were worries that the UK housing market could fall sharply β it had already showed a sharp slowdown in terms of prices, mortgage approvals and lending in 2005. There was also concern that weakness in manufacturing growth β the industry was into its second year of recession or falling output β would undermine company investment spending. This would have meant that there was little to support economic growth in 2006, aside from government spending. In the event, the housing market has recovered, helping propel consumer and retail spending higher, and the manufacturing sector is emerging from recession with a rise in business investment occurring as a result. Strong growth in the global economy, including in particular a recovery in European growth has helped UK exports (the EU accounts for some 55% of UK overseas sales). Relatively low interest rates and earnings growth of around 4% a year has underpinned recovery in retail sales and consumer spending. In the last four quarters, UK economic growth has been 0.7%, or 2.8% if measured for a full year, see chart a.
Interest rates are therefore now rising as inflation remains above target
But headline inflation has been above the 2% target since May and, at 2.4% currently, is likely to accelerate to 2.8% by the end of the year. Import prices are rising and goods prices are picking up, see charts c and d. That means interest rates are likely to rise to 5% in November, after the increase to 4.75% in August, see chart f. But our view is that this will not derail economic growth in 2007. With employment rising and solid growth in earnings growth, despite utility price increases, we believe that the economy will start 2007 on a much more balanced footing than it started 2006, as both consumer and company spending are contributing to activity. Indeed, in 2007, the pace of growth of investment spending will outweigh that of consumer spending, see chart b. Greater demand from consumers will buoy investment spending and economic recovery and housing market strength should help consumer spending. As inflation begins to subside later in 2007, though remain above 2%, see chart e, the Bank of England monetary committee may even think about cutting interest rates before the end of the year, but that will depend on whether they are raised to 5.25% early in 2007. If so, we look for base rates to end 2007 at 5%.
Growth likely to be strong in 2007 but better balanced
What will the economy look like? Growth of around 2ΒΎ% is what we are expecting, similar to this yearβs outturn, with consumer spending rising by around 2Β½% and company investment spending growth of 4%. The housing market revival has gained traction in the second half of this year and should continue into the first half of 2007, though lose some momentum in the second half under the influence of higher interest rates and the issue of affordability (the deposit required to get on the housing ladder will rise as a proportion of income). Government spending should remain solid at around 2Β½% a year, dovetailing with continued public sector net debt of around 3% of gdp, a high ratio for an economy growing so rapidly.
Manufacturing shows better performance though services still lead
In terms of the best performing industries in 2007, services will dominate, with business and financial firms benefiting in particular. But with the manufacturing recovery underway, there will also be some winning industries in these sector as well, including chemicals, electronics and specialist instrument makers. The main losers are likely to be the usual suspects of textiles and clothing and computers and office equipment.
Implications for financial markets
This fast economic growth implies, that mortgage lending will continue to rise but recent trends suggest that consumers are likely to continue running down their credit card borrowing, especially with interest rates on the way up, in favour of fixed rate loans. Despite above trend economic growth, however, there is likely to be a continued high incidence of personal bankruptcies, as the 2004 bankruptcy law change keeps them running at a high level. But solid economic growth should mean that corporate insolvencies remain low. Corporate balance sheets are strong β firms are currently sitting on over Β£65bn of cash - as a result of good profit growth, improved efficiency (outsourcing, productivity gains) and better cash flow after keeping investment pending low in recent years.
The gap between corporate bonds and so called risk free assets - government bonds - might narrow under the influence of faster economic growth and lower defaults but widen under the impact of higher short term interest rates. Acquisitions and mergers activity has been strong in the last few years and is likely to remain buoyant in 2007, as UK companies have a lot of money with which to fund buyouts. Bond and credit spreads might widen out next year from their 2005 level, but are likely to remain lower than at the start of the decade.
Commentary on economic data in the week
US interest rates are forecast to be left on hold at 5.25%
β’ A quiet week for the UK features the release of the CBI industrial trends survey. The survey should give a first indication of the health of the corporate sector and overseas demand at the start of Q4. Strong Q3 gdp data last week strengthened the argument for higher interest rates in November.
β’ The Federal Reserve is on Wednesday forecast to announce no change in interest rates. We expect the fed funds rate to stay on hold at 5.25%. The Fed may repeat that some inflation risks remain.
β’ The German IFO survey of manufacturing confidence may have ended a run of three successive declines in October. Euro zone M3 money supply may underline upside risks to inflation and cement the outlook for higher interest rates in December.
β’ Central bank interest rate decisions are due this week in Sweden and New Zealand. We expect the Riksbank to raise interest rates by 25bp to 2.75% but the RBNZ to keep interest rates on hold at 7.25%. Inflation data from Japan may stir speculation of an increase in interest rates to 0.50% on October 31st or November 16th.
A quiet week for the UK will allow market to catch their breath after the welter of data released last week. The report last Friday that the economy expanded at a quarterly rate of 0.7% in the third quarter confirmed that a rebalancing of growth is finally taking place in the UK, with stronger output in manufacturing compensating for slower growth in the services sector. The annual GDP increase of 2.8%, the best result since the third quarter of 2004, confirmed the solid dynamics of the current economic upswing and guarantees almost certainly that the Bank of England will increase the cost of borrowing to 5.0% at the next MPC meeting on November 9th. The CBI industrial trends survey will be released tomorrow and will offer a first indication of expected industry and manufacturing output at the start of Q4. The CBI last month reported that manufacturing demand strengthened to a 21-month high. A rise in export orders in particular has recently helped demand and bolstered output expectations for the final quarter.
In the US, the Federal Reserve is forecast to conclude its two-day meeting on Wednesday with a decision to leave interest rates at 5.25% for a third successive meeting. However, stronger core inflation data for September published last week means the Fed will need to continue to exercise caution and may therefore decide to reiterate that upside inflation risks remain. The Fed projected inflation would slow in the second half of the year. However, excluding energy, it has accelerated. This could result in a slightly different wording of the inflation assessment in the accompanying FOMC statement. The advance Q3 GDP estimate is due on Friday and is forecast to confirm that economic growth slowed in the third quarter due to a slump in the residential property market.
In the euro zone, we expect the German IFO survey of manufacturing confidence to have edged up for the first time in four months in October, thanks to strong overseas and domestic demand for industrial goods. Euro zone M3 money supply is also due this week. Strong lending
growth in the private and household sectors have stoked concerns at the ECB because of the risks this entails for inflation. A strong number would indicate that lending growth is not wavering, and with the economy growing above trend, this should underline the case for a rise in euro zone interest rates in December to 3.50%. Inflation data from Japan and Australia are likely to weigh on expectations for interest rates in both countries ahead of key central bank meetings in the coming weeks. Sweden's Riksbank is forecast to raise rates this week to 2.75%.
Trevor Williams, Chief Economist
Lloyds TSB Bank,
London EC3R 8BQ
0207 283 - 1000
Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.
Forex Trading News
Daily Forex Market News
Forex news reports can be found on the forex research
headlines page below. Here you will find real-time forex market news reports
provided by respected contributors of currency trading information. Daily forex
market news, weekly forex research and monthly forex news features can be found
Real-time forex market news reports and features providing
other currency trading information can be accessed by clicking on any of the
headlines below. At the top of the forex blog page you will find the latest
forex trading information. Scroll down the page if you are looking for less
recent currency trading information. Scroll to the bottom of fx blog headlines
and click on the link for past reports on forex. Currency world news reports
from previous years can be found on the left sidebar under "FX Archives."