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Monday July 30, 2007 - 10:56:28 GMT
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Economics Weekly: BoE and ECB to keep interest rates on hold

Economics Weekly

BoE and ECB to keep interest rates on hold

• The Bank of England MPC is forecast to keep interest rates on hold on Thursday at 5.75%. Resistance to higher rates from three MPC members at the July meeting and the publication of the August Inflation Report suggest the MPC is likely to take stock of recent data and inflation prospects in the months ahead before deciding whether more rate increases are justified. UK data this week includes manufacturing and services PMI's which may indicate that the economy is already responding to previous rate rises and that a further hike may not be necessary.

• Following the turmoil in financial markets last week, the release of US employment and other key data could soothe nerves about the impact of the housing and the sub-prime lending crisis on the broader US economy. The decline in weekly initial claims this month suggests that non-farm payrolls may have increased by 145,000 in July. The unemployment rate is forecast to have stayed at 4.5%. Core inflation on Tuesday is forecast to have remained unchanged at 1.9% in July. The ISM surveys are expected to show economic activity was robust at the start of Q3.

• In the euro zone, the ECB is forecast to keep interest rates on hold on Thursday at 4.0%. There will be no press conference. Data on unemployment, inflation and the PMI surveys may influence the timing of the next ECB rate increase to 4.25%, widely expected in September or October. Unemployment and retail sales data are also due.

Large swings in global financial markets have a tradition of weighing on interest rate deliberations of central banks - so last week's events will certainly be taken into consideration when the Bank of England and the European Central Bank discuss their respective levels of interest rates on Thursday. In the UK, figures last week from the CBI on industrial trends and the Nationwide on house prices went some way to underscore our view that the UK economy is already responding to the sequence of previous interest rate increases (and the strength of sterling). This week's data may offer more indications supporting our view that base rates have already peaked. Consumer confidence is due on Tuesday and is forecast to show a fall in July related to higher mortgage rates and concerns about employment. This is consistent with the results of our own LTSB July consumer barometer. The CBI distributive trades survey will also be published on Tuesday and may show a drop in reported retail sales in July. Several retailers have reported mixed business conditions in recent weeks, but without generalising for the entire sector, this could be an early sign that interest rate rises are squeezing disposable income and discretionary spending. The July manufacturing PMI survey is due on Wednesday and is forecast to show a drop to 53.8 from 54.3 in June as a result of slower growth in new orders. Output prices may offer some indication about future levels of output price inflation. The services PMI is due on Friday and we expect to see a moderation in activity, with the headline index edging down to 57.4 in July from 57.7 in June.

The US labour market is almost vital to whether the economy can escape the housing downturn relatively unscathed. In the wake of negative home sales data last week, the July employment report on Friday takes on extra significance. We forecast employment growth of 145,000, close to the Q2 average of 148,000, led by hiring in the services industry. Increases in personal income and spending in July are forecast on Tuesday. Core inflation, also due on Tuesday, is forecast to have stabilised at 1.9% in July. The ISM manufacturing and services indices also take a prominent place on this week’s calendar and will offer the first indication about the level of output growth and inflation prospects at the start of Q3.

In the euro zone, the ECB traditionally does not organize a press conference after the August meeting and this means that this week’s rate decision should be a low key event. In contrast, final results of the July manufacturing and service PMI’s and July CPI inflation could impact the debate about when the ECB will next raise interest rates. Strong euro zone M3 money supply growth and German CPI data last week support the case of a September move.

Kenneth Broux, Economist

LloydsTSB Corporate


Economic Research

10 Gresham Street

London, EC2V 7AE


020 7626 1500

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