There are two main concerns for the Bank of England with regard to the near term path for the UK economy: the strength of global indicators and the risk that UK consumption weakness gets worse over the summer. We expect reassurance from both quarters in the coming weeks, encouraging the MPC to delay cutting interest rates until Q4.
There was a raft of data released last week, but in our view the case remains unproven on the UK consumer. Mortgage borrowing, and other indicators of consumer credit, expanded again in May providing further evidence of stabilization in the housing market.
On the other hand, the first indication of June retail sales was a disaster, with the CBI Distributive Trade Survey reporting its weakest headline sales balance in the 22 years since the survey began. The index is volatile on a month-to-month basis, but usually describes the trend in official sales quite well over a period of time. But just as the CBI DTS survey does not represent all of retail sales, retail sales data does not represent all of personal consumption. Household spending on services (which has been strong) is about 3.5 times the size of durable goods (which has been weak). And as Governor Mervyn King has pointed out recently, the resilience of household’s consumption of services supports the notion that overall consumption is being distorted downwards by temporarily weak spending on durables.
Last week’s GDP data provided ample evidence that this is the case. Amid a downward revision to overall GDP growth in Q1 (to 0.4% from 0.5%), consumer spending on durables was recorded at -0.5% quarter on quarter while consumption of services rose by 0.5% quarter on quarter. In ‘genuine’ consumer slowdowns in the past, spending on both goods and services have followed broadly similar patterns of deterioration, typically both contracting at the same time. To our minds, the balance of evidence favours some improvement in overall spending in Q2 after Q1’s dismal 0.1% quarter on quarter growth.
On the global front, our belief that markets had become too gloomy of late has been borne out by this month’s set of purchasing managers’ reports. In the UK, Euroland and the US, the manufacturing PMIs surprised on the upside, and even the Japanese Tankan survey easily beat market expectations for both manufacturing and non-manufacturing sectors. This should reduce some of the pressure on policymakers, particularly the ECB but also the Bank of England, to feel the need to act quickly. And with that in mind, Mervyn King and a number of the other core Bank MPC members are likely to be inclined to continue to wait and see how the data unfold over the coming weeks rather than make any hasty moves which may need to be reversed.
By Steven Andrew, EconomistF&C Asset Management Plc