NEWS / Foreign Exchange

United Kingdom: 20/3 Consumer Prices (Feb)

United Kingdom (Monday, 19th March to Wednesday, 21st March 2007)

20/3 Consumer Prices (Feb)
Financial markets breathed a collective sigh of relief when the inflation figures for January came in much better than expected. After spiking up to a decade high of 3.0% in December, some fall back had been anticipated. However, not even the most optimistic of forecasters had expected the headline rate to drop to 2.7%, effectively taking us back to where we were in November. The largest downward effect on the annual rate came from transport costs, with petrol prices having fallen this year in contrast to a rise 12 months earlier. In addition, food and non-alcoholic drinks prices fell by more than last year. However, there was also an easing in underlying inflationary pressures, with the core rate (ex energy, food, tobacco and alcohol), which climbed to 1.8% in December, falling back to 1.6%. Meanwhile, the headline RPI annual rate eased to 4.2%, whilst the RPIX rate fell to 3.3%. Looking ahead, the forecasting community remains divided on where inflation will be in 12 months time. Everyone agrees that everything else being equal, it should fall sharply as last year??™s increases in energy prices drop out of the annual comparison. The increases in gas and electricity tariffs for example by themselves accounted for a full 1% of the 3% increase in consumer prices in the year to December. Even if these were to remain flat in 2007 (and remember most providers have now announced cuts) by December 2007 inflation should have fallen back to 2.0%. However, the uncertainty lies in what is going to happen to underlying inflation in the months ahead. The pessimists worry that high rates of retail price inflation over the past 12 months will push up pay settlements and this in turn will stoke a further round of price increases. By contrast, the optimists (who include us) maintain that there is sufficient spare capacity within the economy that even if wages do accelerate, producers and retailers will not be able to pass this through in the form of higher prices. Our guess now is that inflation will drop like a stone over the next six months, and will end the year at around 1.5%. If we are right, interest rates will be heading south again before the year is out. However, as regards February, the consensus expects the annual rate to hold steady at 2.7%.

21/3 Minutes of MPC meeting
As expected ??“ apart from an unfortunate nine economists polled by Reuters - the MPC again left interest rates at 5.25% at the beginning of March. The minutes of the meeting are expected to show that Messrs Sentence and Besley remained in a minority of two in calling for a further quarter-point hike in interest rates.

21/3 Financial Statement and Budget Report
Last year??™s Budget Report, Gordon Brown??™s tenth, was tedious affair. With the public finances deteriorating, Mr Brown was too hamstrung by his own fiscal rules ??“ the socalled ???Golden Rule??? of only borrowing (over the economic cycle as a whole) to fianc?© capital expenditure and the ???Sustainable Investment Rule??? of keeping the debt-to-GDP ratio beneath 40% - to do anything apart from tinkering at the micro level. This year, since this will be Mr Brown??™s last Budget, something more is expected. Since the public finances are no better than last year, it is difficult to see him marking this occasion with any major giveaways. Instead, in the run up to the Budget most speculation has surrounded the tax treatment of ???gas guzzlers???. However, Mr Brown would love to leave with a flourish. He surprised the markets in his first Budget by granting operational independence to the Bank of England. He would dearly love to do something just as eye-catching in his eleventh and last.

United States (Monday, 19th March to Wednesday, 21st March 2007)

20/3 Housing Starts (Feb)
Having surprised on the upside in November and December, housing starts slumped 14.3% in January. This brought the total to some 37.8% beneath the level of 12 months earlier. However, just as the figures in December were distorted by the unseasonably mild weather conditions, so the January numbers were affected by a cold snap. Nevertheless, even with this, the three month on three month rate of change actually improved on the month, although it remained in negative territory. The February figures are eagerly awaited to see if the January figures were just a one-off blip. The consensus is looking for a comparatively modest rebound of 2.6% in February.

21/3 FOMC Interest rate decision
As expected, the Federal Reserve again held interest rates at 5.25% at the end of January. However, the real interest was always going to be the form of words in the accompanying policy statement. On balance, the statement was probably more dovish than financial markets had been looking for with the Fed noting core inflation had improved modestly (previous statements had simply said it was likely to improve). That said, the Fed did maintain its bias to tighten, by retaining the view that ???some inflation risks remain???, and by sticking with the expression that ???the extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth???. In our view, no such additional tightening will be necessary, but rates are unlikely to fall until well into the second half of the year. No change is expected this month, but once again all eyes will be on the wording of the policy statement for signs of changing sentiment at the Fed.