NEWS / Foreign Exchange

United Kingdom: 10/5 Industrial production (Mar)

United Kingdom (Wednesday, 9th April to Friday, 11th May 2007)

10/5 Industrial production (Mar)
The industrial production report again failed to live up to market expectations last month. With the consensus looking for a rise of 0.3%, manufacturing output slumped 0.6% in February, whilst January??™s initially reported 0.1% decline was revised to a fall of 0.2%. True, the decline was heavily concentrated in the transport equipment industries (down 1.3%), but on the downside there were no compensating significant increases anywhere else. Fortunately, a further recovery in output from the extraction and utilities industries meant that the overall industrial sector fared somewhat better, but even here production contracted by 0.2% against a central market expectation of a 0.3% rise. The bad news is that the three-month on three-month rate of change now stands at -0.2%, the same as in December. Although it should improve in March, once again it looks as though the industrial sector will provide little, if any, support to overall GDP growth in Q1. Moreover, it also suggests that the inventory adjustment we saw in Q4 has continued into Q1. Looking ahead, the sustained revival in the CBI output expectations balance in recent months (+20% plus in both February and March) would tend to suggest, at face value at least, that conditions within the manufacturing sector ought to be improving. However, whilst there is indeed a strong correlation between the CBI survey and official manufacturing output figures, on a number of occasions in the past output expectations have badly exaggerated the upside potential for manufacturing activity. With sterling strong and activity in the US slowing, we would be very surprised to see manufacturing output accelerate markedly over the coming few months. The consensus is looking for a 0.3% increase in industrial production in March.

10/5 MPC Interest Rate Decision
In April, the MPC voted seven to two to leave interest rates at 5.25%. However, the minutes of the meeting clearly revealed that there are in fact two distinct camps within the no-change group. For one group, there were particular concerns about the outlook for the US economy and UK consumer demand (as we would argue), and whilst there were upside and downside risks to inflation over the medium term, the near-term prospect was for inflation to fall towards target over the next few months. For the second group, however, the balance of risks to inflation remained to the upside over the medium term. Domestic demand remained buoyant, whilst the current 3% or so rate of growth in producer prices, if sustained, was incompatible with achieving target inflation over the medium term. With revised Bank of England growth and inflation projections available, the consensus expects at least three members from this latter group to join with Messrs Besley and Sentence in pushing through a quarter-point rate hike this month. However, David Blanchflower and probably Rachel Lomax are likely to remain in the no-change camp. Speculation of a half-point rise looks just that ??“ speculation. It is certainly difficult to see how such a move would fit in with the Governor Mervyn King??™s stated ambition of increasing the transparency of the MPC??™s decision-making process.

United States (Wednesday, 9th April to Friday, 11th May 2007)

9/5 FOMC Meeting and Interest rate Decision
As expected, the Federal Reserve again held interest rates at 5.25% at its March meeting. However, the markets??™ main interest was always going to be the form of words in the accompanying policy statement. Here, the general consensus was that the Fed had softened its ???bias to tighten??? if not dropped it altogether. Whereas in January the Fed stated that ???the extent and timing of any additional firming (our emphasis) that many be needed??¦will depend on??¦ the outlook for both inflation and economic growth???, this time round the statement merely referred to ???future policy adjustments???, implying greater neutrality as regards the direction of policy in the year ahead. Although the statement also acknowledged the potential for high resource utilisation to sustain inflation pressures, financial markets are now pricing in at least one quarter-point cut in US interest rates before then end of the year. The minutes of the meeting were more hawkish than expected, however, suggesting the change in wording had been driven more by growing downside risks to the real economy than growing confidence that inflation would moderate as expected. The Fed is expected to keep interest rates at 5.25%, but again the key interest will be in the wording of the policy statement.

10/5 Trade Deficit (Mar)
Not for the first time in recent months, the February international trade report was better than expected. With the consensus looking for the goods deficit to widen out again after January??™s sharp improvement, the shortfall narrowed further in February, declining from $65.1bn to $64.5bn. Whilst still huge by any other country??™s standard, this was the smallest visible trade deficit since August 2005. However, the bad news was that with exports falling 2.9% on the month, the improvement only came about because of a 2.1% fall in imports (much higher base). In so far as this has been interpreted as a further indication of the weakness of domestic demand, the dollar weakened further on the release of the figures. However, going forward, we expect net trade to make a modest positive contribution to growth in 2007. Financial markets anticipate a wider deficit of $66.1bn in March.

11/5 Retail Sales (Apr)
Although US retail sales grew by a larger than expected 0.7% in March following an upwardly revised 0.5% in February (0.1% previously), there remains a considerable amount of uncertainty about where US consumer demand goes from here. True, excluding autos, sales growth was even stronger increasing by 0.8% on the month, but with gasoline prices rebounding, if we further exclude spending at gas stations, underlying nominal sales expanded by a comparatively modest 0.4%. Whilst this left the increase in Q1 (on all measures) looking extremely buoyant compared with Q4, if we also take account of price effects a very different picture emerges. After 0.1% increases in March and February and a 1.0% decline in January, overall retail sales in real terms were up only 1.6% at annualised rates in Q1, a sharp deceleration on the 3.1% recorded in Q4. Granted, excluding autos real spending accelerated during the period (2.5% from 1.8%), but after allowing for ???forced??? spending on more expensive gasoline, volume growth slowed from 6.3% to 0.6%. The consensus expects nominal retail sales to rise 0.4% in April.

Eurozone (Wednesday, 9th April to Friday, 11th May 2007)

10/5 ECB Interest Rate Decision
As expected, after having raised interest rates a further quarter-point to 3.75% in March, the ECB left policy unchanged in April. Moreover, by not using the phrase ???strongly vigilant??? as he announced the decision, ECB president Jean-Claude Trichet all but confirmed that rates would also remain on hold in May. However, by stating that upside risks to inflation remained and that the current monetary stance was still ???on the accommodative side??? he also hinted that the ECB had not yet finished raising interest rates. June looks the best bet for the next rise, after which the ECB is then likely to pause.