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July 23, 2008

Hawkish Bank of England Even As Economy Slows
by Victoria Marklew

The relentless stream of negative economic news out of the UK has the headline writers dredging up the old specter of stagflation - a "stagnant" economy with rising inflation. While the UK isn't at the point of recession yet, and there is reason to suppose that the headline inflation rate will start to ease come year's end, the outlook is certainly deteriorating. All told, it was no surprise when the Bank of England's (BoE) nine-member Monetary Policy Committee (MPC) left the repo rate unchanged at 5.0% on July 10. However, this morning's release of the minutes of that meeting did contain a bit of a surprise: while seven of the members opted to leave rates on hold and one argued for a cut, the ninth member had argued in favor of a rate hike. Not only was this three-way split unusual (the first in two years), the tone of the meeting was surprisingly hawkish, with the members debating the need to raise rates to defend their reputation as guardians of price stability. Aside from the one consistent dove on the Committee, there seems to have been little support for considering lower rates. In the end, it was concern that an unexpected rate hike would rattle already-fragile financial markets at a time when the economy is slowing that stayed their hand.

Meanwhile, there was more negative data today. The Confederation of British Industry's (BCI) industrial trends survey showed the total order books balance fell back into negative territory this month, with a reading of -8 versus +1 in June. This brings the past three months' balance to -3, down from +1 in April and +11 in January, while the outlook for orders over the next three months dropped to -12 from +2 in April and +4 in January. The quarterly business optimism balance plunged to -40 in July, down from -23 in April and the weakest reading since October 2001. All told, the survey shows a very weak manufacturing sector heading into Q3.

Chart 1

The labor market has been holding up so far, with (ILO basis) unemployment at 5.2% in March- May, the same rate as in December-February. However, last week's claimant count report showed that the number out of work and claiming benefits rose for the fifth consecutive month in June, and the increase of 15,500 was the largest since December 1992. Today's CBI survey added to fears of a bleak employment outlook. A balance of 27% of firms expect to reduce their headcount over the coming months, a deterioration from 17% in April.

Finally, the housing sector slowdown continues to accelerate toward an outright slump. The British Bankers' Association today reported that mortgage approvals for house purchases - a leading indicator for the market as a whole - plummeted 67% on the year in June to just 21,118, the lowest number since the series began in September 1997.

Chart 8

The MPC noted in their meeting earlier this month that Q2 GDP growth may be slightly stronger than expected but that survey evidence and other reports suggest the economy is continuing to slow. The first look at Q2 GDP comes this Friday, July 25.

Victoria Marklew
The Northern Trust Company
Economic Research Department
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

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