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December 17, 2008

Increasingly-Grim Outlook for UK Implies Lower Rates and Weaker Sterling
by Victoria Marklew

The economic news out of the UK is ever more grim. Today was the turn of employment and retail sales. Claimant count unemployment surged by 75,700 last month, taking the number of unemployed by this measure past the psychologically-important one million mark for the first time since 2001. The broader ILO-basis jobless rate rose from 5.8% in the three months to September, to 6.0% in August-October. As unemployment is usually a lagging indicator, the fact that jobs are being shed at this fast a pace this early in the economic downturn points to a harsh year ahead for employment.

Chart 1

The CBI's distributive trades survey reported this morning that retail sales dropped in early December at their fastest annual pace since the series began in 1983, with the survey balance coming in at -55, down from -46 in November. Expectations for January were also at a record-low at -49. The survey supports anecdotal evidence that deep price cuts by retailers and the government's VAT rate cut earlier this month (from 17.5% to 15.0%) are not tempting buyers into the stores in this key pre-Christmas period.

This morning also brought the minutes of the Bank of England's policy meeting on December 4. Not only was the vote to slash the repo rate by another 100bps unanimous, but the nine Monetary Policy Committee (MPC) members discussed an even larger cut. They decided not to make a more aggressive move for fear of unnerving the markets and triggering an excessive drop in sterling. On the other hand, the members appeared to welcome the sharp fall in the currency in recent weeks, noting that it should help to boost export growth.

Governor King made the same point about the currency in his open letter to the Chancellor yesterday - which was necessitated by the fact that the headline inflation rate came in above 4.0% again last month (at 4.1%). Warning that the outlook for the economy has worsened in recent weeks, the Governor said that there is a risk going forward that inflation could drop below 1% next year. Coming in the wake of the Fed's move yesterday, Governor King's comments, the increasingly dismal economic data, and the very dovish stance of the MPC all point to the BoE continuing with aggressive easing in early 2009. The markets are expecting another 50-100bp rate cut at the January 8 policy meeting, and 100bps is looking more likely. With the European Central Bank taking a less aggressive stance for now, this implies that sterling will continue to plumb record lows against the euro heading into 2009.

Chart 2

Norway's Central Bank Slashes Rates, Warns of Recession

Norway's central bank today slashed its sight deposit rate by a record 175 bps, taking it to 3.0%. Stating that the risk of a "pronounced downturn" in the economy has increased, Norges Bank warned that real GDP is likely to contract in Q4 2008 and again in Q1 2009 - a marked contrast to its forecast of continued growth made just two months ago.

Chart 3

Noting that inflation is likely to fall below the 2.5% target over the course of 2009, the bank also lowered its policy rate projections. It now anticipates the deposit rate being in a range of 2.0-3.0% by late March, and bottoming out at 1.95% in December 2009.

With recent data confirming a sharp slowdown in activity, along with fast-falling business and consumer confidence, Norges Bank looks set to lop at least another 50bps off its sight deposit rate at the next scheduled policy meeting on February 4. This expectation is likely to keep the Norwegian crown at record lows against the euro over the coming weeks.

Chart 4

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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