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August 19, 2006

Bank of England Will probably Hike Again in Q4 - But Only If Data Support Its Outlook
by Victoria Marklew

August 16, 2006: Today's minutes of the BoE's August 3rd Monetary Policy Committee (MPC) meeting, along with earnings and unemployment data for June and inflation data for July, point to another rate hike before the end of the year - but only if the data over the next few months continue to support the BoE's forecasts of a steady growth in consumer spending and rising energy bills and earnings.

At the August 3rd meeting, the MPC members voted 6-1 for a rate hike, with the holdout wanting no change because of concern about the state of the labor market. Recall, the members moved from a balanced view in early July to an outright hike in early August. The trigger appears to have been revised data pointing to much less spare capacity in the economy than previously thought. Policymakers were particularly concerned that rising inflation heading into the new year could boost wage settlements, which tend to be made in January.

Today's data on annual average earnings growth validated these concerns, with earnings rising 4.3% in the three months to June, up from 4.1% in May. The BoE has said that wage growth below 4.5% is consistent with stable prices. If the number keeps edging upward, a Q4 rate hike becomes much more likely.

On the other hand, the unemployment rate also is heading upward, coming in at 5.5% in April-June (5.2% in January-March), the highest in six years. A looser labor market would tend to keep a lid on earnings growth.

Last week's Quarterly Inflation Report from the BoE showed inflation remaining above its 2.0% target in two years, even with the recent hike to 4.75%. BoE Governor King said "there is particularly great uncertainty about the short-term outlook for inflation" and warned that there is a 50-50 chance that inflation would climb past 3.0%. This would force the governor to write an explanatory letter to the government.

July's headline harmonized consumer price index eased a tad, falling 0.1% on the month for an annual rate of 2.4% (2.5% in June). However, the uncertainty centers in large part on higher college tuition fees, which will show up in the October inflation data. There's also the impact of higher energy bills. Utility prices rose at a record rate in July, and suppliers reportedly plan more price hikes in the coming months. If price pressures continue to build over the next few months, a Q4 rate hike becomes probable.

All told, we're left with the usual mantra in times of economic uncertainty: watch the data. July retail sales numbers come out tomorrow; mortgage lending and consumer credit data for the month will be released August 30; and the GfK August consumer confidence survey is released August 31. The MPC will stand pat at the September 7th policy meeting, but the markets will study subsequent August data very closely - particularly CPI on September 12; unemployment and earnings on September 13; and the minutes of the September 7th meeting, which will be published on September 20th.

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.

Copyright © 2005-2008 The Northern Trust Company

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