Strong UK data last week and the decision by the MPC to expand quantitative easing (QE) by less than expected supported the pound. Ahead this week, positive BRC retail sales and RICS house price reports may provide further succour in the short term. However, there is risk of a more dovish BoE Inflation Report on Wednesday which may again show inflation undershooting the target in the medium term. A continuing wide negative output gap and constrained credit conditions are the factors that the MPC cited in its letter to the Chancellor last week requesting extension of QE to £200bn. Assuming these arguments appear in the Quarterly Inflation Report this week, the inflation projection could show CPI inflation below target over the 2-year horizon, even with a continued loose policy stance. But the Governor also warned of the risk that consumer price inflation could rise sharply in the early part of 2010. This suggests that the shape of the inflation profile may shift from the last QIR in August, see chart below, to show a rise near term but a fall below target longer term. Labour market data are also due on Wednesday. For all the talk that the extra £25bn of QE announced last week will be the last, much still depends on the outlook for economic activity. Although recent indicators point to a return to growth in Q4, it is still not clear how strong growth will be in 2010 if policy accommodation is reversed.
In the euro zone, Germany will release September industrial production today, ahead of the first estimate of EU-16 Q3 GDP on Friday. Germany and France already posted positive quarterly growth in Q2 and so are technically out of recession. For the euro zone as a whole, however, quarterly growth was slightly negative in Q2, but it is expected to be positive in Q3. In line with the market consensus, we expect euro zone GDP to have risen 0.5%. The surprise would be if this were not the outcome. PMI data in recent months show a trend toward recovery. The only note of caution is that looking purely at business sentiment suggests that the consensus forecast may be too high. Comments from Trichet last week imply that some of the monetary loosening may start to be withdrawn soon. A positive outcome to the data this week will likely hasten this outcome. But money supply data suggest that growth will still be weak, so there may no quick rise in official interest rates. The German ZEW survey of investor sentiment on Tuesday will also receive attention.
Last week, US Data showed that the unemployment rate rose to 10.2% in October, up from 9.8% in September as non farm payrolls fell by 190,000. The unemployment rate has not been above 10% since 1983. The outcome is clearly negative for US consumer spending and growth prospects and suggests that the Fed could keep interest rates at record lows for some time yet, while waiting for signs of sustained improvement in underlying labour market trends. US bond markets will digest $81bn of supply this week, starting with $40bn of 3-year notes this evening. The trade balance and the University of Michigan consumer sentiment survey, both on Friday, are the main data releases. Elsewhere, China will release a raft of data on Wednesday, while the Bank of Korea on Thursday is expected to keep rates unchanged at 2%, but strong growth there means that the start of policy tightening could well occur in the coming months.
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