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ECONOMIC DATA ANALYSIS

 

ONE DOWN, ONE TO GO

 

• Relief rally following EU Summit measures unified political will trumps outstanding questions for now.

• US debt ceiling issue remains unresolved, despite signs of progress. Preliminary US Q2 GDP to highlight sluggish recovery this week.

• Preliminary UK Q2 GDP is due this week and is also likely to prove extremely subdued, with household sector still struggling. Hopes for stronger Q3 on rebound of oneoff effects in Q2.

 

Financial markets heaved a sigh of relief as the latest EU crisis summit passed a wave of new measures to address the worsening sovereign debt crisis. Amidst measures aimed at supporting Greece directly, including a further €109bn bail out and private sector involvement hoped to total around €40bn, the summit also announced changes for the wider region. Bail out conditions for Portugal and Ireland were also eased with an interest rate reduction and repayment extension. r the scope of the EFSF was greatly expanded, including engagement in secondary market bond purchases. But as much as anything, it was the refound political will to solve the crisis a collective determination described by new IMF Chief Lagarde as “a bit of a first” that added to market confidence. In its wake, the Italian ten year government bond spread over Germany narrowed by over 100bps in a week; equities jumped in excess of 5% and the euro rose to $1.44 from $1.40. With little top tier data to guide them markets are likely to engage in nsidered reflection on the new measures this week particularly how they will be funded.

 

The standoff over the US debt ceiling continues, although substantive progress appears to have been made with the ‘Gang of Six’ proposals. The 22 July ‘soft deadline’ has been missed, while President Obama conceded a willingness for a shortterm fix if it allows time to agree something “big and meaningful”. The coming week sees Q2 GDP, which we expect to be sluggish and Q2’s corporate earnings season continues.

 

Echoes of this will be heard in the UK where preliminary estimates of Q2 GDP also look set to be subdued. We also expect to see further signs of household distress falling consumer confidence and sluggish borrowing.

 

Eurozone HICP : As markets consider the implications of the recent summit measures, price pressures continue to mount across the wider currency union. We look for July’s preliminary euro area CPI to register an annual outturn of 2.8%, compared with 2.7% in June. Energy prices have fallen back during the month, but the annual CPI rate is likely to be boosted by clothing and household base effects. We look for euro area price pressure to peak around 3% later in the summer. Inflation expectations, however, remain under control with little evidence of ‘second round’ effects feeding into wages against a backdrop of extreme volatility in government bond markets. Nevertheless, the ECB seems unlikely to lose its focus on the inflationary threat and we still forecast a final increase in the refi rate to 1.75% before year end.

 

US GDP : While markets continue to watch the high stakes political battle that surrounds debt ceiling extension, this week will provide an update of the underlying health of the US economy. We expect to see confirmation that the pace of growth slowed for the second successive quarter as consumer spending struggled in the face of higher commodity prices and the impact of the Japanese earthquake on auto sales. We forecast annualised growth of 1.7%, from 1.9% in the first quarter. Durable goods purchases are expected to bear the brunt, with a sharp decline likely, while overall spending growth is forecast to slow to 1% from 2.2% in Q1. The main offset is predicted to come from stronger fixed investment spending on the back of a bounce in construction after the adverse weather conditions in Q1, but growth in business equipment spending is set to soften on renewed concerns about the outlook. Net exports should also contribute gnificantly to Q2 GDP growth than in Q1, while both government consumption and inventories should detract from growth. The report will also include annual revisions back to 2003. Looking ahead, key surveys appear to have reached a bottom, but are yet to post convincing signs of rebound. July’s Chicago PMI on Friday will provide a further update on the outlook for Q3 GDP.

 

UK GDP : Amidst obal tensions, the UK recovery has floundered in recent quarters. Q1 saw expansion of 0.5% following Q4’s 0.5% decline, meaning the economy stagnated around the turn of the year. The first print of Q2’s release on Tuesday could add to the sense of foreboding. We forecast ‘growth’ of just 0.1% in Q2, but concede that we see downside risks to this outlook. While a soft Q2 would further bolster market expectations for Bank Rate to be on hold until end2012 – and may add to calls for further QE we suspect that this weakness has been exacerbated by oneoff factors. Manufacturing output was affected by the

 

UK GfK consumer confidence : Underpinning the sluggish pace of GDP is weak household spending growth. The level of consumer pessimism seen in H1 2011 has only been worse twice over the past three decades: during the financial crisis and in the early 1990s. While GfK recorded a steep climb in May, we think this reflected the Royal Wedding effect, which unwound somewhat in the next month. We expect a further weakening in July and pencil in a drop in the headline index to 27 from 25. Real incomes will remain under pressure in Q3, with steep increases in utility tariffs already announced. This will maintain households’ gloom and leave the economy needing a pickup in activity from nonconsumer sources.

 

BoE personal lending : A subdued household sector and weak confidence does not bode well for household borrowing. We forecast a modest increase in consumer credit in June, with consumers taking advantage of high street discounting, but using credit to do so. The housing market appears to remain in a state of torpor. Admittedly the RICS housing survey suggests modest improvement, while CML gross lending jumped sharply in June. However, we suspect that mortgage approvals will continue to fall on the year, pencilling in 46k in June, while mortgage lending is expected to remain at £1.1bn. While still increasing nominally, outstanding mortgage debt should account for just over 80% of GDP in 2011, from 85% in 2010.

 

DIsclaimer

 

Whilst Lloyds TSB Bank plc and Bank of Scotland plc have exercised reasonable care in preparing this material and any views or information expressed or presented are based on sources it believes to be accurate and reliable, no representation or warranty, express or implied, is made as to the accuracy, reliability or completeness of the facts and data contained herein.

 

 

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