Economic Outlook: King under pressure to raise UK interest rates

A rise in UK interest rates on Thursday looks likely after Mervyn King, governor of the Bank of England, was narrowly outvoted over an increase in June.

“It is not quite ‘back me or sack me’ but as the governor acknowledged recently, he cannot be at odds with his committee on a regular basis,” says Ross Walker, UK economist at Royal Bank of Scotland.

Mr Walker says the members of the Monetary Policy Committee who favour higher rates appear to be hardening their position after the June meeting minutes said “a slowing of demand growth to below potential was probably necessary if inflation was to hit the target”.

This week’s data releases will illuminate some crucial issues for policymakers and could have a vital influence on whether UK rates rise to 6 per cent before the end of the year.

Pricing pressures are key concerns in the UK purchasing managers’ surveys for manufacturing (due on Monday) and the service sector (due on Wednesday). A rise in the manufacturing output prices series from May’s 56.9 would take it into record territory. (A reading above 50 indicates an increase compared to the previous month). The headline measure for the June manufacturing PMI is forecast to remain unchanged at 44.9 after a stronger than expected showing in May.

Prices charged in the service sector retreated to 52.5 in May but this series has been recording upward pressure since January 2002. New business and employment are continuing to rise and, combined with rising food prices, these suggest service-sector inflationary pressures will remain elevated.

The headline measure for the June service-sector PMI is expected to remain stable around 57.2.

The Halifax will release house price inflation data for June this week, with a rise from 10.6 per cent in May to 10.8 per cent expected. This would confirm the strength seen in Nationwide’s June survey last week. Combined with an unexpected spike in mortgage approvals in May, these data could bolster policymakers concerns over inflationary pressures, even though a moderation in housing market activity is clearly underway.

Friday brings the official date on UK manufacturing output for May with a year-on-year growth expected to moderate from 1.3 per cent in April to 0.9 per cent.

Eurozone interest rates are expected to remain unchanged at 4 per cent on Thursday but the European Central bank will reiterate its concerns about inflationary pressures due to high oil prices, strong money supply growth and rising capacity utilisation. Further increases in interest rates have been priced in by money markets before the end of the year and it is unlikely that the ECB will signal any significant change in its stance from the June meeting as unemployment is continuing to decline and money supply growth remains uncomfortably high.

Manufacturing activity in the Eurozone remains robust but has shown signs of softening in recent months, according the PMI survey, as the stronger euro and rising interest rates start to weigh on the sector.

However, the initial estimate for the June survey suggested the headline PMI rose from 55 in May to to 55.4 so the full survey will identify the improvements have happened. One clear seam of strength is the employment measure which is at a six- and-a half year high, suggesting further job gains are likely.

The initial estimate for the June Eurozone service-sector survey indicated that the headline PMI rose from 57.3 in May to 58.3. Again the employment measure has made encouraging gains and the incoming new business measure has hit a 12-month high.

The strength in the employment measures in the PMI’s surveys is one key reason why analysts anticipate an improvement in Eurozone consumer spending in the second half of this year.

Thursday brings Eurozone retail sales with a drop of 0.1 per cent expected in May due to weakness in Italy and Germany. This would slow the year-on-year growth rate from 1.7 per cent in may to 1.5 per cent.

The outlook for the US economy remains balanced between weakness in the housing market and property related sectors and continued signs of strength in the rest of the economy.

The US manufacturing sector is expected to show further recovery in the Institute of Supply Management survey for June, due on Monday. No change is expected in the headline measure from May’s reading of 55 but new orders have shown improvement since November.

The ISM non-manufacturing survey also points to a rebound in US economic growth with the headline measure rising to 59.7 in May, the highest for almost a year, helped by increases for new orders and employment. The consensus forecast for June is for a fall to 57.5.

However, US pending home sales have fallen by 7.6 per cent in the past two months, sinking to the lowest level since February 2003. Tuesday brings data for May with a marginal increase of 0.6 per cent expected.

Friday brings US employment data with non-farm payrolls expected to register a robust rise of 157,000 in June after an increase of 120,000 in May. The unemployment rate is expected to remain unchanged at 4.5 per cent in spite of ongoing weakness in construction and housing related industries.