Market Preview: UK homeowners anxiously await BoE decision on rates

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British homeowners are in for a nervous wait as an increase in UK interest rates on Thursday cannot be ruled out. Just one city economist forecast January’s surprise rate rise but a repeat move is thought unlikely, with only five out of 62 analysts expecting an increase this month.

However, Michael Saunders of Citigroup regards the chances of a rate rise in February as high as 50:50, greater than the low probability priced in by the market.

Mr Saunders expects early action by the Bank of England because inflation risks are rising, through high nominal demand growth, reduced deflation in consumer goods, and a pick-up in inflation expectations and pay deals.

Back-to-back rate increases are rare – the last occasion was in the summer of 2004 – but this week’s data releases will illustrate why the risks of further monetary tightening are rising.

Activity in the UK service sector is running at a 10-year high and this was an important factor behind last month’s rate rise. January’s purchasing managers’ (PMI) survey, due out on Monday, is expected to ease back from 60.6 in December to 60.1 (above 50 indicates expansion) but this marginal fall would not indicate a significant slowdown. The drop in new business in December, if repeated in January, would suggest activity should begin to cool. However, inflationary pressures – the prices charged measure – has shown little sign of moderating.

Developments in wage settlements and consumers’ inflation expectations remain crucial for the interest rate outlook.

The latest pay settlements information shows a rise from 3 per cent in the three months to December to 3.5 per cent in January which Income Data Services attributed to higher inflation. The sample was relatively small but this muted rise could provide some comfort to the Bank of England which has clearly anticipated upward pressure on wage settlements. Ben Broadbent, senior European economist at Goldman Sachs, says pay settlements could rise by at least 1½ percentage points compared with last year while maintaining inflation below target.

The evidence for how consumers are reacting to higher interest rates remains mixed. The British Retail Consortium’s survey, due on Tuesday, is expected to show a rise of 2.5 per cent in like-for-like sales value in January, unchanged from December.

However, last year’s record level of insolvencies – at 107,288 – highlights the vulnerability of many households to rising interest rates. Mortgage repossession rose 28.7 per cent to 91,195 last year and, with household debt at record levels, pressure on borrowers looks set to increase.

Howard Archer of Global Insight says: “The debt problem may not be a major overall threat to the economy [but] it will have a limiting impact on consumer spending and overall growth.”

UK manufacturing output for December, due on Wednesday, is expected to slow from 2.4 per cent in November to 2.1 per cent.

In Germany, factory orders for December, due out on Monday, are expected to rise from 6.1 per cent in November to 7.4 per cent. Germany’s manufacturing sector grew by 6.2 per cent year on year in November and another strong rise of 6.1 per cent is expected for overall industrial output in December data, also due out on Monday.

In France, manufacturing output is expected to rebound from -0.2 per cent year on year in November to 1.3 per cent in December’s data, due on Friday.

January’s eurozone service sector PMI, due out out on Monday, is expected to moderate from 57.2 in December to 56.9.

Eurozone interest rates are expected to remain unchanged at 3.5 per cent on Thursday but an increase in March has been strongly signalled.

There is limited economic information due from the US this week. US productivity data, due on Wednesday, is expected to rise by 1.2 per cent (annualised) in the fourth quarter, a healthy improvement on the 0.2 per cent recorded in the third quarter. Growth in unit labour costs is expected to rise from 2.3 per cent to 2.5 per cent.

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