Chief Economist's Weekly Brief - Deflating fears
Deflation risks are receding across the advanced economies. Japan is the exception, where falling prices threaten to stifle its nascent recovery.
The minutes from the November Monetary Policy Committee (MPC) revealed a three way split. The majority voted to expand QE by £25bn. But David Miles was in favour of a bigger boost (£40bn) to provide greater insurance against downside risks to growth and inflation. Spencer Dale voted against an increase, fearing that further injections may add fuel to asset price bubbles and so prove costly to rectify, as well as complicating the task of meeting the inflation target in the future. Policymakers will have taken some heart from the news that the amount of money circulating in the economy picked up last month. Money holdings grew by 1.8% m/m in October.
The Treasury's borrowing projections may still be met, but hopes of an undershoot appear to be receding. Previous data had pointed to an underlying improvement. Just a month ago, an extrapolation of the trends in the first half of the fiscal year suggested that the full year deficit would be just over £150bn. While this still pointed to a gigantic hole in the government’s coffers (c10% of GDP), it would still have been some way below the Treasury’s £175bn forecast, made at the time of the Budget.
But October’s figures were something of a car crash, with a monthly deficit of £11.4bn - almost twice as large as analysts had expected. As a result, the full-year projection has surged to over £170bn - a dramatic deterioration in the space of a month. The moderation in public spending in October is welcome, but the fact that borrowing still exceeded expectations serves to emphasise the scale of the collapse in revenues.
Consumer price inflation jumped in October. The rise to 1.5% from 1.1% in September was almost entirely the result of gyrations in oil prices. Rising prices for second hand cars, an unintended consequence of the scrappage scheme, also contributed to inflation, as did rising food and DVD prices.
But price rises weren’t uniform across the economy. In fact, retailers sacrificed margins to get shoppers through the door. Clothing prices fell almost 6% compared to last year, helping lower retail prices for the fifth consecutive month. But this strategy looks to have done the trick - sales volumes were up a healthy 3.4% y/y, the largest rise in seventeen months. This was driven by a rebound in spending at clothing stores, possibly as consumers stocked up on winter wear, while stabilisation in the housing market probably helped household goods stores.
Falling prices remained a feature of the US economy in October. Consumer price inflation was negative for the eighth, and likely last, consecutive month at -0.2% y/y, down from -1.3% in September. As the steep declines in oil prices drop out of the calculation, inflation is likely to tick up.
US retail sales rose by 1.4% m/m in October. Demand has gradually returned since April’s low point but sales remain down on last year. Core retail sales, which exclude autos and gasoline, and are a better assessment of consumer demand, advanced by 0.3% m/m and stand only a fraction below last year’s level. Three consecutive monthly increases confirm an improvement in US consumer demand.
But US housing market data were disappointing. Housing starts tumbled by nearly 11% m/m in October to 529K units, the lowest level since April. Declines were seen across every region and sector, with the steepest falls in the number of multi-family developments started (-35% m/m). The expiration of the homebuyer tax credit in November would have weighed heavily on groundbreaking activity. The extension of this scheme in both length (to April 2010) and coverage (beyond first time buyers), mean that starts are likely to pick up again soon.
The Japanese government declared that their economy had slipped back into deflation. The last period of deflation ended only in 2006, after consumer prices in Japan had fallen almost continuously for seven years. A sustained period of deflation increases the risks of the economy contracting again as consumers delay purchases and spending falls. Nationwide spending at department stores fell by 11% last month, prompting government calls for the central bank to keep policy simulative. But with rates on hold at 0.1% there may be little extra the Bank of Japan can do.
Gold recorded yet another record high last week, hitting $1,152 per ounce. The gold rally appears to stem from investors seeking to hedge against a weak dollar as well as strong demand from China driving the price upwards.