BAse rates on hold but for how long?

Base rates on hold this week as the MPC voted to hold rates at 0.5% and withstand any further pressure to increase QE above the £375 billion level. Speculation continues that rates will remain on hold into 2016 but can we really be so sure that UK base rates will remain at such low levels for a further three year period?

In the USA Bernanke has opted for a QE infinite policy, injecting $85 billion monthly into the US economy until unemployment falls below 6.5% or inflation ticks higher above the 2.5% level. So much for forward guidance, it just gives the markets more things to fret about.

In Europe the ECB held rates this week, forecasting negative GDP growth this year of -0.6%. Croatia with slowing growth and rising unemployment meets the convergence criteria apparently and will join the ranks of the soaring unemployed in Europe. It really is a difficult international back drop, against which to set rates in the domestic economy.

The latest signals are that rates will rise sooner rather than later in the UK as a raft of data suggests the recovery in the second quarter could continue at trend rate of over 2%. Car sales in April and May have increased by almost 10% compared to 2012 and latest data from the British Retail Consortium suggests retail sales in May increased by almost 2% like for like.

More convincingly, the latest survey data from Markit/CIPS PMI® surveys suggest the worst may be over in the construction sector. The short lived fillip to output from the outgoing labour administration has now worked it’s way in and out of the system. The latest boost to new home construction from the Treasury Homes for Heroes campaign may be having some effect. The construction index moved into positive territory led by residential building activity.

The UK manufacturing sector continued its positive start to the second quarter of 2013. After returning to growth in April, May saw operating conditions improve at the fastest pace in over a year, with growth of production and new orders both improving. At 51.3 in May, up from 50.2 in April, the seasonally adjusted Markit/CIPS Purchasing Manager’s Index® (PMI®) posted its highest reading since March 2012 and remained above the neutral 50.0 mark for the second straight month.

But it was in the service sector, the most positive signals to growth were found. The headline seasonally adjusted Business Activity Index hit 54.9, up from April’s 52.9, the index signaled a strong rate of growth, the largest since March 2012. New business activity increased at the fastest rate for three years.

It has been a great couple of weeks for the Chancellor, with inflation falling, the deficit dropping and growth confirmed in the first quarter. Even the trade figures improved in April according to latest data this week. Alas, the improvement in trade for the wrong reasons, imports fell as exports remained flat. No signs of a booming economy in the second quarter but survey data suggests the recovery is continuing at a respectable pace. The UK economy should experience growth well above 1.0% this year, despite the problems in Europe. No pressure for rate rises in the short term.

What happened to sterling?
It’s all about dollar weakness this week. Sterling rallied to 1.552 from 1.5198 against the dollar and to 1.1763 from 1.1687 against the Euro. The Euro dollar closed at 1.3216 from 1.2996 and against the Yen, the dollar closed below the critical 100 level at 97.6. Why? US jobs data suggests more QE is guaranteed in the short term.

Oil Price Brent Crude closed at $104.56 from $100.39. In June last year Brent Crude averaged $95! The best for inflation may be over, oil prices will be up 10% this month compared to last year.

Markets, settlement week. The Dow closed at 15,248 from 15,115. The FTSE closed at 6,411 from 6,583. The easy calls have been made for the moment. Nervous money should move to the sidelines before the Autumn moves.

UK Ten year gilt yields increased to 2.09 from 2.03 - US gilt yields closed up at 2.18 from 2.13. The great rotation continues albeit at a subdued rate.

As for gold, closed at $1,384 from $1,387. The excitement is over for now, this is a hung chart.

That’s all for this week, don’t miss The Sunday Times and Croissants out tomorrow. 

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