ECONOMIC DATA ANALYSIS - SPECTRE OF GREEK PSI ECLIPSES FED MEETING

ECONOMIC DATA ANALYSIS
FRIDAY 20 JANUARY 2012
SPECTRE OF GREEK PSI ECLIPSES FED MEETING
• Greek PSI deal disappointment could derail fragile improvement in confidence.
• US Q4 GDP to post upside surprise, Fed policy expected unchanged, but policy goals debated?
• UK Q4 GDP to show start of renewed recession, MPC minutes to record votes for more QE.
Last week’s positive tone ended abruptly with S&P’s ratings downgrade of key Euro area economies. Nevertheless, sentiment has slowly inched higher, in part on improving US releases, including corporate earnings reports, but also on successful European debt auctions and the prospects for the Greek debt restructuring (PSI). A Greek PSI deal will be key for the coming week. On balance we are hopeful that an agreement can be reached for Monday’s finance ministers meeting deadline and will allow at least 70% participation in the debt exchange before end- February. A failure to clear this hurdle could overturn this year’s early optimism. Finance ministers will also discuss wider issues surrounding the second Greek bail-out package and, ahead of next week’s leaders’ Summit, the fiscal compact and withholding tax proposals. Economic news in the Euro area, including ‘flash’ estimates of January’s PMIs and key German and French business surveys are likely to post gains - flagged by this week’s German ZEW survey. This casts doubt on whether the Euro area will see a technical recession, with Q1 possibly escaping contraction after Q4’s sharper than expected drop.
US events this week will see it try to reassert itself as the dominant driver of global sentiment. Despite South Carolina’s Primary on Saturday, markets will await Wednesday’s key Federal Reserve announcement and Friday’s first estimate of Q4 GDP. We see little chance of the Fed changing policy, despite more dovish tones from some officials over the past month. With the US showing some signs of shaking off its credit crisis hangover and the Fed mid-way through its Maturity Extension Program (MEP), we see little need for additional stimulus at this stage. But the first two-day meeting ahead of the semi-annual testimony to Congress is always important. The Fed will additionally publish individual members Fed Funds rate forecasts from this meeting. It may also see discussion regarding inflation targeting. First estimates of Q4 GDP on Friday will also prove interesting. We are optimistic of nascent signs of recovery, but our 3% (annualised) forecast for Q4 GDP owes much to a short-term inventory effect. That said, we remain relatively upbeat for 2012 as whole, forecasting 2½%.
The UK will see a similar focus. Wednesday brings both first estimates of Q4 GDP and minutes to January’s MPC meeting. Despite a buoyant quarter for retail activity, official releases have otherwise been bleak. This has led us to forecast a 0.2% reported contraction in Q4 GDP (weaker than the consensus -0.1%). Yet even this assumes upward revisions to initial official estimates. On our view, the UK is unlikely to reverse this decline until H2 2012, with risks remaining skewed to the downside given Euro area developments. Given this sobering assessment of the UK outlook, we think minutes to January’s MPC meeting may surprise. We think that this meeting will have been a closer decision than many suppose with a debate about whether to pre-announce the expected £50bn QE extension in February. The main argument against is likely to have been to see next month’s Inflation Report projections. Yet we believe some members will have been sufficiently convinced of the need for additional stimulus and will have voted for an increase in the asset purchase target this month. On our view, both GDP and MPC minutes should support gilts although maybe only relatively if a successful Greek PSI deal continues to lift risk sentiment.
UK DATA PREVIEW    FRIDAY 20 JANUARY 2012
GDP (Q4, 1st est.)  Amidst continued euro area turmoil, the outlook for the domestic economy has weakened further of late. Despite the 0.5% expansion in Q3 GDP, the continued deterioration in business surveys and the weak industrial production numbers for November suggest that GDP contracted in Q4. While the sharp drop in October services output adds weight to a large drop in output in the final quarter of 2011, the index is prone to heavy revisions and we look for some of this weakness to be revised away. Nevertheless, the weakness in production surveys is expected to add to the downside risk. This raises the possibility of a larger contraction in Q4 GDP than the - 0.1% suggested by our Business Barometer, and pencil in a fall of 0.2%, bolstering the MPC’s case for further QE.
MPC minutes (Jan) The Bank of England left policy unchanged in January, including its QE target at £275bn. As a result gilt purchases will cease before the next MPC policy decision (9 Feb). With the Bank forecasting inflation to fal l significantly this year; current inflation falling slightly faster still; and GDP likely to undershoot the Bank’s near-term projections, we see a strong case for further QE. We expect the minutes to reveal a close debate in January, with two members expected to have voted for more QE immediately, with others pointing to next month’s Inflation Report projections as a reason to hold off. This would send an important signal to markets, not only that a further £50bn of QE is likely next month, but that additional stimulus is likely further down the line. As such, we see these minutes supporting gilt yields around historic lows.
Public finances (Dec) The impact of the slowdown in economic activity is yet to have a visible impact on the public finances. In December, we forecast PSNBX to total £14.4bn (£11.6bn including financial interventions). The underlying deficit is thus likely to narrow by £1.5bn on the previous year, broadly in line with the average improvement seen this financial year. This suggests the finances may undershoot the revised official PSNB target of £127bn - no mean feat against a background of weakening economic activity. This reflects a marked slowing in central government spending growth, which has slowed to around 1% on the year. The deficit improvement will provide ongoing support to gilts ‘safe-haven’ status. However, a fresh recession is likely to result in disappointing receipts growth as we move into 2012-13.
CBI Industrial Trends Survey – Business Optimism (Jan) The CBI’s quarterly industrial trends survey includes an estimate of business optimism that has proven a particularly good lead indicator for official output. January’s survey will be closely watched for confirmation of the recovery in the manufacturing PMI, which picked up sharply in December to 49.6 from 47.7 in the previous month. We are suspicious of the scale of this rebound. As such, we suspect that the coming week’s business optimism index, which fell to a 2½ year low of -30 in Q4, will post just a modest rebound in Q1. In turn, this suggests that official manufacturing output will struggle to expand in Q1 after what we see as a 1% drop in Q4. The deceleration in global - particularly Euro area - activity has put UK attempts to rebalance on hold. This has been felt chiefly in the manufacturing sector.
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