Research Dept. News
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Monthly Report, num 285 - November 2005
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European Union - United Kingdom
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United Kingdom: rise in inflation complicates monetary policy
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In United Kingdom, after hitting bottom in second quarter, economy moves into modest recovery mode in third quarter, although poor state of consumption reduces recovery potential.
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The British economic picture continues to become complicated as the year ends. After growing by a modest 1.5% year-to-year in the second quarter, prospects are for a contained improvement in the second half-year and the initial publication of the GDP for the third quarter, with growth of 1.6% year-to-year, confirms this scenario.
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In any case, available indicators for the third quarter continue to show a troubling weakness in private consumption. With retail sales growing at a modest 0.7% year-to-year in September, consumer confidence at annual lows as of September and industrial production of consumer goods dropping by 0.5% year-to-year in August, the drive in household consumption will necessarily be limited. On the positive side stands investment which seems to be settling into an upward path.
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Nor can we expect any sharp recovery from the foreign sector. Although growth of exports is satisfactory, with an 11% year-to-year rate of increase in the second quarter and a similar rate in the July-August period, the recent rise in imports is increasing the British trade deficit.
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A review of supply indicators, which are more sensitive for determining changes in cycle, shows a slightly better situation, with economic sentiment regaining ground in the third quarter, mainly because of the trend in industrial confidence and in services. Nevertheless, industrial production figures remain negative (year-to-year drop of 1.9% in August).
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In situation of weakness in economic activity combined with rise in prices, monetary policy faces dilemma of helping consolidate recovery or halting inflationary spiral before it starts. Bank of England watches while making no change in interest rates at past two meetings.
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In this situation of gradually emerging from a stage of low growth, the rise in prices has complicated the scene. In September, the CPI grew by 2.5% year-to-year, whereas producer prices rose by 3.3%. Although the increased price of oil was the main culprit for the rise in inflation, the truth is that this is making it difficult for the Bank of England to orient its monetary policy.
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To start with, its stated inflation objective which establishes that consumer prices must not go above 2% year-to-year, has been exceeded by a half percentage point. Furthermore, forecasts indicate that the current inflation level will scarcely be reduced in coming quarters and that it is not expected it will go below 2% all through 2006. The dilemma of the Bank of England, whether to contribute to consolidate recovery or to urgently halt inflation, is patent. For the moment, in its last two meetings on September 6 and October 8 respectively, it opted for maintaining the reference rate at 4.5%.
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