Bank of England Quarterly Inflation Report is the Main U.K. Economic Release for Week Beginning 9 February

Also on Wednesday, data are expected to show that sharply contracting economic activity is taking an ever-increasing toll on the labour market. Claimant count unemployment is forecast to have surged by 90,000 in January, which would be up from an already worryingly high 77,900 in December. The claimant count unemployment rate is forecast to rise to 3.8% in January from 3.6% in December, and a low of 2.5% in the early months of 2008. The unemployment rate is seen climbing to 6.3% on the International Labour Organization (ILO) measure in the three months to December, and it is very possible that the number of unemployed on this measure could have reached two million. Reports of companies laying off workers are now depressingly commonplace, while a growing number of companies are folding. There is a rapidly increasing danger that claimant count unemployment (1.16 million in December) will reach two million before the end of 2009. Furthermore, unemployment on the ILO measure (1.923 million in the three months to November) seems ever more likely to reach three million by the end of the year.

Meanwhile, average earnings growth is expected to have been muted in December. We expect underlying average earnings growth (excluding bonus payments) to have moderated to 3.5% in the three months to December. Headline average annual earnings growth is seen at an even lower 3.0% in the three months to December. These levels would be substantially below the 4.5% level that the Bank of England considers broadly consistent with its 2.0% consumer price inflation target. Earnings growth seems likely to be significantly weaker in 2009, given that unemployment is soaring, inflation is falling back sharply, and inflation expectations have plunged.

The British Retail Consortium (BRC) retail sales monitor for January (out overnight on Monday/Tuesday) is expected to indicate that sales remained muted overall in January, despite apparent heightened discounting in the clearance sales. The consensus forecast is for the BRC to show that total retail sales fell by around 1.0% year-on-year in January after dropping 1.4% in December. On a like-for-like basis (which strips out the effect of additional floor space), retail sales are seen falling 2.8% year-on-year in January after a drop of 3.3% year-on-year in December. According to the BRC, December's sales were the weakest monthly performance in the survey's 14-year history, excluding distortions caused by the timing of Easter.

It is possible that retail sales were lifted in January by increasingly cash-strapped and pressurized consumers looking to concentrate their spending when they can get the best value for their money and, therefore, being particularly keen to take advantage of the clearance sales. Even if this proves to have been the case though, there seems little doubt that retailers will face a desperately difficult 2009 as consumers cut their spending substantially in the face of major headwinds. This will keep pressure on retailers to price competitively through the year, which will obviously impact on margins. As a result, many more retailers seem certain to go under in 2009.

Consumers are being hit by sharply rising unemployment, slowing income growth, very tight credit conditions, falling house prices, sharply lower equity prices, increased debt levels, and hits to their pensions. On top of this, many consumers are retrenching out of choice, reflecting their deep concerns about the economy and jobs. These factors will undoubtedly hit consumer spending hard through 2009, outweighing the support coming from more competitive pricing by retailers, the VAT cut, and low interest rates. Indeed, the low interest rates are having a mixed impact on consumers, as sharply reduced savings rates are hitting many people hard.

January's housing market survey from the Royal Institute of Chartered Surveyors (out overnight Monday/Tuesday) will be closely watched to see if there are signs that housing market activity is at least stabilizing at very low levels. While the RICS survey has been reporting a marked increase in buyer enquiries in recent months, this has not been translating into higher house sales. Indeed, December's RICS survey showed that completed sales per surveyor fell to a record low of just 10.1 in the three months to November from 10.6 in the three months to October. This was the lowest level since records started in 1978. Meanwhile, we expect the RICS to report that a balance of -72% of surveyors reported that house prices increased over the previous three months. This would be little changed from -73.5% in December. It would mark an 18th successive negative balance, and would still be one of the sharpest on record, albeit up from the record low of -94.9% in April.

There are currently some signs that housing activity may be stabilizing at a very weak level, but the sector remains under substantial downward pressure from recession, sharply rising unemployment, waning income growth, ongoing very tight credit conditions, widespread belief that house prices will fall significantly further, and an unwillingness of many people to commit to buying a house when the economic outlook and job prospects look so bad. On top of this, it is very difficult for many first-time buyers to find the larger deposits that are now widely required of them. Finally, although affordability has improved significantly in recent months as house prices and mortgage rates have fallen, most affordability ratios are still relatively stretched compared to long-term norms. These factors look likely to outweigh—for some time to come—the beneficial impact of lower mortgage interest rates resulting from the Bank of England slashing interest rates, particularly as many buyers with small deposits still face mortgage rates of over 6% (if they can actually get a mortgage). Furthermore, even if government measures aimed at lifting mortgage lending increasingly work, it will clearly take time for confidence to improve and mortgage lending to pick up significantly.

The trade deficit (out Tuesday) is expected to have narrowed modestly in December, after widening sharply in November. While U.K. exporters are benefiting from the very weak pound, this is being more than outweighed by sharply weaker domestic demand in key foreign markets—notably, the Eurozone and the United States. Nevertheless, net trade will benefit from U.K. imports being limited by deeply contracting domestic demand over the coming months. In addition, sharply lower oil prices will help to limit the trade deficit, as the United Kingdom is now a net importer of oil. Of interest to the Bank of England will be what happened to import prices in December. Muted oil and commodity prices will have a major dampening impact, but this is being countered by the inflationary impact of the weaker pound.

By Howard Archer