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Latest manufacturing data a rare glint of sunshine for George Osborne

Better-than-expected economic data gives the Bank of England pause for thought on QE2

In normal times, Monday’s snapshot of UK manufacturing would be seen as moderately encouraging news. After a run of lousy economic data, the City was expecting the CIPS/Markit report from industry’s purchasing managers to show a decline for the ninth month in a row.

Instead, the index rose back above the 50-level that marks the cut-off point between expansion and contraction. A welcome – and rare – glint of sunlight for George Osborne as he prepared to address the Conservative party faithful in Manchester.

These, though, are far from normal times. The third quarter of 2011 saw the sharpest fall in stock markets since the dot com bubble was rapidly deflating in 2002, and overnight reports that austerity-stricken Greece is, predictably enough, going to miss its deficit reduction targets meant the first trading day of the fourth quarter started on a sombre note as well.

As far as the financial markets were concerned, the only real issue arising from the manufacturing PMI was the impact it might have on the timing of a fresh round of quantitative easing from the Bank of England.

Before we get on to that subject, it is worth noting that the purchasing managers survey was a bit less good than it looked. To be sure, output rose but only because factories cleared their backlog of work. New orders, although also up a bit, remain hard to come by, especially from overseas. What’s more, today’s modest improvement does not really compensate for the poor performance of industry in previous months. According to Samuel Tombs, UK analyst at Capital Economics, the PMIs for the third quarter of 2011 are consistent with a drop in manufacturing output of as much as 1%, bigger than the 0.2% drop in the second quarter.

Even so, today’s PMI will probably give the Bank’s monetary policy committee pause for thought when it mulls the case for more QE at the two-day meeting starting on Wednesday. Taken in isolation, the report would suggest that any policy move from Threadneedle Street will be put back until November, when the Bank publishes its quarterly analysis of the state of the economy. There is some talk in the markets of a co-ordinated easing of policy at that point involving the Bank, the European Central Bank and the US Federal Reserve.

There are other reasons why the Bank might choose to delay. Inflation has yet to peak and given that QE is supposed to be a tool to prevent deflation, the MPC would ideally like to see price pressures start to abate before moving. Clearly, a softening-up process has begun, with MPC members making the case for policy activism, but the Bank might prefer another month just to make sure the financial markets and the public are well prepared.

All that said, more QE this week remains a possibility. Manufacturing now only represents a small proportion of national output, and it will diminish in importance still further when the Office for National Statistics releases data for the National Accounts on Wednesday. Some activities, such as publishing, which are currently classified as manufacturing, will be moved into the service sector. As a result, manufacturing may account for little more than 10% of national output and services close to 80%. The PMI for services comes out on Wednesday, and will have a far bigger bearing on the Bank’s decision. Last month’s was a shocker.

Bottom line: the mood is currently so negative that even good news is ignored. Markets are now primed for a double-dip recession rather than a soft patch. Despite high inflation, there is going to be more QE. The only question is when. As things stand, it will not be this month. But that could change. © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds