Fed expected to keep US interest rates low

The Federal Reserve is expected on Wednesday to maintain its pledge to keep US interest rates close to zero for "an extended period" after Ben Bernanke warned that US economic recovery still faced "formidable headwinds", such as tight credit conditions and rising unemployment.

Mr Bernanke's re-appointment as chairman of the Federal Reserve by the Senate banking committee is expected on Thursday. Investors, meanwhile, are increasingly wondering when he will signal any changes to the exceptionally loose US monetary policies and liquidity conditions that have propelled asset markets higher this year.

This week's data releases will highlight how recovery in manufacturing and inflationary pressures are developing in the fourth quarter.

Industrial output fell in France and Germany during October as car output dropped, and this will be reflected in the overall eurozone production data out today. Eurozone industrial production is seen falling 0.7 per cent in October, but that would still allow the year-on-year decline to slow from -12.9 per cent in September to -11.5 per cent.

US industrial production during November, the figures for which are due out tomorrow, is expected to rise 0.5 per cent. This would slow the year-on-year decline from -7.1 per cent in October to -5.4 per cent. US producer prices are expected to show the headline measure returning to positive territory for the first time in a year, with the year-on-year rate rising from -1.9 per cent in October to 1.6 per cent.

US consumer price inflation is also likely to move into positive territory for the first time since February, with the headline measure expected to rise from -0.2 per cent in October to 1.8 per cent. Core inflation, though, remains low and could sink below 1 per cent next year following a sharp slowdown in labour costs. Bruce Kasman, economist at JPMorgan, says that with US unemployment expected to remain near 10 per cent for some time and core inflation likely to fall to a historic low, it is unlikely the Fed will move interest rates higher next year.

In the UK, inflation data for November, due out tomorrow, should show the headline consumer price index rising from 1.5 per cent in October to 1.7 per cent. The government's decision to reinstate value added tax at 17.5 per cent from January, combined with higher oil prices, will push inflation sharply higher in coming months.

The UK labour market is showing encouraging signs of stabilising. The unemployment rate is expected to remain unchanged at 5.1 per cent in October's data, due out on Wednesday.

UK retail sales figures for November, expected on Thursday, are forecast to increase by 0.4 per cent. This would raise the year-on-year growth rate from 3.4 per cent to 3.5 per cent.

Spending may well pick up in advance of January's VAT increase, and survey evidence suggests there has been an improvement in households' assessment of their financial prospects over the next 12 months and their willingness to make large purchases.