Chief Economist’s Weekly Briefing – Well, where did that come from?

business-18061_1280.jpgThree members of the Monetary Policy Committee voted last week to raise Bank Rate to 0.5%, a surprise to say the least. At 2.9%, inflation is above target and heading higher. Yet while employment continues to rise, wage growth is slowing, consumers are under pressure and there is enough uncertainty around to think that tightening monetary policy can wait for a while.

Why the change of tune? Some on the MPC have been surprised by the speed with which inflation has risen and they think that stronger demand from exports and investment spending will help keep growth going, even if the consumer side of the economy is feeling the squeeze. That argument wasn’t strong enough to convince any of the Bank officials to vote for a rise and one of those who voted for a hike has now left the committee. With two vacancies to be filled the MPC’s voting position could be a lot more finely balanced than we’ve been used to.

Winning. The UK’s job market remains a curious game of two halves. From the labour demand side it could hardly be better. Employment rose, and unemployment and inactivity fell (. Each of these indicators set or matched records, most of which go back to the 1970s. There are a near-high 770,000 job vacancies as employers look to add to the workforce, so we can expect their patterns to continue for a while. However …

Losing. With labour demand so buoyant we’d be entitled to expect wage inflation that was strong, possibly too strong. Yet regular pay growth, which excludes bonuses, slipped to just 1.7% y/y, it’s slowest rate since 2014. Adjusting for consumer price inflation, regular pay fell by 0.6%y/y. That represents a material squeeze on our spending power and one that’s set to persist for months to come, depressing consumers’ spending.

Back to reality. All eyes are on the retail sector for signs of how UK consumers are responding to the squeeze on their budgets. April’s numbers provided a welcome boost, benefitting from strong spending over Easter. Unfortunately May’s figures showed that strength was short-lived. Sales fell by 1.2%m/m and were only 0.9% higher than 12 months earlier. The longer view provides a little more comfort.  If we look at sales in 2017 to date and compare them to the same period last year then growth is still above 2%, which is perfectly respectable. But momentum is clearly draining away. Retailers will probably be pleased to see any growth in the second half of the year.

Public service broadcast. Just over 5 million people work in the UK public sector, down from a peak of 5¾ million in 2009. Recent falls have predominantly come from local government. Since 2009 local government employees have fallen by a quarter (N.Ireland = -3%), or by over 0.5 million. In contrast, the overall number working for central government, that includes teachers, NHS staff, is at a record high. The driver of the rise is NHS workers, up 2% in the year to March and by 11% over the past decade. An ageing population is unlikely to change this trend.

Recovering. Industrial production within Northern Ireland slipped marginally in Q1 following Q4’s record high. But manufacturing output continued its upward trajectory. Following a quarterly and annual rise of 0.9%, output stood at its highest level in almost nine years in Q1. That means 85% of the output lost during the downturn has been recouped. Northern Ireland’s service sector recovery has not been as impressive. Less than two-thirds of the service sector output lost during the downturn has been recovered so far. Much of this is a legacy of the property downturn. Despite output rising by 3.1% y/y in Q1 to a fresh 8 ½-year high, service sector activity remains almost 5% below the credit-fuelled ‘freak peak’ of Q4 2006.

Record breakers. Some sectors of the Northern Ireland economy have seen better days. But others have never had it so good. Within services; the transport, storage, information & communication sector is booming. This sub-sector, which includes everything from computer programmers to parcel delivery vans saw output surge by 9% y/y in Q1 2017 – a record high. Manufacturing has its star performers too. Manufacturers of chemicals & pharmaceutical products posted their highest output figures on record. Metal bashers saw activity within their sector (basic & fabricated metal products) jump by one-fifth in the space of a year. Again output has never been higher. Let’s hope more sectors of the economy can emulate these record breakers.

Lagging or flagging? The labour market is said to be a lagging indicator of economic activity.  Rises or falls in output generally impact on the jobs market a few quarters down the road. But, in Northern Ireland, output growth is currently holding up reasonably well whilst employment growth is slowing. The Labour Force Survey (LFS) signalled a hefty 3.5% y/y fall in the number of employees in Q1, whilst the Quarterly Employment Survey is not as bleak, with a marginal fall in employee numbers compared to Q4 2016. Private sector employment is at a record high, but the pace of job creation has slipped to a 3½-year low (+2.3% y/y). Rather than lagging, it seems that the current labour market data is flagging up some concerns about the recovery’s prospects in the months to come.

Full-time whistle?  The slowdown in Northern Ireland’s employment growth conceals contrasting fortunes for sectors and between full-timers and part-timers. Using the Quarterly Employment Survey, it is clear that full-time employment growth is slowing at an even faster rate than total employment. In Q1 2017, full-time employment expanded at its weakest pace in four years. This is one third of the UK growth-rate, while part-time employment growth in NI is running at three times the UK rate. What is particularly concerning is that the economy’s largest sector – services – saw full-time employment growth grind to a halt in Q1. This doesn’t necessarily mean the final whistle for the current recovery, but economic spectators will be watching closely in the quarters ahead.

An ill wind. A little-discussed consequence of  the gap between the inflation rate and wage growth, is the boost it can provide to business profits. Labour costs rose by 1.1% in the first quarter compared with Q1 2016. That’s lower than the rise in prices. So even absent any change in orders, many businesses, particularly service firms with little need for imports, saw revenue rise faster the costs. So while attention (rightly) is focused on the effect falling real wages has on consumer spending, some businesses benefit and some of those will choose to boost investment, jobs or both.

Retreat. US inflation retreated again in May, falling to 1.9%. The core rate fell to 1.7%. Despite this and despite revising down its near-term inflation forecast, the Fed hiked rates by 25bps. It was widely expected so passed with little fanfare. Of more interest was the ‘Addendum to the Policy Normalization Principles’. It’s not one to be squeezed into the suitcase for the summer getaway. It sets out the Fed’s plans for shrinking its balance sheet, which ballooned through quantitative easing. Reinvestment of the proceeds from maturing securities will be phased out, limited by gradually rising caps.

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