Chief Economist’s Weekly Briefing – Living with the virus

Following a strong rebound in economic activity, last week saw a slight pullback across macro indicators. While the public health experts in the UK are warning about future lockdowns, especially during the winter months, and PM Johnson confirmed the delay in full reopening by four weeks, there remains no obvious signs of consumer concerns yet. 

Still robust. Last week saw a moderation in the performance of the high frequency indicators, particularly related to consumer spending. Retail footfall in the UK declined by 7% in the week to 14th June, with the drag from high streets and shopping centres. CHAPS transactions declined by 7% and seated diners were down 28% over the week. However, this follows bumper spending last month due to transitory factors such as pay day, spring bank holiday and school half-term, plus pent up demand. Most importantly, spending continues at pace compared to the start of the year.

Elated not deflated. Retail sales declined by 1.4% in May. Strange as it may seem, that bodes well for the UK economic recovery, signaling that consumers are going out and spending more on services at last. The main driver of the decline, a 5.7% drop in food store sales, came as people flocked to newly re-opened pubs and restaurants instead of dining-in. Despite the dip, overall retail sales remain a thumping 9% above Feb-2020 levels, buoyed by rising DIY and furniture sales, together with still strong online spending (50% above pre-pandemic levels). It seems many of our new habits are here to stay.

Improving solidly. The UK unemployment rate inched down further to 4.7% in three months to April (vs 4.8% in March). What is noteworthy here is that the decline is due to an increase in employment that is growing at a rate similar to the pre-pandemic era! Further, gains are likely to continue in May as payroll employees rose by 0.7% over the month and online job adverts soared past their pre-pandemic level by c. 30%. Alongside this, average weekly earnings rose sharply to 5.6% y/y. But base effects are at work here, as c.27% of the staff was furloughed as of end April’20 (vs 11% in Apr’21), resulting in significant decline in average pay then. Underlying pay pressure remains modest, hopefully posing limited upward pressure on inflation.

Narrowing. Northern Ireland’s labour market moved up a few gears in Q2 2021. Unemployment fell back to 3.1% which is the lowest rate in the UK (that sounds more impressive than it is). More encouraging was the continued rise in staff numbers. HMRC payrolls data revealed a sixth successive monthly rise with 745,944 employed in May. That means two-thirds of the 16,000 jobs lost last year have been recovered since November. Payrolls are now only 5.5k below February 2020’s high (-0.7%). We could well see a return to pre-pandemic levels in the next month or so. But when the furlough scheme ends many of these gains could be wiped out.  

Widening. Recouping Northern Ireland’s lost output from the pandemic took a further step backwards in Q1 2021. The services and industrial sectors both started the year the way 2020 ended with a fall in quarterly output. Local private sector services firms saw output contract by 2.1% q/q with output almost 8% below Q4 2019’s pre-pandemic level. Manufacturing output fell by 1.4% q/q in the first quarter with activity 2.4% below Q4 2019 levels. This was despite six of the ten sub-sectors recording growth. Indeed, output within seven sectors is now above pre-pandemic levels. Aerospace remains an outlier dragging the Transport Equipment sector down to half of Q4 2019 levels. Outside of aerospace, manufacturing output appears to be taking-off. 

Surprise. UK consumer price inflation quickened from 1.5% y/y in April to 2.1% y/y for May, marking the highest annual CPI rate in almost two years.  A pick-up in inflationary pressures had been anticipated but May’s reading exceeded City analysts’ expectations for a 1.8% print. Petrol and diesel price rise of almost 18% y/y was the biggest driver of inflationary pressures. Base effects are pushing inflation higher but the temporary VAT cut for the hospitality sector is keeping CPI down. Exclude these indirect taxes and CPI is running at 3.8% y/y – its highest rate since April 2009. A headline CPI rate of 3% plus in the coming months looks increasingly likely.

The calm after the storm. House prices in UK grew 8.9% y/y in April, the first deceleration since the spectacular run started last year. House prices in the North-East are up by c.17%, while London remains the laggard with a 3.3% price rise. March had seen a frenzied activity as the erstwhile deadline for the stamp-duty holiday loomed. The housing market softened in April with ‘only’ c. 120k transactions, a drop of one-third. But the outlook looks quite good, with both output and the labour market consistently surpassing expectations. And of course, the stamp-duty holiday will now remain in place in some shape or form until Sep.

Diversion. Trade like water tends to find its own level.  The NI Protocol has redrawn the UK’s single market and customs union with signs that it is boosting trade across the Irish border but reducing it across the Irish Sea. Data from Ireland’s statistical office revealed exports from North to South more than doubled in Jan – Apr 2021 relative to pre-pandemic levels two years ago. Conversely RoI imports from Great Britain (GB exports) fell by over 50% during the same period. NI imports from the RoI are up one-third in Jan-Apr 2021 versus the same period in 2019. Yet RoI exports east to GB fell by 14% in value terms. No timely NI-GB data currently exists but trade volumes are expected to have fallen.

Home is where (some) of the work is. When it comes to the long-term effects of Covid on the economy, nothing divides opinion quite like attitudes towards homeworking. First, it’s easy for office workers (like your authors) to overestimate how many people worked from home last year. In the UK in 2020 37% of people worked from home at some point, up from 27% the year before. So the biggest difference was that people who had previously worked from home a bit, now did so a lot. Not that everyone was suddenly doing it. But the trend is sticky. Of those currently homeworking, 85% expected to have a hybrid approach in the future. But different businesses have different expectations over how much time employees will spend in the office. And many don’t yet know. Lots still to work out then.

Risk on, risk up. Broadly there are two elements to climate transition, cutting emissions (achieving net zero) while accepting we must prepare for inevitable changes to the climate. The latest report from the Climate Change Committee, the body tasked with advising the UK government on the climate transition, concerns the latter. Foot-dragging has meant the gap between the level of risk we face and the level of adaptation underway has widened in the past five years. The most urgent risk areas for action in the coming two years run the gamut across the natural environment and the economy, including risks to natural carbon stores, crops, livestock, the supply of food and climate-related failures of the power system.

Hawkish. As expected, the Federal Reserve left official US interest rates and the pace of QE unchanged, but the Fed’s US rate projections were upgraded. Seven FOMC members now expect the first US rate hike in 2022, up from four in March. Thirteen members anticipate the first rate increase in 2023 (seven in March).  The median 2023 US rate projection is now two 0.25% rate hikes. The Fed upgraded its inflation forecast for Q4 2021 to 3.0%, from 2.2% in March, but 2022 and 2023 inflation projections were little changed. The countdown to a tapering of QE has begun, but a US rate rise is some way off.

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