Chief Economist’s Weekly Briefing – 3 vs 2 to the doves

The recent jump in inflation and pockets of tight labour market conditions prompted two members of the Monetary Policy Committee (MPC) to indicate an earlier than anticipated tightening of policy. But with signs of softer activity three MPC members took a more ‘dovish’ stance. Looks like the Bank won’t break ranks with the Fed & ECB just yet.  

Cooling off. The UK’s PMI hit a four-month low in July, providing further evidence of a softening in the recovery after the initial bumper growth period in the spring. Mind you, at 57.7 the headline reading continues to signal expansion, but it’s a bit of a drop from June’s 62.2. Shortages of staff and raw materials are being widely reported. Both manufacturing and services took a hit. While optimism around the outlook is at its lowest for nine months. The rising Delta strain concerns inevitably adds to consumer caution. More worryingly, a picture of underlying weakening of demand is emerging. New orders fell to 55.2 vs 62 in June.

World in motion. Retail sales rose by 0.5% from May to June as football fever boosted food store sales. Compared to last June retail sales are still almost 10% higher, with online sales up 40% compared to their pre-Covid level. A modest softening in data is a reasonable assumption – the third wave seems to have blunted the habits of some consumers through July while the ‘pingdemic’ curtails activity too. While further ahead the £20 cut to Universal Credit will also drag. But there’s strong job growth to report with more to come if job adverts are anything to go by. Then there’s all those savings piles. Pretty solid backing, in other words.

On the move. The data relates to before, ahem, ‘Freedom Day’ in England (or Scotland’s switch to Level 0) but we’re continuing to see steady improvement in lifestyles and commercial activity. Not all are necessarily good for the environment however – daily flights are up 6% and motor traffic is up 5%. Still, the much harassed (or in truth, neglected) high-street is seeing more shoppers, with footfall up 3%, the first rise since early June. And given the weather, seaside promenades are doing well. Job adverts and table sittings are flourishing.

‘Tight policy is not the right policy’. Talking about the medium-term prospects for the economy, Jonathan Haskel, a member of the MPC, outlined how the economy is likely to be less scarred in the long term than initially envisaged. A combination of robust labour market conditions alongside businesses continuing to invest (barring in buildings and structures) have helped to limit the damage. Further, the structural forces set in motion by the pandemic – working from home, rapid digitisation – support supply-side optimism. As a result, inflationary pressures are transitory and the risk of a preemptive monetary tightening harming the recovery outweighs the risk of a temporary period of above-target inflation.

Mismatch. Ben Broadbent, the deputy governor for MPC, discussed the future course of inflation in his latest speech. He reiterated the wider stance of the Bank, outlined in its June meeting, that the rapid price rise of consumer goods is likely to be transitory as consumers switch back to spending on services and supply bottlenecks ease. However, he warned rate-setters to not overlook the indications from the labour market. The mismatch between the jobs and workers available could continue for some sectors/ particular places, resulting in a wage increase and somewhat sticky medium-term inflation.

Phoenix. Hospitality is the sector most affected by the Covid-9 pandemic. In April 2020 the sector’s turnover decreased by 86%. But it is being reborn from the ashes. The sector has adapted to the new reality with the proportion of businesses temporarily closed falling from 81% in the spring 2020 lockdown to 54% in the early 2021 lockdown. In May 2021, we saw the highest turnover since August 2020, although it is still around 25% lower than in 2019. And the number of vacancies in Apr-Jun 2021 were nearly five and a half times higher in Dec-Feb last year, and higher than pre-pandemic levels. A good reason to have a pint at the pub!

Aiming for 100%. Public sector net borrowing was £22.8bn in June, meaning total borrowing in the first three months of the current financial year stood at £70bn, which, although raising the stock of debt to 99.7% of GDP (the highest in the past 60 years), is still around a quarter less than what Office for Budget Responsibility had expected. That’s mainly explained by the faster recovery driving an improvement in tax receipts and lower than predicted spending on income support schemes. But that might not hold as rising inflation and additional costs are expected to bite later in the year.Dovish. Following the recent ECB strategy review, ECB president Lagarde announced a change in the ECB’s forward guidance on euro area official interest rates at July’s Council meeting. The ECB president stated that interest rates will now remain at their present or lower levels until it sees inflation “reaching 2% well ahead of the end of its projection horizon”, rather than “below but close to 2%” previously, signaling a more dovish policy stance. The ECB will also allow scope for euro area inflation to remain above its target for a “transitory” period. While far from indicating the ECB is about to try and run the economy hot in the pursuit its new inflation goal, it does suggest that the hurdle for an ECB rate hike has been raised.

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