Chief Economist’s Weekly Briefing – When the going gets tough

Tis the season of Q2 growth figures. China’s growth picked up, albeit with signs of sluggishness. The US surpassed its pre-pandemic levels despite growth falling short of market expectations. The Euro area embarked on its road to recovery but below its pre-pandemic levels. So all eyes on UK GDP next week, amid signs of greater consumer caution plus a ‘pingdemic’ led slowdown in June.

Restrained (mostly).  There’s no sign of households throwing caution to the wind and embarking on a spending spree as the UK economy re-opens.  Not that they don’t have the resources to splurge, having amassed a stonking £170bn ‘excess savings’ since the pandemic began.  On the contrary, households added another £9.8bn to their cash pile in June and borrowed a meagre £0.3bn net consumer credit (75% below the pre-pandemic norm).  For now, exuberance is contained to the housing market.  Net mortgage borrowing hit a whopping £17.9bn ahead of the Stamp Duty holiday tapering, smashing March’s previous record (£11.5bn) clear out the water.

Still cautious. UK residents have been out in full force following July 19th’s ‘Freedom Day’, with in-restaurant dining up 23% in Manchester and daily flights up 17% on the previous week, road traffic at 98% of Feb’20 levels and a 17% increase in cars heading to ports following the start of the summer hols. Yet there are limited indication of a pick up in consumer spending. Card spend rose by merely 2% over the week ending 25th Jul and retail footfall up  by 4% compared to the prior week.

4 vs 2 to the doves. Prospects of a hawkish stance by the Bank of England were further dampened by outgoing MPC member Gertjan Vlieghe’s speech at LSE. He positioned himself firmly in the transient-inflation camp with intention to wait until the impacts of end of government support schemes are clear. Unsurprisingly, he provided support for keeping the current monetary stimulus in place for “several quarters at least, and probably longer.” More broadly, he outlined that due to structural forces pushing interest rates lower, not much tightening will be required even after that and that during next crisis, interest rates could go deep in negative territory.

Unmasking. Covid pandemic has largely masked Brexit impact on the UK economy. However, one place it can’t hide is the reading on trade. A recent report by ONS on trade in services shows that UK service exports and imports have declined since the start of 2019, with trade for EU countries falling more than trade with non-EU countries. Share of total service imports from the EU fell by 9ppt in the two years to Q1-21! That said, coronavirus has had a bigger impact lately- service types that are reliant on the movement of people, such as travel, manufacturing, have been hit the most.

Out of the woods. Growth returned to the euro area in Q2 after two consecutive quarter of pandemic-driven downturn. GDP grew by 2% in the three months to June, surpassing both the US (1.6%) and China (1.3%). Both business and consumer confidence rebounded, helped by lifting of restrictions in May alongside speeding up of the rollout of vaccination programme. However, the effect of supply side bottlenecks continued to bite, particularly for Germany where shortage of semiconductor held back some of the gains. All said, Euro area’s GDP is still 3% short of the its pre-pandemic level.

Progress. Little by little the Federal Reserve is moving towards reducing its sizeable balance sheet. Fed Chair Jay Powell acknowledged that the US had made “progress” but not “substantial further progress” towards attaining its goals for tapering, namely price stability and maximum employment. Mr Powell admitted there was more “upside risk” to the US inflation outlook but remains confident that higher inflation will prove transitory. He also highlighted the need to see strong job numbers in coming months whilst downplaying concerns about the economic impact of the Delta variant. An announcement on tapering could occur at the September Fed meeting, following the Jackson Hole policy symposium at the end of August.

Emptying. The US eclipsed its pre-pandemic peak in economic output in Q2 – an important milestone in the Covid recovery (the UK, all going well, should get there too before year end!). The headline figure of 6.5% annualised GDP growth actually fell short of expectations, dragged down by an increasingly pervasive feature of the Covid-wounded economy – supply-chain issues. In this case US firms were forced to burn through inventories. The statisticians count that as a drag on growth. But it’s not just supply problems, the demand-side is supercharged. Consumer spending rose at an 11.8% annualised pace. Producers literally can’t keep pace and inevitably inflation is creeping up. 6% growth was the fastest since the early 1980s.

Fault lines widen. Growth prospects have diverged further across countries as per the IMF’s July update to the World Economic Outlook. While global  growth remains unchanged for 2021 at 6%y/y, compared to its April forecasts, differential access to vaccines has split the global recovery into two blocks – those which can expect see normalization in economic activity towards the later part of this year, largely advanced economies and those who will likely face a setback due to resurgent infections and rising Covid death tolls. 2022 is a slightly upwardly revised to 4.9%, largely due to upgrades for advanced economies, particularly the US.

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