Chief Economist’s Weekly Briefing – hawkish undertone

Last week, the Bank of England decided to shake things up a little. While monetary policy was left unchanged in August, the meeting was significant as the Bank made notable changes to its outlook for both inflation and the labour market. The ‘Old Lady’ also gave new guidance on how it plans to wind down its largest ever QE programme.

A step closer. Against a rapidly shifting economic backdrop, the Bank of England revisited its economic forecasts in its August meeting. While growth estimates were unchanged, the unemployment rate was revised down, again, as the Bank is no longer assuming a spike as policy support is withdrawn. Negative rates are now in the MPC’s toolbox and thresholds for adjustments to the Bank’s stock of assets have been lowered to 0.5% (vs 1.5% earlier), the bank rate when the MPC will consider ceasing to invest in maturing gilts. The next step – outright sale of assets – will only commence when rates reach 1, currently beyond the five-year horizon.

Inflation’s back, but not for good. So say the Bank of England’s Monetary Policy Committee as it forecasts a peak of 4% for CPI at the end of 2021, before expecting it to fall back towards the 2% target in the following year. Why does the Bank think this bout of price rises will be temporary? Well it blames faster prices on factors such as Covid-induced supply bottlenecks and the recent jump in energy costs, neither of which it believes will be sustained or repeated in the longer run. But it remains vigilant to price pressures in the wider economy, especially signs of higher pay growth. Only then will the MPC consider raising Bank Rate from its record low of 0.1%.

New order. The world, it seems, really is in motion. The skies are busy, with UK flights up 117% since the 23rd March, the week international travel reopened. Restaurant covers rose 10% on the previous week and UK online job adverts are so stratospheric they’ll shortly need oxygen masks – 135% the level seen in Feb 2020. Pedestrians and cyclists in London and Greater Manchester are up 9% and 18% respectively. In one way these stats aren’t too surprising. Afterall, we’re emerging from an epic economic and social shutdown. But don’t let that dispel the enormity of what’s been achieved.

Pressure point. Ten out of 12 UK regions posted slower increases in output levels in July according to NatWest’s regional PMI data.  A moderation was expected after the boost to activity in earlier months that followed an easing of lockdown restrictions. The South West (62.2) and Northern Ireland (54.1)bookended the regional league table for output growth.  The former, which has benefited from the ‘staycation’ boom, also topped the table for employment growth. Alongside Northern Ireland and the North East it was one of just three regions to report a pick-up in the pace of hiring in July.  Inflationary pressures intensified with three-quarters of the UK regions reporting record rises in input cost inflation, once again led by Northern Ireland.

Three-speed. Northern Ireland’s private sector exhibited a three-speed recovery with manufacturing and services continuing to record robust rates of growth in output and new orders in July. But retailers recorded slower rates of growth across these measures whilst the construction industry has seen its performance go into reverse. Output, new orders and employment within the construction industry all contracted in July.  These difficulties within construction are linked to severe cost increases and supply-chain difficulties which have triggered a slump in confidence within the sector. Both construction and retail expect activity to be lower in 12 months’ time. Conversely, services and manufacturing firms remain optimistic and expect strong growth in the year ahead.

Chipped windscreen.  UK new car registrations languished at just 123,000 last month. That’s the slowest July in 23 years and one-fifth below the same month in 2019.Dealers in Northern Ireland had their worst July since the SMMT series began with sales down 14% relative to July 2019.  Vehicle sales should be pulling-away by now, going on the recent acceleration in economic activity and pick-up in consumer confidence.  Instead manufacturers have been rear-ended by disruption to supply-chains, with car production throttled by shortages of computer chips and staff. Demand has been slow to rev-up too with consumers hesitant, perhaps awaiting the release of new electric models before exchanging their pandemic savings for that ‘new car smell’.

Cooling off. The flash U.S. Composite PMI Output fell to a four-month low of 59.7 in July from 63.7 in June. Business activity grew at a slower pace for a second straight month in July amid supply constraints. Businesses are combating raw material and labour shortages, due to the fallout of the economy’s reopening after severe disruptions caused by the pandemic. At the sector level, the services sector PMI fell to 59.8 from 64.6 in June, slowing further from May’s record high. Meanwhile, an upswing of new orders resulted in the manufacturing PMI to rise to an all-time high reading of 63.1 from 62.1 in June.

On track. The Eurozone recovery is on track, as the region’s composite PMI hit 60.2, the highest in 15 years. The expansion of business activity was visible in both the manufacturing and the service sector. Again, Germany was at the forefront of the recovery with a record high PMI of 62.4. with the equivalent survey for the Republic of Ireland (65.0) hitting an all-time high too. The latest Eurozone PMI indicates improvements in both domestic and international markets led by easing virus restrictions and vaccination progress. However, firms are still cautious and July PMI would have been slightly higher if not for the Delta variant, which continues to pose a risk to the ongoing recovery. 

Brick-and-mortar. Eurozone retail sales grew by 1.5% m/m in June and were 5% higher than a year before. Ireland, Germany, and Latvia had strong showing reflecting the timing of easing of lockdown in these countries. Sales of motor fuel and non-food items grew in June, while online shopping and sales of food items declined as people ventured out, indicating further reversal of covid-time spending patterns. Retail sales now stand at highest ever levels, arguably propelled by the pent-up demand. And so it is quite possible that sales have already peaked.

Dimming. China’s growth outlook has darkened a little. The export engine is slowing as demand in the West pivots back towards services. But some of China’s structural growth challenges are coming back into focus as the economy normalises. Second, some substantial policy interventions, both real and potential, have taken their toll in recent weeks. The private education sector, ride-hailing and online gaming have been under the microscope. A reminder, if it was needed, that incorporating political risk is a difficult task when it comes to China. Finally, as with other countries, rising cases of the Delta variant are threatening to undermine the recovery. Cue talk of policy support and some trimmed growth forecasts.

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