Chief Economist’s Weekly Briefing – Headwinds

We’re getting there. Last week’s GDP data showed we’re just 0.6% below the pre-pandemic peak in output. At a far less progressed stage is the climate transition. But amidst the concerns was much progress from COP26. The challenge for both the recovery and achieving net zero is to keep up the momentum in the face of multiple headwinds. 

Glasgow Climate Pact was signed Saturday night at the COP26, which overrun by a day. Under the agreement, nations will have to provide updates to their emissions cutting pledges annually, instead of every 5 years. Funding to help developing countries adapt to the impacts of climate change will at least double. And the establishment of rules on global carbon trading should help bring down emissions. However, developed nations refused to set up a specialised fund to pay for loss and damage from climate change in developing countries. And an historical agreement on coal was watered down from “phase out” to “phase down”. COP26 was a step in the right direction. Now comes the delivery. And the clock is already ticking.

Moderation. The pace of the UK recovery slowed considerably in the third quarter: GDP growth of 1.3% pales against the blistering 5.5% expansion chalked-up in Q2. End-of-lockdown exuberance has given way to a more gradual normalisation in consumer behaviour. Household spending rose 2% in Q3 – benefiting hospitality and leisure sectors – but remains more than 4% below pre-pandemic levels.Along with a pitifully weak recovery in exports, that explains why the UK recovery lags other advanced economies’ (GDP still 2.1% below Q4 2019). Momentum is building once again though. After dipping 0.2% in July, GDP grew 0.2% in August and 0.6% in September. Maybe slow and steady will win the race.

Spend it, where you can. People appear to have been opening up their wallets in recent weeks. Aggregate UK spending in the first week of November climbed to 5% above its pre-pandemic level, a new high for 2021. Work-related spending climbed but the main contribution came from “delayables” suggesting that the more organised amongst us might be well into their Christmas shopping! There’s good reason to get ready early this year too. Frozen turkeys were reported as being in low stock, or unavailable, in roughly 1 in 5 UK stores. Retailers are already battling hard to maintain their stocks heading into the busy season. That’s not helped by a shortage of drivers, with 4 times more job vacancies in the logistics sector than pre-pandemic. Spare a thought for those having to cover extra shifts this festive season.

Widening. Post-Brexit, the UK is keen to bolster its trading relationship beyond the EU and this is certainly occurring when we look at imports. Virtually all the rise in overall imports in September was due to the 11% increase from non-EU countries. Imports from outside the EU have now exceeded those inside the EU for nine months running. Imports for Q3 rose by £2.9bn (+2.5%) relative to the previous quarter while exports fell by a similar amount (-3.4%). Returning to pre-pandemic/Brexit transition levels remains a challenge with exports almost 12% below Q3 2018 levels.

Mixed Bag. Business activity, as measured by the PMIs, improved across all UK regions in October. However, inflationary pressures and supply chain problems, combined with labour shortages, intensified. Wales (61.5) and London (60.5) documented the biggest rise. Stronger demand was documented across all regions with Wales coming first in new orders growth (63.5) followed by the North West (58.5). But elevated demand allowed firms to pass higher costs to customers with a further sharp increase in prices in October. NI tops the table for input cost & output price inflation. Employment picked up in most regions with the North East and London coming up with the faster rates of job creation. While labour shortages mean many are firms are struggling to fill vacancies.

E-commerce. The ongoing pandemic and resulting furlough scheme created upward pressure on unit labour costs (ULC) – the average cost of labour per unit of output. In Q2 ULCs were 7.5% above their pre-pandemic level. Almost all UK industries recorded a rise in ULC, which was driven by rising employment costs without a corresponding rise in output, partially due to lower demand. The one exception was the wholesale and retail sector, which notched up a 3% decline in ULCs compared to pre-pandemic. The reason behind it is the shift to online sales, with less labour needed as a result.

Spike. US consumer prices jumped 0.9% between September and October, following a 0.4% rise in September. That pushed the annual rate of inflation to 6.2% – the highest for 31 years. The core CPI also surprised on the upside, increasing 0.6% month on month. The main culprit was a 0.4% rise in primary and owners’ equivalent rent, the fastest pace since 2006, and which accounts for around 30% of the core CPI. But price rises were broad-based. Witness higher new and used car prices, lodging costs (higher hotel occupancy), hospital services, furnishings, and recreation. All this suggests that the Federal Reserve’s narrative of “transitory” US inflation is looking increasingly hard to maintain.

Soaring. China factory-gate inflation hit a 26-year high in October, rising 13.5% over the year. Tight supply of domestic energy alongside raw materials shortages explains much of the rise. Another factor recently added to this was a further uptick in already high shipping costs as trade flows rebounded around the world. Consumer prices too were up – 1.5%y/y vs 0.7% in September. Vegetable prices jumped by c.17%, as surging production costs were feeding into the price of essential goods. Still, some expect that central bankers in Beijing will prioritise slowing economic momentum over inflationary concerns, and opt to ease policy in coming months.

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