Chief Economist’s Weekly Briefing – From Alpha to Omicron

Concerns over the spread of the new Omicron variant prompted the UK to reintroduce restrictions on travel and mask-wearing this week. Difficult decisions lie ahead for the Bank of England, which must balance a potential knock to the economic recovery with evidence of increasingly widespread cost pressures and tight labour market conditions. The odds of a rate hike at next month’s Monetary Policy Committee meeting may be receding but the jury is still out.

Strong. The UK enjoyed a strong expansion in business activity in November, with the Markit/CIPS composite PMI reading 57.7 in November, similar to 57.8 last month. This signals a healthy rate of expansion, despite supply shortages. New orders reached the highest levels since June, reflecting improved domestic demand. Not all good though: rising price pressures appear to be widespread, both for services and manufacturing firms, driven by higher wages, fuel, energy, and raw materials. Input price inflation reached the highest levels since January 1998. Omicron notwithstanding, that reinforces the case for a BoE rate rise next month.

A bridge to…Huw Pill’s debut speech as BoE’s Chief Economist – before news of Omicron broke – was dedicated to reviewing Covid’s impact on the economy and the success of the policy measures taken so far. In the early days of the pandemic, Governor Andrew Bailey talked about policy ‘creating a bridge’ to allow firms and households to make it to the other side of economic shock. We might not be quite back to pre-Covid output or employment, but we’re very largely there and so: policy has done its job. Thus, Pill’s expectation that it will soon be appropriate to put interest rates back up, albeit he has preferred to wait and see the impact of furlough ending. That adds-up to a likely, though far from assured, extra vote to raise rates the next time the Monetary Policy Committee (MPC) meets – though the spread of Omicron casts this into further doubt.

Vigilant. In his latest speech, MPC member Jonathan Haskel focused on historic developments in UK inflation. External forces explained 62% of the deviation from the BoE’s 2% inflation target between 1995 and 2019, driven by: food & energy (24%), taxes (13%) and sharp moves in exchange rates and input prices (25%). Mr Haskell downplayed worries about the inflationary impact of global supply disruption, though he expressed some concern about potential for wage growth to accelerate. Despite warning that “if the labour market stays tight, the bank rate will have to rise”, he did not suggest any urgency for higher rates.

Tens of thousands at last!  It took a global pandemic and Brexit to achieve the target. Net migration fell considerably in 2020, to a mere 34K. That’s an 88% drop compared with the 2019 figure of 271K. Immigration was much lower: an estimated 268K people moved to the UK during 2020, down from 592K in 2019. Emigration also fell, but to a lesser extent, an estimated 234K people left the UK to live abroad in 2020, compared with 300K in 2019. Net migration for EU nationals was negative, adding to labour market tightness: 94K more EU nationals estimated to have left the UK than arrived. 

Confessions of a Shopaholic. With holiday season approaching, UK retail footfall grew by 4% last week. While overall spending on credit and debit cards remained broadly unchanged at 103% of its pre-pandemic levels, there was a 5-percentage point spike in spending on goods such as clothing and furnishing. And in a sign that workers are returning to offices and people are socialising more, transactions at Pret A Manger stores continued to climb and OpenTable reported occupancy of 17% above compared 2019 levels for a second successive week.

Good, for now. Business activity in the Eurozone expanded at a decent clip in November: the composite PMI rose to 55.8, confounding expectations of a slowdown. Services activity hit a three-month high. Manufacturing output also grew, boosted by a rise in stock levels as firms guard against possible supply chain disruptions.Yet the skies are darkening. Supply shortages contributed to record reports of price inflation. Along with the ongoing spike in Covid infections across the continent, accompanied by new lockdowns in places, that looks likely to put a break on growth in coming months. 

Hot enough. The pace of US business activity slowed in November, but the economy is still running hot. The composite PMI eased to 56.5 down from October’s 57.6 reading but remains above the pre-pandemic average. Ongoing supply chain disruption and labour shortages are acting as a handbrake on private sector growth and resulting in mounting backlogs and record rises in input cost inflation. These pressures are evident amongst both manufacturers and services firms. Clearly without these supply constraints the US economy would be running even hotter.

And it begins. The Fed joins the bandwagon of central banks that are slowly shifting towards policy normalization. While the policy rate was kept unchanged, the asset purchase programme will be tapered from this month onwards, purchases to be reduced by $15bn per month. While this was expected, the tone of the minutes turned more hawkish. The near-term inflation forecast was revised up, but it’s still expected to return to 2% by end of 2022. Risks were flagged to the upside, with inflation likely being more persistent. Not surprisingly, some members were in favour of faster pace of tapering to make room for rate hikes, if need be. Looks like the hawks are in the lead!

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