Chief Economist’s Weekly Briefing – The Return of Uncertainty

After a strong global recovery, Russia’s invasion of Ukraine clouds the economic outlook which was already suffering from rising energy prices. New and wide-ranging sanctions are now being added to the mix of supply chain bottlenecks, all of which are likely to exacerbate inflationary pressures for consumers and businesses.

Isolation. Large scale invasion of Ukraine by Russia has triggered a series of sanctions actions from other countries. The UK, US and EU have imposed heavy personal sanctions on individuals connected with the invasion, severely limited access to international financial markets and use of foreign assets, stopped access to dual-purpose imports of goods and components. Individual companies and institutions are also cutting ties with Russia. The effect is to isolate Russia from other countries’ economies, with the notable exception of a stream of Russian oil and gas. It is early to judge the effects but falls in the Ruble and Russian stock markets point to a lot of pain.

Petrol into fire. Commodity prices have jumped following the Russia’s invasion of Ukraine. The price of Brent crude has leapt to $105 pb, from $93 at the start of this week, while natural gas futures have jumped by 30% this year, 40% in 2023 and 60% in 2024. According to Pantheon Economics, this surge in energy prices, if sustained, will boost the CPI by an extra 1.5 ppts. Higher gas and electricity prices will not feed into CPI in the short-term due to the Ofgem’s price cap. But motorists will feel oil price increase within 3 weeks while higher energy prices will also slow growth.

Still Recovering. UK regional GVA expanded by 1.0% Q/Q in the final quarter of 2021 bookended by the North East (+0.7%) and the South West (1.2%). Last November the Financial Times ran with headlines based on earlier data that Northern Ireland had the best post-lockdown recovery aided by the Northern Ireland (NI) Protocol. Not so now. NI actually had one of the weakest recoveries. Since Q4 2020, all the UK regions that don’t have the NI Protocol outpaced NI in terms of real GVA growth. Wales is the only region to see output in Q4 2021 return to pre-pandemic levels. Scotland and NI are 5.0% and 1.1% adrift respectively with the West Midlands (think car production) almost 10% below Q4 2019 levels.

Stronger, but more expensive. The latest public finance data showed the recent strength of the recovery, but also costs of heading into a higher rate environment. January’s tax receipts were 10% higher than a year ago, strong enough to generate small surplus of £2.9bn. But rising inflation meant that the Government’s costs were up too because the interest rate on much of our public debt is linked to the Retail Prices Index, RPI. The next Budget will be on the 23rd of March, when the Chancellor will have to weigh competing priorities of reducing the budget deficit and meeting other demands for spending, especially given the squeeze on real incomes which set to drop by 2.0% this year, the most since the Second World War.

Diplomatic. Quizzed by MPs on the outlook for monetary policy, Bank of England Governor, Andrew Bailey, trod a fine line.  Neither hawk nor dove, team transient nor permanent, the Governor may well have succeeded in leaving all camps wanting.  Bailey acknowledged that price and wage-setting decisions now ‘very clearly’ pose upside risks to inflation, reiterating his previous plea for companies and workers alike to exercise restraint in these settings.  Yet he stressed again that interest rates needn’t rise very far to bring inflation back to target, noting that energy prices may fall-back.  Of course, the invasion of Ukraine makes that unlikely anytime soon.

Rebound. UK’s PMIs reading in February point out to a rapid rebound from the Omicron hit. The Markit/CIPS composite PMI rose to 60.2 from 54.2 in January the higher levels seen since June 2021. Main driver of this rise was service sector recovery where the index rose to an eight-month high—60.8 from 54.1— in January as consumers relaxed about Omicron. In addition, the manufacturing sector, which was largely unattached by Omicron, benefited from a further easing of supply chain disruptions and held steady strong levels (57.3). The rise in output comes with an increase in input cost inflation which was the steepest since November. Real time data suggest that activity has picked up in recent weeks and combined with widespread price increases gives the green light for another hike rate in March.

Shedding the virus effects. Fast moving indicators suggest that the UK economy swiftly shed the drag on economic activity from the Omicron variant in February, barring some disruption caused by extreme weather conditions. CHAPS Card spend data was up 2% over the week ending 17th Feb, a whisker away from its pre-pandemic level. Further, with lifting of restrictions, a higher share of workers worked exclusively from the office (54%), which will likely boost future spend. But recovery is progressing with risks alongside. For one labour market conditions remained tight. Volume of job adverts was c.50% above its pre-pandemic level, led by higher-than-average level of unfilled positions in transport and logistics. What’s more, UK consumer confidence plunged in February (-26) as surging cost of living hit morale even before Russia invaded Ukraine.

Business as usual. And while businesses are gaining confidence due to better trading prospects, inflation continues to be the major impediment to their overall performance. 39% of the businesses currently trading reported an increase in the prices from the last month in February, up from 33% in January ‘22. And while, “Hybrid” is the buzzword in the post-Covid world, c.18% of the workforce were estimated to be working both from home and office, this could pose structural headwinds to the property sector.

Regaining momentum. Eurozone PMI recovered to a 5-month high in February to 55.8 from 52.3 in January as Covid-related restrictions were relaxed while new orders and job market improved. However, energy bills and wages has led to the sharpest price increases on record. Evidence of steep increases in prices could add pressures to European Central Bank to tighten monetary policy faster than expected. Similarly, U.S. Composite PMI rebounded from the Omicron wave after output index rose to 56.0 after an 18-month low of 51.1 last month. The manufacturing and services activity were stronger as demand rebounded and supply constraints moderated. As US and EU PMIs gain momentum, further intensification of inflationary pressures will most likely cast a shadow as the final consumer attempts to tackle cost of living pressures.

Leave a Reply