Chief Economist’s Weekly Briefing – Inflation with a chance of downturn

Disappointing economic data for the UK economy last week: declining retail sales, weakening PMI surveys and falling consumer confidence. To add to that, new projections from the IMF suggest that the UK would have the slowest growth in the G7 in 2023. Weak economic data underlines the balancing act facing the Bank of England, bringing inflation back to target while preserving the recovery.

The Palace of Westminster in London in the evening – England

Setback. The war in Ukraine will contribute to a slowdown in global growth according to the International Monetary Fund (IMF). In its World Economic Outlook published last week,the IMF now expects the world economy to expand by 3.6% this year and 2023. That is 0.8 ppts lower for 2022 and 0.2 ppts lower for 2023 than its previous forecast in January, and a sharp fall from an estimated 6.1% in 2021. 143 countries, including the UK, had their growth forecasts downgraded. War-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7% in advanced economies and 8.7% in emerging market and developing economies — 1.8 and 2.8 pp higher than projected in January.

Under Pressure. Following a second consecutive month of decline, the volume of UK retail sales fell more than expected in March, falling 1.4% from February, perhaps a hint that the high inflation is hutting consumer spending, but it’s also a bit of the anticipated switch into services spend – we’re prioritising experiences right now! Non-store sales were hit hard as households cut back on discretionary purchases (-7.9% MoM). Storm clouds elsewhere too, separate data showed that GfK UK consumer confidence dropped to -38 in April, the lowest level since 2008, driven by concerns over the soaring cost of living.

Resilience retained. On a happy note, high frequency indicators point towards continued momentum in first half of April. CHAPS card spend data rose by another 5% vs last month. While some of the increase is driven by ‘work-related’ spending which reflects the higher cost of motor fuel, other components such as social spend and delayable also rose at a healthy clip. The latter is corroborated by UK seated diners holding up at 138% of its pre-pandemic level, the highest since early September 2021. Google mobility geodata also shows that visits to ‘retail and recreation’ locations picked up by 8% in the week to 15th April. Meanwhile, the labour market remains in strong shape, job openings are 44% above their pre-pandemic trend.

Spike. Wordle fans trying to guess the latest PMI headlines are likely to focus on inflation. ‘Spike’ or ‘surge’ sum up the UK flash PMI for April. Manufacturers saw last November’s record high in input cost inflation equalled with firms raising their prices at a record rate. Services firms fared little better with costs rising at the second-highest pace since the survey began 20 years ago. The cost-of-living crisis and uncertainty linked to the war in Ukraine have adversely affected client demand. Both sectors reported a notable slowing in new order growth and are scaling back their expectations for growth in the year ahead. Not all bad though, the latest PMI reading suggest that UK has the highest output growth in comparison with other major advanced economies (i.e., USA, France, Germany, Japan, Australia).

In a soup. The colossal rise in the energy prices due to the disruption caused by Russia’s invasion of Ukraine has stunted the performance of business. In April, around 29% of businesses reported that their production and/or suppliers had been affected by the surge in energy prices, up from 25% in the previous month; with the hospitality sector reporting the highest percentage, at 56%. Further, the shortage of workers is a persistent problem. Around 14% of businesses reported that they were experiencing labour shortages, similar to the 13% in early March, and a figure little changed over the past six months. Coupled with inflation and it’s clear businesses are having aa tough time of it.

Narrow Path. The path for inflation from here is subject to plenty of uncertainty as it continues to be buffeted by supply chain disruptions and surging energy prices. That makes the task of central banks, which need to keep prices low and stable while also avoiding recession, even more challenging. The Governor of the Bank of England, Andrew Bailey warned that “it is a narrow path” of dealing with two opposing forces: uncomfortably tight labour market conditions and historically high inflation. Governor Bailey has also acknowledged that the economy might fall into recession if the central bank raised interest rates too far. Setting policy in this environment is an unenviable task.

Winter or Spring. Some good news for the eurozone economy as business activity accelerated in April, according to the bloc’s composite PMI, which hit 55.8 in April vs 54.9 in March. Like the UK, it’s services where spring has sprung, with the easing of restrictions and the related return to more pre-pandemic ways of living and socialising supporting rebounding activity. But the iron grip of winter holds fast for manufacturing, where supply constraints, both labour and raw materials, plus rising costs, are putting output firmly on ice. The sector is close to staling. Yet any thaw seems distant.

Good start. China’s GDP held up at the start of the year with 4.8% growth vs the equivalent period in 2021. That compared favourably with both the consensus of 4.4% and previous quarter’s figure of 4%. But not all is well. The Q1 growth was buoyed by strong growth in January and February. But a 3.5% decline in retail sales highlighted the adverse impact of the dynamic zero-Covid policy and associated lockdowns on the economy. The national unemployment rate rose to 5.8% – the highest since May 2020. China is emerging as an additional risk to a global economy being buffeted by war, high inflation and the risk of central banks tightening too much to price pressures. 

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