Chief Economist’s Weekly Briefing – The double whammy

Central bankers adopted a more hawkish tone at an industry get together last week, warning that the era of low rates and modest inflation may be at an end following the double whammy of Russia’s invasion of Ukraine and the Covid shock. Gloom still dominates global headlines: US consumer confidence deteriorated amidst inflationary concerns, while price pressures continue to build in the Eurozone.

Strong but not for long. UK household spending held up well in Q1’22, rising 0.6% over the quarter (adjusted for inflation). The largest positive contribution to growth came from restaurants and hotels, followed by the recreation sector. Once again, this speaks to increased adaptation by firms and customers to episodes of virus resurgence (as well as highlighting the potential for a small rebound after winding back remaining lockdown measures). There were areas of weakness though: particularly transport and tourism. Overall, spend is still 0.4% below its pre-pandemic level.  The ongoing intensification of the real income squeeze means we may have to wait for longer before the gap closes.

On the up. Rising prices are the single biggest issue for businesses according to the Office of National Statistics’ latest survey, with half of UK firms reporting that costs went up in May, compared to the previous month. In response businesses are raising the prices they charge, with 30% expecting to put the increase through in July, prompted in the main by rising energy costs. Inflation now looks to be taking its toll on demand as well. The sectors where reported turnover fell the most in May were leisure and retail, showing just how squeezed consumers now are.

Diesel power. As any driver will attest, prices at the pump have reached eye-watering levels. A litre of diesel is within a whisker of £2 according to government data. High global oil prices are, of course, a key reason. But an additional problem is a bottleneck in the global refining system. Some of the plants shut during Covid have yet to come back on. China’s lockdown during spring has reduced its exports substantially. Throw in the trend of outsourcing in recent decades (UK refining capacity is down over 30%) and it makes for difficult territory. We’re not alone. This is a problem shared, as low global inventory numbers make clear. Things may improve as new capacity comes in later this year. But for now, it’s painful.

Wait and watch. Governor Bailey’s remarks last week at the European Central Bank conference were reflective of the prevailing economic uncertainty. A 50bps hike in the Monetary Policy Committee’s next meeting was not ruled out, though other things are on the table too. Hawkish comments referenced the recent CPI print, which suggests that price pressures are broadening, while the job market is tight, and services inflation is up. But that was duly moderated by the view that economic growth is at a turning point and that markets are pricing in upside risks for the rates increases. Bailey did not attribute positives or negatives to the recent moves in the exchange rate and saw the make-up of inflation shifting from a goods supply shock to the ‘post-covid’ energy and food shock.

Normalising, not for long. During the pandemic years, borrowing and saving by UKhouseholds and companies looked anything but normal, with exceptionally large borrowing by companies, especially SMEs, and exceptionally large savings by households. Now we see some normalisation in the credit markets. Household savings in May (£5.7bn) are close to their pre-pandemic levels (£5.6 bn on average). SMEs continued to repay debts accumulated during the pandemic (repayment of £0.2bn), making May the 13th consecutive month of repayments. Mortgage net borrowing is elevated and increasing, demonstrating the strength of the property market – £7.4bn in May up from £4.2bn in April vs £4.3bn on average pre-pandemic. But cost-of-living crisis might disrupt the picture again.

99 Problems. Consumer spending power is being hammered by soaring inflation, which already shows up in high frequency indicators. As rail strikes across Britain unleased a summer of travel misery, transit station visits decreased by 6% in the week ending 24th of June vs previous week. Elsewhere, Pret a Manger transactions declined at most locations, and UK seated diners fell by 16 ppts. At the same time, in late June 35% of businesses reported their production and/or suppliers had been affected by recent surges in energy prices, up 2ppts on May.

Cost benefit analysis.“The price of freedom is worth paying”, declared Boris Johnson. And while Ukraine is suffering the biggest cost, other countries are feeling the pinch. Take the Baltics. If you thought inflation was high here (and it is), check out Estonia, where annual average prices rose by 22% in June, or Lithuania (20.5%), or Latvia (19%). For comparison, a year ago these figures were 3.7%, 3.5% and 2.7%. Just like across the eurozone, where annual inflation reached 8.6%, rising energy prices are the key (but not the only) factor. Energy inflation increased by 42% across the EZ in June.

A sliver of hope. A soft recovery is underway in China; the official manufacturing PMI inched into expansionary territory in June, reaching 50.2 (vs. 49.6 in May), the first month of expansion since February.  That follows an easing of lockdowns in major cities, including Shanghai. But recovery is far from uniform and headwinds persist. The supplier delivery time index, output and new orders registered the largest gains, but new export orders and employment remain under pressure. The rebound was even more sizeable for non-manufacturing PMIs which recorded 54.7 in June (47.8 in May), driven by construction activity. The Caixin PMI —focused on small private and export-oriented firms— paints an even stronger picture for manufacturing (51.7). The economy will continue to pick up in the coming months as restrictions are relaxed further and government stimulus provides support.

Leave a Reply