Chief Economist’s Weekly Briefing – 7 days

If Craig David was to put last week’s frenetic financial market activity to music,  it would go something like this:

The pound slumped on a Monday

Took flak from the IMF on Tuesday 

We saw BoE buying Gilts again on Wednesday

And on Thursday and Friday and Saturday

We chilled for a 45p tax U-turn on Sunday

A dramatic week as markets fretted over the UK’s debt sustainability. This morning’s U-turn on the 45% rate of income tax has provided some relief. But will it draw a line under events? That looks challenging. Particularly when there are a number of other factors driving market turmoil. 2022 has been a wild ride so far. Buckle up for Q4. 

Borrow amid the sorrow. Resolution Foundation estimates that Treasury will have to borrow a staggering £411bn extra over the next five years to cover the hole in the budget left by support to energy bills and tax cuts. Add in rising borrowing costs and you have a detachment from the fiscal rule of debt falling as a share of GDP by the end of the Parliament. Markets were spooked, and rightly so. Sterling fell, govt. borrowing costs rose, and pressure on monetary tightening has increased. But it’s not all about the market. RF also estimates a 1% erosion of living standards from the currency shock as import prices rise. Will reversing the cut to the top rate of income tax be enough to deal with those challenges?

Dipping. Revisions to Q2 2022 GDP revealed that instead of contracting, the UK economy actually expanded by 0.2% q/q. That means the threat of a ‘technical recession’, two successive quarters of contraction (Q2 & Q3 had been pencilled in) has been lifted, for now. Not so for Northern Ireland’s Composite Economic Index (NICEI), which fell by 0.1% q/q from Q1 2022’s 15-year high. That was the first quarterly decline in five quarters.  Private sector services pulled the private sector output component down by 0.2% q/q. NI output may still be above pre-pandemic levels, but it still remains below Q2 2007’s pre-Global Financial Crisis (GFC) peak. Returning to that high is likely to be 2024 at the earliest.

Last orders? The prospect of imminent interest rate hikes seems to have encouraged homebuyers to complete their deals. UK mortgage approvals increased markedly to 74,300 in August, up almost 17% on the previous month and 11% above the pre-pandemic average. Following last week’s run on mortgage offers, October is expected to be a lean month with significant re-pricing expected to crimp demand going forward. The cost-of-living crisis has seen more people reach for the plastic to fund their consumer spending. An additional £500m was put on UK credit cards in August, up 12.9% on the same month a year ago. That’s the fastest annual rate of credit card spending since 2005.

Fragile future. Borrowing is not all that UK consumers are doing. The latest Opinions and Lifestyles Survey reveals that people are looking for higher paying jobs, promotions, working extra hours or even juggling two jobs to cope with the cost-of-living crisis. That said, a majority (63%) are not doing anything different in terms of work. But with energy bills, rent, and mortgage payments increasing, it is not surprising that 42% express feeling unsure about the future, while only 26% feel sure, the rest feeling neither way. The cost-of-living crisis and climate change remain the main reasons for worry.

Context. The on-the-ground reality for the vulnerable is even more stark. With focus on tax cuts for the richest, let’s look at the other end of the income distribution. First, the share of UK households with no adult working increased to 14.1% in Q2. The share of children in workless households also rose slightly to 10.2%. And the share of children living in both relative and absolute poverty is higher. Data for 2021 shows 27% of children live in relative and 23% in absolute poverty. Inflation means absolute poverty (which follows living standards) could see this rise to 31% – a third of all children! It’s also the first time absolute poverty has risen outside a recession. It’s against this backdrop that the government’s fiscal policy is being judged.

Up and down. No, not financial markets this time, but instead concerns about inflation and energy prices. A quarter of UK businesses reported inflation as being their main concern in September, with another fifth picking energy prices specifically. Perhaps then it will bring some comfort to know that the wholesale gas price fell by 50% from its peak in August. Sure, it remains high, at 50% above its level last year, but is now far from astronomical. Many businesses and most households are now sheltered from its volatility, so the loudest cheers might come from the Treasury, who will shortly be picking up the bill. Such unexpected savings will be most welcome as they try to make their budget add up.

Higher and higher. Eurozone inflation rose to a new record high of 10% in September, up from 9.1% the prior month according to the flash estimate.  Spiralling energy costs – now 41% higher than a year before – made the biggest contribution to lifting the headline CPI rate into the double-digits, but an array of other products saw price rises accelerate: from food to (rail) fares.  Core inflation climbed too, up 0.5ppt to 4.8% amidst rising services prices.  Against this backdrop it’s looking likely the ECB will again hike rates by 75 bps when they meet next. 

The Price of War. According to the recent OECD Economic outlook it will be steep and paid by countries across the world. Skyrocketing energy and food prices are aggravating inflationary pressures. Global growth is projected to slow from 3% in 2022 to 2¼% in 2023, well below the pace foreseen prior to the war. GDP growth is projected to slow sharply in 2023 to ½% in the US, ¼% in the euro area, and 0% in the UK. Growth in China is projected to drop to 3.2% this year, amidst COVID-19 shutdowns and property market weakness, but policy support could help growth recover in 2023.

Weakening. On that note, a thin silver lining came as China’s factory activity unexpectedly grew in September with the official manufacturing PMI rising to 50.1 from 49.4 in August after two months of contraction. Easing of Covid measures in parts of the country helped restore growth in the output component, reflecting the resilience of large state-owned enterprises as well as the recovery from energy disruptions in August. But this reading belies a sharp downturn in the private sector, as Caixin PMI fell to 48.1 vs. 49.5 in August. The sector is more exposed to tightening of zero-covid measures. Energy disruptions, a property slump, and zero-covid policy are adding to the mounting concerns of a global slowdown.

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