Chief Economist’s Weekly Briefing – On thin ice

Bank of England governor Andrew Bailey’s trip to the US for the annual IMF and World Bank meetings will not shield him from worries back home. The BoE is caught in the crossfire between raising rates to tame inflation and concerns that much higher mortgage rates would push the UK into a sharp downturn. Against this backdrop, every word Bailey and his colleagues utter will be closely scrutinised. 

Jagged little pill.  BoE’s Chief Economist, Huw Pill, was at pains to stress the “temporary and targeted” nature of its up-to-£65bn operation to restore financial stability by restarting Government bond purchases to bring down rising yields.  The measures do not, he said, amount to a change in the direction of monetary policy.  Nor can they prevent the “inevitable” re-pricing of UK financial assets.  In fact, those market developments and the recent fiscal easing – think Energy Price Guarantee and Mini Budget tax cuts – will prompt a “significant and necessary monetary policy response” when the MPC next meets.  That’s scheduled for 3rd November and will be informed by the Chancellor’s next update on tax and spending on 31 October.

Plucky. A chink of light in these rapidly darkening days.  Wholesale gas prices fell 17% in the week to 2nd October and are now 60% below the peak reached on 31st August. Yet there’s a long winter ahead, and business and household worries about energy prices remain valid. The UK labour market continues to soften, albeit slightly, with online jobs down 17% on the year (unchanged on the week) while small business jobs have fallen year-on-year for five months on the bounce. Yet folk are still marking end-of the-month payday with a meal out. The economy’s down, but defiantly not out.

Turning up the heat. Rising energy costs have been a big worry for businesses of all sizes this year and while the drop in gas prices is a respite, some damage has already been done. The latest insolvency data for England & Wales shows that it might have led more firms to fail. In Q2 this year 10,500 firms were declared insolvent or went into liquidation.  That’s up on the 7,500 firms that went bust in Q2 2019. Construction, hotels & restaurants and retail were the three industries with most insolvencies.  Of these, hotel & restaurant businesses were the most concerned about energy prices and saw that concern rise the most between February and October this year. Sure, the new energy price guarantee will help tame energy costs from rising further, but businesses are still worried. And surveys point to that.

Pricey. In the latest wave of fortnightly UK business survey (BICS) companies reported that input price inflation (24%) and energy prices (23%) continue to remain the top two concerns for them. 34% reported they have fixed or hedged electricity contacts, and 29% for gas. Of these, 18% are expecting their electricity bills to increase by more than 300% at the end of their contract, and 17% expect the same for their gas bills. Growing cost pressures are eroding profit margins – 42% of businesses reported they had not passed on their higher costs to customers, with businesses in the professional services reporting the highest proportion, at 66%.

Moving On Up. BoE’s Decision Maker Panel survey results reinforce these worries. UK businesses still expect their costs to rise at a rapid pace of 9.1% in the coming year, three times higher than pre-pandemic cost growth. A large contributing factor to these cost pressures are rising wages, which business leaders now predict will rise by 5.9% in the next 12 months. Given these figures, it is unsurprising that businesses anticipate their prices to rise by almost 7% by this time next year to manage soaring costs. Alongside this, they are also contending with mounting uncertainty, with 10% more firms citing the war in Ukraine as one of their top three sources of uncertainty than just last month.

Unhealthy yet productive? The UK labour market has been doing relatively well but the emergence of long Covid raised focus on the impact on work of ill health. A Resolution Foundation report reveals that long Covid prevalence (1M people) is lower than the pre-pandemic increase in the number of working-age disabled people (up by 2.3M since 2013). And this in turn is due to an increase in disability, rather than an increase in the disabled employment rate. This means that the worsening reported health of the working-age population predates the pandemic. Still productivity has improved. Output per hour worked and output per worker were higher in Q2 than their pre-pandemic level. This growth has been driven by within industry effects, but still productivity stands to lose from growing ill health.

Mixed. The US labour market is tight but some demand-side cooling in underway. US employers added 263,000 new jobs, down from 315,000 in August while the number of job openings declined by 1.1M in August. Despite that the unemployment rate dipped to 3.5% from 3.7% in August, pointing to a tight labour market and underscoring Fed’s aggressive tightening campaign. With the labour market still tight, wage gains remain solid. Average hourly earnings in September increased for a second straight month at same rate of 0.3%, translating to an annual pace of 5.0%. The debate rests on how high jobless rate will need to rise to return inflation to target. Recent projections by Feb suggest that a rise of 4.4% next year will suffice to slow down price rises substantially.

Bleak. That’s the verdict of economists on Eurozone’s retail sales outlook. Retail sales volume declined 0.3% m/m and 2.9% y/y in August, as accelerating inflation continued to squeeze household incomes. This was despite a marked rise in car fuel sales (by 3.2% m/m), and was driven by declines in food and drinks, and online shopping sales. The decline underlines economists’ expectations that the Eurozone is likely to enter a recession in the coming quarters, hit by the energy price shock. But ECB policymakers have expressed that growth concerns should not prevent a needed rise in interest rates.

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