All eyes today on the new chancellor. Since taking office last Friday, Jeremy Hunt is sparing no time in pacifying panic-stricken markets by undoing much of the controversial tax measures announced by his predecessor. This has already borne fruit—gilts and sterling rallied this morning. But this won’t completely fill the gap in public finances. Besides, the deteriorating growth outlook, continued real income squeeze and higher mortgage rates will weigh on the economy through next year.
Downturn. The economic slowdown is intensifying, GDP fell in Aug by 0.3% both m/m and on a 3-month over the previous three-month basis. This might mark the start of a downturn. Output in consumer facing services—one of the few areas of resilience in the economy up until now—fell by 1.8% MoM, and remained 8.9% below pre-pandemic levels. The impact of the intense real income squeeze on households and demand seems to have arrived. The decline in global goods trade also hit manufacturing output while chunky falls in industrial production acted as a further drag. In the meantime, the resilience of the real economy started to deplete, given that now one-third of households no longer have meaningful savings left. Needless to say, the coming downturn will be deeper than initially anticipated.
History rhymes. Atypically, the UK’s recent economic history relied heavily on a rising supply of workers. That supply has now stopped (and growth with it). Between spring and summer the UK employment rate fell 0.3ppts. Worse. It’s unemployment’s not rising as people have stopped looking for work altogether. Inactivity rose by 0.6ppts over the period and is 1.4ppts higher than pre-pandemic. A combination of Covid, poor health outcomes and an ageing population seem at play. The rise is concentrated in those aged 50-64, often male and due to long term sickness. The UK is an outlier. Remember the ‘the sick man of Europe’?
Ready and waiting. With inflation “unacceptably high” and the Monetary Policy Committee “unwavering” in their commitment to bringing it down to 2%, the Bank of England’s Chief Economist remains of the view that monetary policy must undergo a “significant” tightening in just over a fortnight. Policymakers, we’re told, remain focussed squarely on fighting inflation and will not be distracted by “temporary and targeted” financial stability interventions. So what could affect the magnitude of interest rate rises on 3rd November? This morning’s announcement on fiscal policy changes are top of the list, especially if these will affect markets’ inflation expectations. Tightening up on the fiscal side paves the way for less stringency on the monetary side, all else equal.
Feeling the squeeze. Real-time indicators revealed that gas prices fell by another 19% in the week to 9th October and now sit 65% lower than their August peak. With the energy price cap freeze now set to last six months, rather than two years (albeit with more targeted support set to continue longer), we’re going back to watching wholesale gas prices very closely. Elsewhere, the pinch of inflation is being felt, with retail footfall this last week only reaching 89% of its equivalent pre-pandemic level and online spending declining 19% since last week. The outlook for businesses looks equally tight, with almost half (47%) reporting that their input costs had risen since August. While online job adverts rose slightly by 5% in the last week, the current economic outlook far outweighs this modest perk.
A cold winter. The BOE’s latest credit conditions survey paints a gloomy picture, with a slight increase in defaults on mortgages and on loans to SMEs in Q3. Lenders are expecting defaults on mortgages, credit cards and other loans in the next quarter to continue climbing from today’s low levels as the cost-of-living crisis continues to bite. Lenders are tightening their belts, with the availability of household credit decreasing in Q3 and expected to decrease further in Q4. While demand for credit card lending is expected to increase, testing the financial resilience of consumers relying on plastic in the months leading to the festive period.
Slowing down. 3 in 5 local firms reported a slowdown in demand during the third quarter according to the latest NI Chamber of Commerce and Industry survey. Escalating costs are taking their toll with confidence around profitability plummeting for both manufacturing and services firms. 1 in 4 businesses have seen energy costs rise by 50% or more over the last quarter. Wage pressures are mounting too with the share of employers offering pay rises over 5% doubling to 45% in the last year. NI’s manufacturing performance deteriorated significantly in the latest quarter with order books weakening. Local manufacturers are also more concerned about interest rate hikes than any other UK region.It is worth noting this survey was completed in August, before what Kwasi Kwarteng described as “a little turbulence” on financial markets.
Upheaval. The IMF’s World Economic Outlook is far from uplifting. The forecast for global growth has been slashed again, with a paltry 2.7% growth forecast compared to 2.9% projected in the July report. This is the slowest growth profile since 2001, except for the financial crisis and the most severe phase of the pandemic. And it comes with a one-in-four chance that growth will slip below 2% next year. The reasons? Well, how long have you got? Rising cost-of-living pressures, supply-chain disruptions, tightening financial conditions, and a growing risk of monetary policy miscalculation amid all this. Unsurprisingly, about a third of the world economy faces a technical recession next year.
Unchartered waters. The low interest rate and low volatility world of the last decade has gone. A smorgasbord of downside risks, ranging from higher than anticipated inflation to a more pronounced slowdown in China – have materialised since April. Alongside the deterioration in the global economic outlook the IMF has been vocal on the deterioration in the global financial stability outlook. In response to inflationary pressures, interest rate hikes have led to a tightening in global financial conditions. As a result, strains in markets have been increasingly evident with a sell-off in asset prices and stresses in funding markets. We are now in a higher interest rate and higher volatility environment. To quote the IMF “navigating the unchartered waters of high inflation and tighter financial conditions requires a delicate balance by policymakers”.
Persisting. Notwithstanding record doses of policy tightening by the Fed, US consumer prices continued to rise further ahead in September. The headline print rose 0.4% over the month, above consensus expectations. But the bad news really was the 0.6% rise in the core measure, driven by the services sector, where price pressures persist. There was a further rise in airline fares while the pandemic-related surge in housing costs remains very much in train. There are some silver linings. Margin compression from overall weaker demand suggests a sharp fall in some prices next year. Inflation is moderating in areas where there is excess inventory (furnishings, clothes etc). And base effects should mean the rate beginning to decline soon. Time will tell! For now, the long-awaited pivot from Fed still has some way to go.