Chief Economist’s Weekly Briefing – On shaky ground

It’s Bank of England decision time this week as the MPC will meet to set (and likely raise) Bank Rate. How are we placed currently? For one, the economic downturn is gathering steam. For another, businesses appear in no hurry to stop raising prices, even with energy prices coming down. But cost of living concerns remain entrenched. Difficult territory. And plenty for the Bank of England to ponder whether to bring its rate tightening cycle to an end. 

Duunn-dunn. 29-year-old Steven Spielberg only agreed to direct Jaws if he didn’t have to show the shark for the first hour. Anticipation heightens fear. So too today. As it’s only as the cost-of-living crisis enters its second year that the undeniable shark-shadow emerges. The ‘flash’ UK PMI dropped to 47.8 in January (from 49), the steepest fall in two years, driven by services. Manufacturing production, although weak (46.6) improved. Still, inflation’s bite is softening, with input cost pressures easing. Business optimism is up too. But we still don’t know if, or how hard, the shark will bite.

Cold and coping. Until then, Britons are doing all they can to sail through. In the latest Public Opinions survey, when asked about the important issues facing the UK today, cost of living (93%), the NHS (89%), and the economy (76%) remain the top three concerns. Not surprising given that 92% reported a rise in their cost-of-living over the previous year and 67% reported a rise over previous month. Even with gas prices coming down and goods inflation retreating, people are spending less on non-essentials (69%) and using less fuel in their homes (59%).

January blues. It’s been a shaky start to the year. While gas prices fell by 4% in the last week, electricity prices were up by 17%, but both have deflated from the equivalent week last year. While retail footfall remained broadly unchanged from the previous week, Revolut debit card spending recorded a drop of 2%, suggesting the post-Christmas slump is starting to settle in. With online job adverts 22% lower than this time last year, it’s no surprise that people are taking a more cautious approach to their New Year spending.

Itchy feet. Advertised vacancies in NI eased by 8% quarter-on-quarter in Q4 2022 but the number of postings is still close to 90% above pre-pandemic levels (Q4-19). That’s according to the latest report which was supplemented with a survey of 1,500 job hunters. The cost-of-living crisis is motivating 61% of jobseekers to look for a new job.  Salary comes in top of the list, whilst flexibility and hybrid models fall back to third and fourth place. 70% of those seeking a new job research salary from the outset. But it is not just the salary that matters. 82% of local jobseekers consider perks and benefits when looking for a new job, with health insurance the most attractive benefit.     

Pressure rising. With price fluctuations comes uncertainty. The latest business surveys from the ONS points to there being plenty of pricing pressure in the pipeline, despite recent falls in wholesale gas markets. Over a third of businesses are considering raising prices in February, with energy costs being the primary driver. But staff costs are rising too (cue high wage pressures especially in the private sector), as a quarter of businesses have seen their labour costs rise in the last 3 months, even more so in the leisure industry where 44% of businesses spent more on staff. While international central banks are starting to talk about pausing their rate rises, it may be hard for the MPC to match that rhetoric in the face of such pressures.

Under pressure. No it’s not a song by Bowie but the state of the local construction industry. Firms may be busy with current workloads but the latest Construction Employers Federation survey cites costs pressures and mounting pessimism for the year ahead. 50% of firms said their profit margins deteriorated in 2022. Some 62% of respondents do not expect to increase their turnover in 2023. A similar proportion stated that inflationary pressures were continuing to pose serious financial concerns. Increased cost of materials; Inflation; Access to skilled labour; and Political uncertainty/ no functioning NI Executive are the four main challenges facing construction in 2023. Clearly these aren’t just confined to construction.       

Fiscally challenged.  Public sector borrowing ballooned last month, hitting £27.4 billion, the highest December figure ever recorded. The culprits? Spending on energy bills support schemes and rising debt interest costs. The latter swelled to £17bn, another unwelcome record, as spiralling inflation drove up payments on index-linked gilts. There’s a glimmer of hope for the Chancellor as he prepares his March Budget though.  Year to date borrowing is still less than forecast by the Office for Budget Responsibility. Inflation is beginning to ease. And plummeting wholesale gas prices are vastly improving the outlook for costs of the Energy Price Guarantee scheme.

Work to do. For the long-term improvement in standards of living, productivity growth is the most important factor. So, it’s not surprising that it gets so much attention. According to the most recent statistics, in Q3 2022 output per hour was 1.6% above average for 2019. This is 0.8 ppts below the trend based on the pre-pandemic decade, which itself witnessed disappointing productivity performance to begin with. The sectors which contributed most positively were manufacturing, construction, and administrative services. The losers? Public services, wholesale & retail, and transport. For now, there are few signs of a material boost to productivity.

Resilient: The US economy surpassed expectations in the final quarter of 2022. Economists forecasted 2.6% growth, but GDP overshot that slightly, expanding by 2.9% in Q4 2022. This marked a slowdown from the 3.2% growth seen in Q3. But this was expected given the Fed’s aggressive approach to raising its policy rate to tackle stronger than expected inflation. The Fed has raised rates by more than 4 ppts, with a further 0.25% hike expected this week. Many economists expect the US to fall into recession in H2, with unemployment rates closing in on 5%. However, Fed officials remain optimistic that a “soft landing” can still be achieved. 

Upbeat.  Good news pouring in from the Eurozone which saw the composite PMI rise to 50.2 in Jan, exiting contractionary territory (a sub-50 reading) after six months. The drivers? Gains in services and softer fall in manufacturing. To add to the cheer, input cost inflation cooled in line with easing of supply chain pressures and falling energy prices. EU confidence data showed improved sentiment and sunnier growth outlooks. Modest bright spots in the US too, where composite PMI hit a three-month high of 46.6 in Jan from 45.0 in Dec. Softer declines were registered in both services and manufacturing. What is worrisome however is that the rate of input cost inflation accelerated in the new year, putting pressure on the Fed to continue the tightening cycle. 

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