Chief Economist’s Weekly Briefing – Start of the end

Last week the Bank of England joined the bandwagon of advanced economies’ central banks in continuing to hike interest rates. But it came with two sources of hope. First were some clearer signs that the Bank is approaching the end of the tightening cycle. Second was a slightly rosier outlook, namely a shallower recession and a less sluggish recovery, than was forecast in November. It’s still set to be a distinctly challenging year, but it counts as good news for now. 

Ten out of ten. The Bank of England (BoE) increased official interest rates by 0.5% to a 15-year high of 4%. Monetary Policy Committee members voted 7-2 in favour of the tenth consecutive hike. New forecasts anticipate inflation will ease quickly from the 10.5% annual rate in December, to under 4% by the end of 2023, and to fall significantly below the 2% target in 2024, as expectations of “ongoing” tightening have given way to a more data-led approach. BoE officials justified the move as an ‘insurance’ against future price rises, with Governor Andrew Bailey stating, “we need to be absolutely sure that we are really turning the corner on inflation”.

Not great, but we’ll take it. The sense of optimism at the start the year was visible in the BoE’s latest forecasts. Back in November, those estimates painted a bleak picture of a significant and prolonged recession. While still challenging, its revised outlook is far less so. It expects the economy to contract by around 0.5% this year, compared to November’s -1.5%. The forecast recovery is still sluggish, but less so. The rate of joblessness is expected to climb to 4.4% a year from now (trimmed from 5%+). While inflation is expected to fall more quickly to within touching distance of 2% a year from now.

Sick man. Even with the BoE’s upgrades to growth, the IMF’s latest round of forecast updates highlighted the weakness of the UK’s growth prospects. 2023 is predicted to bring a small recession with a 0.6% fall in output, in contrast to varying degrees of growth in most other countries across the globe. The UK’s exposure to gas prices is an obvious drawback, but the IMF also highlighted how labour participation was yet to reach its pre-pandemic level, meaning the UK has fewer workers to drive growth. Reducing the obstacles to work looks like an increasingly vital policy priority.

On message. New business data lends weight to the view that we are now at, or near, the peak of the rate-rising cycle.  Inflation expectations are declining.  Business leaders expect CPI to be 6.4% in one year’s time, down 1ppt in the past month, and 3.7% in three years (the lowest recorded response since last Spring).  Firms also anticipate that pay growth will moderate as the labour market slackens. Wages are expected to rise 5.7% over the next year, not 6.3% as envisaged in December.  Staffing difficulties are fading fast too: just over a third of firms find recruitment much harder than normal versus two-thirds in mid-2022.

Sleeping giant. Not saying the housing market is cold-blooded, but it’s hibernating this winter. Mortgage approvals for house purchase fell by 23% between November and December, to 35.6k. Absent early lockdown, it’s the lowest since the dark days of the financial crisis. Consumer credit grew, with an annual growth rate on credit cards of 12.4%. Now, although this is fastest growth since the mid-noughties credit frenzy, and potentially a sign of stress, higher inflation will naturally accelerate balance growth. Overall, the money supply is growing between 2-3% per year, down from c.15% in 2020. So the monetarists among you should be reassured.

Mismatch. The Fed remains in rate-hiking mode but, as expected, downshifted to a modest 25bps rise last week. That brings the cumulative total of tightening to 450bps since March 2022 and takes the target Funds Rate to 4.50 – 4.75%. Disinflation is well underway, but Jay Powell still wants “substantially more evidence” that inflation is coming down for good. To that end, a push in rates above 5% is still expected, according to the Fed guidance, with no rate cuts until next year. However, financial markets remain unconvinced and are still pricing in rate cuts later this year (4.3% priced in for Dec-23) as inflation plummets.

Hawkish Pivot. The European Central Bank raised its deposit and refinancing rates by 50bps, to 2.5% and 3%, respectively. The move, which was in line with expectations from financial markets and economists, came despite a slight decline in inflation in Dec ’22 (9.2% from 10.1% in Nov). Striking a hawkish tone, ECB President Lagarde signalled that the bank would “stay the course” on raising rates — a hint that more than one half-point rise was planned, highlighting the concern that inflation may remain elevated despite the recent fall in energy prices.

Boom, boom, boom. News of China’s economic recovery could not be better timed. Only days after the end of the Spring festival, the National Bureau of Statistics (NBS) reported that China’s general PMI broke into expansionary territory (>50) in January, reaching 52.9 from 42.6 in December. The manufacturing PMI inched just above the 50-point waterline of zero growth, but the star of the show was the non-manufacturing (services) component which saw even more material gains. A whopping 13 points over the 41.6 December reading to 54.4. The economy’s exit from strict zero-Covid norms released pent-up demand. Notwithstanding the 0.8 ppts upward revision by the IMF, growth in 2023 will still be somewhat constrained by historical standards, due to the lingering property market crisis.

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