Chief Economist’s Weekly Briefing – Time to press pause?

The distressed takeover of Credit Suisse over the weekend will revive nervousness in financial markets and likely lead central banks to pause their rate hikes, despite a stream of otherwise relatively solid economic data. Markets have given a strong signal that events over the past week mean less rate hikes, as financial stability concerns feature more prominently in decisions on rates.

Going for growth. It’s almost easy to forget there was a Budget amidst last week’s significant financial developments. And it was a Budget designed to address some of the obstacles to economic growth. From weak labour force participation to depressed business investment, there were announcements to try to incentivise greater activity. But those policies, as well as other choices like freezing fuel duty, come at a cost. Whilst it passed the Chancellor’s fiscal tests, this Budget continued the trend of promising more spending when the forecasts are good, but not reining it in when the outlook turns south. Hence we’ve got debt to GDP on a stubbornly rising trajectory and a historically large budget deficit at a time when monetary policy is trying to cool inflation down. The supply side focus In the Budget gives less of a reason for the MPC to counter with more tightening, but it’s still an important factor to consider when it meets next.

Down, but not out. The latest labour market data on wages serves in favour of the MPC holding at 4%. Although employment growth is still steady, firms are taking other measures such as reducing working hours, initiating some redundancies, and most importantly, going easier on wage hikes. Thus, in January wage growth (both including and excluding bonuses) decelerated. But surveys suggest they will remain elevated for some months.  The KPMG/ REC UK Report on Jobs showed that in February firms raised wages for permanent roles to lock in candidates, while for temporary positions the increases were softer compared to January. So while there’s less reason to tighten than before, wage pressures are still intact.

Cause for pause. New data on the UK public’s inflation expectations give BoE policymakers another reason to hold off raising rates when they meet this Thursday. Households’ expectations for year-ahead inflation tumbled to a 16-month low of 3.9% in February, down nearly 1point since last quarter. Better still, households now think inflation will average just 3% over the longer-term. News that inflation expectations are well anchored gives the Monetary Policy Committee more reason to press pause on this extraordinary tightening cycle.

Welcome news. UK business confidence jumps to the highest level in a year—43% in Feb from 18% in Oct—according to the Accenture/ S&P Global UK Business Outlook Report, due to falling gas prices. The boost in future activity was reflected in nearly all the 14 surveyed sectors with businesses predicting a jump in customer demand and further easing of inflationary pressures. Hospitality firms registered positive sentiment for the first time in a year, with hopes that squeezed budgets will keep more people on “staycation” mode rather than travelling abroad. All welcome news then? Not quite. A well-known British problem was evident in the survey; capex and R&D plans continue to lag. Something that the investment incentives announced in the Budget will be looking to fix.

Recxit? It looks like Northern Ireland has exited its technical recession (Recxit) due to strong growth in services. Services output increased by 1.0% q/q in Q4 2022 taking activity to a new series high.  This more than offsets the quarterly decline in local industrial production (mainly manufacturing) of 0.6% in Q4 2022. Local retailers posted strong sales (+2.2%) which compared favourably with a decline amongst their GB counterparts. Unlike GB, local firms are benefitting from strong cross-border trade. This boost extends beyond retailing into ‘Other Services’ – a category encompassing arts & recreation; private & residential healthcare (incl. cosmetic surgery & dentistry); beauty treatment and tattoo parlours. Activity is 20% above pre-pandemic levels with the surge in demand for private health arguably a response to NHS waiting lists.    

What recession? Signs of stress in the local labour market are conspicuous by their absence. In the three months to January 2023 just 21,000 individuals were unemployed. That equates to an unemployment rate of 2.4%. There have only been two occasions when NI has had a lower rate. There are no signs of that changing anytime soon with just 20 confirmed redundancies last month. Meanwhile the number of employees on local payrolls hit yet another record high in February – up 2.2% y/y. The median employee is also seeing abnormally high wage growth with earnings up 7% y/y in February. That may be high from an historical perspective, but it remains well below the rate of inflation. So, the real terms earnings recession continues.     

 Steady. Real-time indicators for the UK showed only minor changes from the previous week, suggesting the economic climate is calming. A slightly higher proportion of businesses expected turnover to increase in April, to a net balance of 9.3%, up 1% from March and the highest figure recorded since April 2022. Consumer behaviour indicators were broadly unchanged from the previous week, with credit and debit card spending down only 1%. Demand for fuel rose by 6% in the last week, as wholesale prices continue to fall (down 4% this week), while gas prices remained stable. 

Refresh. Once a year the UK’s CPI basket of consumer goods and services gets updated and reweighted to reflect spending habits. 26 items have been added to the 2023 shopping basket and 16 items were removed with 743 items overall. Wraps & tortillas have been added to the Bread & Cereals category for the first time alongside frozen berries within ‘fruit’. E-bikes, soundbars, sanitary towels and home-security cameras are also new entries. The latter aims to capture the wide range of video doorbells available. Dropped items included digital compact cameras (we use smartphones instead), tampons, alcopops, 20 super king size cigarettes and CDs outside of the top 40.  

The domino effect: This month saw the second biggest US banking failure in history. On March 8th, Silvergate Bank announced that it would liquidate due to losses suffered in its loan portfolio. Two days later, Silicon Valley Bank collapsed after announcing an attempt to raise capital, causing a bank run to occur, with customers withdrawing a total of $42bn by the next day. And finally, Signature bank was closed down by regulators and forced into liquidation. Addressing the string of failures, President Biden declared the US banking system to be “safe”, vowing to introduce tighter regulations, while also ensuring “no losses will be borne by the taxpayers”. We will have to see what’s in store, and whether words are enough to end the period of financial turbulence.

Unfazed, for now. The ECB stuck to its guns and raised the deposit rate by 50bps to 3%. It was far from an easy decision given the turmoil in the banking sector on both sides of the pond. Future decisions would also be complicated as the ECB will look at “financial data” as in input into its decisions. In other words, taming inflation would not be at the cost of toppling over fragile financial markets. ECB president Lagarde said that it is now “impossible to determine the path of rates.” Market pricing around the future path for rates have seen significant swings over the past week, but in aggregate are pointing to less hikes prior to the past week’s events. Financial stress tends to weight on growth and broader economic activity. So, in effect, doing some of the job of central bankers for them but restraining price pressures in the economy.

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