Chief Economist’s Weekly Briefing – In the woods

The latest quarter seems to have gone by without signs of a downturn in spending or a recession. The drop in energy prices has certainly helped. And where it didn’t, savings were the saviour. But it is too early to celebrate. High inflation is still a major concern for businesses and consumers, weighing on demand. And on the other side of the cost-of-living squeeze lies the long-standing problems of low investment and weak productivity. 

Consumption Economics. In the face of increased cost of living pressures, the latest UK money and credit data showed that households have drawn on their saving more actively in recent months to sustain spending. The monthly pace of savings in Feb increased by £3.6bn, below its 2018-19 average. But the large flow of deposits into interest-bearing time accounts in January shows that many households do not intend to draw on their remaining savings going forward. High borrowing costs continue to drag on the housing market. While UK mortgage approvals edged up to 43.5k, they remained 35% below pre-pandemic levels. While forward looking data suggests the weakness intends to hang around for a while yet.  

How high and how long? This is the question that the Bank of England governor, Andrew Bailey, tried to answer last week. As the pressure of energy costs on prices is expected to subside in coming months, he is confident that the current level of Bank Rate (4.25%) will help bring inflation down to its 2% target. But the longer-term outlook is less certain. Long-term supply-side factors — population ageing and low productivity growth — put downward pressure on interest rates. But in the shorter run the rise in labour market inactivity seems likely to have contributed to a higher equilibrium interest rate. So, the MPC will be paying close attention to evidence of the numbers of folk joining the labour force.

Modest strides. Real-time indicators showed that while the UK economy is facing the same challenges, there are some glimmers of hope. The average price of gas continues to decline, dropping by 12% in the latest week, marking the tenth consecutive weekly fall. While prices are heading in the right direction, it is worth noting that they are still 3x higher than their pre-pandemic levels. So it comes as no surprise that energy prices remain the primary concern reported by businesses for April, at 17%, followed by inflation at 15%. Consumer behaviour indicators showed mixed activity, with retail footfall at 97% of the previous week and demand for fuel per transaction increasing by 5%. While there is cause for optimism, we are far from being out of the woods just yet. 

Struggling. It was a tough winter for many in the UK, as the cost-of-living crisis took hold. 16% of adults reported experiencing low food security, with 21% eating food past its use-by date and 14% reducing the size or number of meals to save money. Furthermore, 1 in 5 adults reported being unable to keep warm in their homes, impacting their mental and physical health. Many are also being forced to make adjustments regarding their health by taking less medication to keep prescription costs down (10%). Populations facing the most difficulties in terms of food, energy, and health are those who have depressive symptoms, live in the most deprived areas of England, are unemployed, and those aged 16-29.

Cut it out. We know low investment plays a big role in the UK’s weak economic performance. Often overlooked is the public side which accounts for around a fifth of total investment. Last week the Resolution Foundation set the scale of the problem and potential remedies. This century UK public investment has averaged just 2.5% per year; (it’s 3.7% across OECD economies). It’s not just low, it’s volatile, with governments finding it easy to wield the axe when public finances are under pressure. Stopping the lurch from feast to famine would be a good place to start when thinking about solutions. But more institutional change might be necessary, including setting public investment through an Act at the start of each parliament.

Sophie’s choice. Higher productivity begets choices. The French are more productive, so have greater choice over having more income or leisure. And they’re very publicly ‘negotiating’ this trade off via raising the pension age from 62 to 64. Meanwhile our state pension age is already rising to 67. Question is whether to go to 68. If we’re living longer then it’s a relatively simple delay. Problem is, we’ve stopped living longer. In 2006, we thought a man born in 1971 aged 50 would live to 86.3 years. By 2016 this had dropped to 83.9 years. Less jam today doesn’t mean more tomorrow. That’s a tougher choice.

Beginning of the end?  Eurozone inflation plunged to 6.9% in March, down 1.6 ppts in a month, exceeding expectations for a more modest fall. Lower energy prices were the primary cause of the decline, falling 2.2% in the month. While the energy price shock may now be over, inflation could yet prove sticky from here onwards. Core inflation crept up 0.1ppt to 5.7%, led by rising services prices. With the labour market set to remain tight—the Eurozone unemployment rate remained historically low, at 6.6%, in February—this may only be the beginning of the end of the inflation story.

Imbalanced. China’s March PMIs reveal a multi-speed reopening-driven recovery led by services and construction, with manufacturing playing a supporting role. The general PMI rose to 57.0 from 56.4 in Feb, driven by growth in the non-manufacturing component to 58.2 (vs 56.3 in Feb).  This is in line with the strong growth in catering retail sales relative to goods retail sales in the first two months. But the manufacturing component witnessed a slowdown from 52.6 to 51.9. Domestic demand is outperforming global demand, but the gains are unevenly distributed, with large enterprises outperforming small-sized firms. The outlook remains that of a lopsided, moderate (by China’s standards) GDP growth of around 5% as softer global demand weighs on manufacturing growth.

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