Chief Economist’s Weekly Briefing – 5 is the magic number

All those thinking that May saw the end of interest rate hikes, think again. With the economy performing better than anticipated, but core and services price inflation remaining stubborn, many now think the Bank of England will be pressed to advance monetary tightening a tad bit more. An economy that has so far remained fairly resilient to higher rates may yet face a sterner test. 

Core blimey! UK CPI finally fell into single-digit territory for the first time in eight months, although April’s 8.7% y/y print was stronger than expected. Energy and food price rises have dominated the inflation headlines over the last year, but it is what lies beneath that is concerning. Core CPI, which excludes these items, jumped from 6.2% to 6.8% y/y – a 31-year high. Mobile phone charges more than doubled to 7.9% y/y and increased costs of second-hand cars were part of broad-based price rises. Services inflation also hit a 31-year high of 6.9% y/y. Halving the headline CPI rate this year is still achievable. Halving the core CPI is a lot more difficult. The risk of more persistent inflation is crystallising. Markets are pricing for a Bank Rate of 5.5%

Growth or no growth? The latest data from S&P UK composite PMIs showed that the UK economy continues to remain resilient. May’s reading, despite edging down from April’s 12 month high to 53.9 from 54.9, firmly remains in expansionary territory. Services continue to be the main driver of activity, while manufacturing declined for a third month running to 46.9. That said, strong wage growth pushed up costs for services firms. While business surveys point to robust growth in GDP in Q2, after a 0.1% rise in Q1, there is a case that the pace of the recovery is more fragile. The greater resilience in the activity data is certainly welcome news but on the other hand stronger core inflationary pressures means that the BoE will have more work to do.

Pressures and boosts. The real-time indicators reflected the inflationary pressure that UK businesses are currently feeling, as 15% of businesses continued to report inflation as their main concern for June 2023. However, consumers don’t seem to be deterred from hitting the shops as card purchases were broadly stable. GB consumers also received a boost to their finances with energy regulator Ofgem announcing household energy bills will be cut 17% from July (does not apply in NI). Wholesale gas and electricity prices fell by 16% and 25% respectively when compared with the previous week – the lowest level of 2023 to date.

A Full House? Average UK house prices increased by 4.1% in the 12 months to March, with all nations in the UK experiencing increases. But the year-on-year perspective doesn’t reveal all about the underlying outlook. Since a UK average historic high of £292,552 in Nov’22, house prices have fallen for a fifth consecutive month. According to some estimates, the number of prospective buyers is down 30% compared with Mar’22. With demand flagging and Bank Rate hiked again, the consensus view remains of further downward pressure on UK house prices for the foreseeable future.

Supply constraints. NI’s Residential Property Price Index posted its biggest quarterly decline in a decade in Q1 2023. The 1.8% fall halved the annual rate of house price growth to 5%, with the standardised house price now at £172k. There are contrasting fortunes for new and second-hand dwellings though. The average price of the former continued to climb higher (13% y/y) but the latter recorded two successive quarters of price declines, taking the annual inflation rate to just 3%. The supply of new builds coming onto the market is slowing and propping up prices. The first quarter saw a 25% y/y drop and the worst Q1 in eight years. There is little to suggest this trend will change.

Another turning point?  Retail sales in the UK volumes grew modestly in April, rising 0.5%. That partially reverses a weather-related dip in March and pushes the three-month growth rate up to 0.8%: the highest for 20 months. Sales growth was broad-based. Food store sale volumes increased 0.7% despite eye-wateringly high food price inflation. Clothing stores and online retailers grew sales by 0.2% respectively, whilst department store sales rose 1.7%.  It’s early calling it a turnaround in retail fortunes. Those may well remain subdued whilst household incomes continue to be squeezed. But in the end, gradually easing inflation should win out.

Persistence. The latest UK public sector finances release shows a continuation of overall trends of rising borrowing and spending across the public sector. Net borrowing in April was £25.6bn, which was not only £11.9bn more than last April but was £3.1bn more than forecasted by the OBR. On the flip side, interest payments from the central government were £9.8bn which was £3.1bn higher than last April, which is not surprising due to current RPI inflation. Government subsidy spend increased to £3.9bn, which is a result of the ongoing costs of the energy support schemes for both households and businesses.

Welcoming. Long-term immigration into the UK was estimated at 1.2m in 2022, subtract the 560k or so emigrants and you get a net migration figure of 606k – a record level! It was largely driven by non-EU nationals with about 925k of the 1.2m immigrants from outside the EU. And the reasons for their arrivals vary. 172k were through humanitarian routes, with 114k of those from Ukraine. The biggest category was study (360k), followed by work (235k) – a boon for an economy suffering labour shortages. The trend suggests immigration slowed in the second half of the year, supported by Home Office figures for skilled worker visas which suggest overseas hiring is slowing (except in the health and care sectors). The surge may be on the wane.

A Passage from India. Changes to where NI’s migrant workers come from are clearly illustrated in the latest figures for National Insurance Registrations. Pre-Brexit, the EU (excluding Ireland) accounted for 77% of new registrations; today it accounts for just 8%. Conversely, India now accounts for 16-times as many new National Insurance Registrations as it did in 2015/16. Whilst Brexit has cut off the supply of migrant workers from the EU, it has effectively opened a passage from India with changes to visa requirements for non-EU workers. Regarding India, this is particularly the case regarding highly skilled and medical staff.

Sticky. Tina Turner’s passing offers a reminder that the past never entirely leaves. And current business surveys are not helping allay fears that the spectre of 70’s and 80’s is returning to haunt us. The US and Eurozone PMIs tell similar stories. Activity is healthy, hitting 54.5 in the US in May and a respectable 53.3 across the Eurozone (albeit down slightly). The service sector is leading the charge in both as manufacturing softens – more so in the latter. Trouble is, services inflation is uncomfortably sticky, for both prices paid and prices charged. Removing this without a severe economic intrusion may prove impossible.

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