Chief Economist’s Weekly Briefing – Caution is Key

If the phrase “self-fulfilling expectations” is anything to go by, taming inflation will continue to be tough. Businesses are doubtful of the central bank’s messaging on projected inflation. They expect it, and wage growth, to remain elevated. Consumers are growing cautious too. Many households are prioritising debt repayments in the face of high rates. Elsewhere, US job market is still strong but easing, while China’s economic recovery is losing steam.

Transmission. Ever wondered about the real-world impact of hiking Bank Rate 440bps? Read on. Gross mortgage lending dropped to just £17bn in Apr, two-fifths below 2022 level; a sure sign fewer homes are changing hands, and for less money. Homeowners are striving to pay-down mortgages quicker: overpayments have risen £500m per month. Makes sense, seeing as new mortgage rates hit 4.46%, a threefold rise in 18 months. It means mortgage debt is shrinking at the fastest pace ever recorded, Covid-period excepted. Expect these conditions to persist: home purchase mortgage approvals dipped to 48.7k in Apr, one-quarter below ‘normal’. Monetary policy at work.

Once bitten, twice shy.  Business concerns about Covid-19 and supply chain disruption are ‘so last year’ for decision makers. Conversely, inflationary pressures remain under the spotlight. Inflation expectations for the year ahead have ticked up from 5.6% y/y in April to 5.9% y/y in May. That compares with BoE projections of between 3-4% in Q2 2024. Over the next two to three years, firms aren’t buying into the BoE’s inflation-target (2%) undershoot story. Instead, they expect CPI to remain relatively sticky at 3.5% in 3-years’ time. Wage inflation has been sticky too but is expected to ease from 6.7% (May-23) to 5.2% y/y in 12 months’ time. That’s still uncomfortably high.

Not guilty. A lie is purportedly halfway round the world before the truth has got its boots on. The crime here is ‘Greedflation’ – firms using inflation to hoard excess profits. Yet the evidence doesn’t stack up. The UK’s non-financial firms earned a net rate of return of 9.8% in Q4 2022, the same as Q3. Indeed, returns are notable by their stability since 2017. It’s true that North Sea firms rode the waves of higher global energy prices, but these dropped by 11.2ppts to 12.7% in Q4. In the finger pointing game of inflation, the culprit seems to lurk elsewhere.  

Spending carefully. The latest UK credit and debit card spending data showed transactions starting to recover towards the end of May, but people are still being careful. Spend on staples has increased the most over the last year, by around 7%.  Work-related expenses (including commuting) were up 3%, whilst spending on social activities actually fell by 3%.  As consumer confidence edges up, we are seeing some more discretionary spending, with the delayables category climbing close to 3.5%. With overall inflation still surprisingly strong this cautious consumer behaviour looks set to continue.

Food for thought. Such caution makes sense considering that the cost-of-living continues to dominate public opinion as the biggest issue the UK faces today. 92% of survey participants in an ONS study mentioned it, slightly down from 93% a month prior. And between 17th May and 29th May 2023, nearly two-thirds of adults (67%) reported their cost of living had increased compared with a month ago. The price of food shopping was mentioned in 97% of responses, reflecting sticky inflationary pressure on food prices that remains in double digits (19.1% for April 2023; ONS). The next biggest issues identified were the NHS (87%), the economy (73%) and climate change and the environment (60%).

Bringing down. Headline inflation in the Eurozone had dropped to 6.1% y/y in May, from 7.0% in April, well below the 10.6% peak in October, but well above the 2% target of the European Central Bank. Given the decrease in energy prices, the energy component was already disinflationary. Welcome news in any case, but let’s not get carried away. Core inflation – which strips out volatile items – fell by just 0.3% to 5.3% in May. The big problem is still food prices; the price of processed food, alcohol and tobacco rose 13.4% – down from 14.6% a month earlier. While the eurozone’s inflation fell more than expected and is now at the lowest level since Russia invaded Ukraine, that won’t be enough to stop the ECB from raising rates again.

Faltering. China’s reopening rebound has been driven by consumption. But without any broad stimulus, the growth in the industrial sector leaves much to be desired. The official manufacturing PMI fell to 48.8 in May from 49.2 in April, dragged down by tremendous weakness in raw materials processing. Slightly more optimistic was the Caixin (non-official) manufacturing PMI reading, which rose 1.3 points to 50.9; the key reason is probably the different sector weightings. Non-manufacturing PMI continued to grow but at a softer pace. The uneven recovery caused the general PMI to drop to 52.9 from 54.4. With consumer prices barely rising in April and youth jobless rate reaching record levels, the sustainability of China’s recovery story is a big question mark.

Mixed bag. The US economy continued to create jobs at a rapid pace last month, with non-farm payrolls surging more than expected, and adding 339k in May. However, the unemployment rate jumped by more than expected to 3.7% from 3.4% – the highest level since Oct’22 – thanks to a 310k drop in household employment and a 130K increase in the size of the labour force. Wage growth moderated, edging down to 4.3% y/y, after a 0.3% monthly gain. Average hours worked for all employees, meanwhile, slipped, suggesting companies may be starting to cut back. The key judgement for policymakers to pause on the tightening cycle is whether the jobs market is slowing enough to take the heat off inflation. The latest data report makes the assessment tough; contradictory signals are prevailing; job growth is high, but unemployment is up, and wage growth is slowing.

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