Chief Economist’s Weekly Briefing – Signs of Life?

As temperatures around the UK begin to hot up, there is added cause for optimism on the horizon. Energy prices, though still a pressing issue, are receding. Globally, there are positive signs of a bounce-back despite enduring inflationary undertones. Sticky core inflation presents a tricky balancing act between sustaining the recovery, controlling price pressures, and maintaining financial stability. Ahead lies a busy week for central banks, with the Fed and European Central Bank in action. The key question for now is: are we done with the tightening campaign?

Here comes the sun… The good weather and bank holidays seem to be lifting consumer’s spirits and spending habits: UK spending was up across the board in May. Debit card spending saw the largest increases in “entertainment” and “retail” over the last week; by 13 and 7 percentage points respectively. And for businesses, labour shortages continue to ease, with 63% of firms not experiencing worker shortages in May vs. 47% in August last year.

Little by little. Relief over the gradually improving outlook is palpable amongst UK businesses. Although energy prices and inflation remain the top sources of worry, each bothering around 15% of firms, both are becoming less pressing concerns as the days drift by. Nearly one-quarter of firms reported having no concerns in June, the most relaxed position for a year. Looking forward, what’s set to replace them as the stuff of CEO nightmares? Answer: interest rates. After a big rise in salience in June, interest rates are now bothering 1 in 20 of all businesses and 1 in 3 of those in the real estate industry.

Capital growth. Business confidence did slip a little in May, with the overall UK PMI scores dropping from 54.9 to 54.0, but London consolidated its position as the fastest growing region with a very strong score of 58.5 (NI = 51.4).  Firms in the capital reported very high levels of new business and expectations for future activity levels, but were comparatively cautious on employment levels, suggesting the gradual cooling of the labour market may continue. Elsewhere the prospect of easing inflationary pressure gained credence as most regions indicated that prices were rising at their slowest pace for over 2 years.  Some long-awaited respite from inflation would be welcomed by many.

Cost-of-living relief can be found at the forefront of this respite. Diesel prices are down by a quarter since last July. Oil prices have fallen 10% this year, weighed down by a less-than-stellar recovery in China and cooler demand in the US. Even a production cut from Saudi Arabia couldn’t do the trick: oil prices are little changed from a week ago. But regained pricing power might not be far away. US shale oil production, the main contributor to global oil supplies in recent years, is showing signs of peaking. That matters. The last US oil production peak in 1970 contributed to a subsequent decade of much higher and volatile prices.

EV or not EV. Despite the fall in petrol and diesel prices, EVs are still around 60% cheaper to drive than a car running on either. EVs are not subject to Fuel Duty and are currently exempt from Vehicle Excise Duty. The increasing prevalence of EVs means an annual shortfall in government revenues of £10 billion is projected to materialise by the early 2030s. One potential response being floated is introducing a national per-mile ‘Road Duty’ of around 6p per mile (plus VAT) for a typical electric car. In order to implement it by 2027, the Government would need to get moving ASAP.

Global cheer. The global economy is enjoying some early summer sunshine. Growth accelerated to an 18-month high according to the global composite PMI, hitting 54.4 in May, up from 54.2 in April. Services outperformed manufacturing, with firms in the sector reporting their strongest growth since November 2021. Yet while the US, China and India all saw growth accelerate, momentum slowed in the UK and eurozone. Still, that might be outweighed by news that price pressures eased, for both input costs and prices charged. While any impact on UK inflation context may be lagged and diluted, it’s welcome, nonetheless.

Still Sticky. The latest OECD forecasts suggests that the world economy will expand by 2.7% this year and 2.9% next year weathering the storm following banking turmoil on both sides of the Atlantic. But it’s not yet time to bust out the champagne. Sticky core inflation will offset falling energy prices, with headline inflation persisting at 6.6% globally in 2023 and falling to 4.3% in 2024. Core inflation will stick around at 6.5% this year, and 4.5% in 2024 y/y in the OECD. That would require interest rates to remain at their high levels for some time or rise slightly higher. OECD advise that it’s now time for fiscal support to be scaled back to allow economies to get their public finances into better shape and tackle the costs of an ageing population.  

Zeroing. China’s consumer price growth remained close to zero in May, with the headline index rising by only 0.2% y/y, following 0.1% in April. The latest sign that economic recovery is stalling. It’s a similar story on producer prices, which fell 4.6% y/y in May, the sharpest decrease in over seven years, after declining 3.6% in Apr. The world’s second-largest economy seems to have a different set of problems to the rest of the world: one where weak growth is accompanied by low inflation. After a rebound following the lifting of Covid-19 restrictions, goods consumption remains weak while overall consumption is constrained by relative high unemployment. Sluggish recovery of domestic demand seems a story that will continue keeping inflation low, while latest trade data suggest that exports slumped more than expected in May, reinforcing fears of a slowing recovery. 

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