Chief Economist’s Weekly Briefing – Pause, Cut, Raise

With major central banks (Fed, ECB, People’s Bank of China) adopting divergent stances on monetary policy last week, all eyes are on the Bank of England this week. Rates expectations have steepened as the economy continues to fare well, and high wage growth points to sticky inflation. Another quarter-point hike seems like a done deal.

Canary in the coalmine? The UK economy expanded modestly in April by 0.2% m/m.  That partially reversed a strike-related dip in March, leaving three-month growth at 0.1%. Respectable enough, given industrial action continues to weigh on health output. Other service sectors performed well. A 3.9% pick-up in car sales combined with decent takings for bars and pubs contributed to 1% growth in consumer-facing services. That bodes well for coming months. Yet all is not well: construction output fell 0.6%, with housebuilding dropping 3%. Ripples from the choppy housing market may be an early warning of the strengthening impact of higher rates.

Patience is a virtue. Businesses are patiently waiting for the economy to turn a corner. There seem to be slow improvements as the number of UK businesses reporting an increase in the price of goods and services decreased by 18 ppts to 30% when compared to Sep’22. However, only 19% expect their turnover to increase in July reflecting the fact that 23% of businesses reported a fall in their turnover in May. This outlook is largely due to the energy crisis causing an increase in costs, which 41% of businesses reported they absorbed, and 25% reported passing on to customers.

Feeling the Pinch. And the inflationary context has honed a cautious public perception towards inflation. An Ipsos survey found that 70% of UK respondents were expecting prices in shops to increase over the next 12 months, with 28% expecting this to be by 5% or more. In addition, 51% of responses indicated that interest rates on mortgages, bank loans and savings had “risen a lot” in the last year. The majority of respondents also believed fast rises in prices would weaken the UK economy. So what actions are people taking? The most common answers involved cutting back spending and shopping around for better value goods and services.

Record Breakers. Rarer than hen’s teeth have been the times in my working life when average pay has risen 6.5% y/y. Rarer still for that to be a real term pay cut (by 2%). Such are Les Temps Modernes. Economic growth may be flat, but the UK is a jobs-rich manor. Records were set this Spring. Starting with the number in work, with UK employees and the self-employed both up.  Jobs rose by a record-busting 395k in the quarter to March. This helped the number of hours worked to also post a new high of 15.8m hours. Not bad given we lost over 1/4 m to strikes in April alone. Unemployment is below its pre-pandemic rate. In short, with over a million jobs still unfilled, the labour market remains tight.

Getting there. Real-time data provide further evidence to this. Online job adverts may be down 10% on last year but they are still around 16% above the pre-Covid level and are in fact little changed over the past three months. The indication of a less confident demand outlook may lie in the part-time/ weekend category seeing the strongest growth. We continue to rediscover old travel habits. In the week to 11 June, the number of UK flights were 5% higher than the equivalent period last year, still around 10% below the pre-Covid level in 2019.

And here. Wholesale gas prices have been on a downward trend all year, with the typical UK energy bill set to fall to around £2k from July. That’s still not normal. Prices are close to 50% above their 2014-19 level. But it’s a welcome development. And not just for here. Europe’s upcoming winter looks increasingly gas-secure with storage levels set to be healthy. The premium to history can be put down to a market that is expected to remain tight and vulnerable to price spikes for a few years. It won’t be until 2026 a supply resolution materialises when new export plants in the US and Qatar start shipping fuel.

Skip, not pause. The annual pace of US inflation eased to its lowest level in more than two years. It cooled to 4% in May from a year earlier, its lowest level since Mar’21 and a step down from the 4.9% annual increase in April. In response, the Federal Reserve announced to hold its benchmark interest rate steady for the first time in more than a year following 10 consecutive hikes. This marked the first reprieve in the central bank’s aggressive monetary tightening campaign since it first started raising rates in Mar‘22. All said, the Fed still holds out the prospect of further rises later this year as price gains linger and a sticky core badgers.

A bit tighter still. European Central Bank President Christine Lagarde announced another interest rate rise, to 3.5% last week and paved the way for further increases, saying the ECB still had ground to cover.  New forecasts from the central bank predicted 5% inflation by the end of this year but that it would take till 2025 for price rises to get close the official target of 2%.  The source of this extra pressure on prices?  A stronger labour market, where wage growth is still expected to cool only very slowly, reaching 4% in 2025.

Leave a Reply