Chief Economist’s Weekly Briefing – More to come

The battle against high inflation is not over yet. Granted, business surveys show prices to be a waning area of concern, as firms now fear muted demand. That seems to be corroborated by a dip in consumer spending. But wages are still on the rise. So barring a minority of dovish voices, the Bank of England’s resolve to bring inflation back to target remains firm. More hikes are coming. 

Just in time. Despite a modest increase (by 2,051), May’s UK mortgage approvals were below their decadal average. Unsurprising. With rates on the rise the incentive is to repay debt and that’s mostly what folks are doing, especially with mortgages. Gross repayments rose to £18.9bn. But the squeeze is on. And households are tapping savings and credit to make ends meet. Consumer credit rose 7.5% y/y, while household withdrew a whopping £4.6bn in deposits (a record). Only time deposits, ISAs and NS&I grew. Firms repaid a net £0.6bn of loans in May. So, money’s tightening. Which should pinch inflationary impulses, albeit not painlessly.

Trade off. In her final speech as a member of the MPC, Prof. Tenreyro talked about the challenges of setting monetary policy in times of large shocks. The Covid pandemic and a war in Ukraine exerted extraordinary pressures on global prices. Despite some unexpected strength in recent inflation and wage growth data, she believes that the tightening already in the pipeline would be sufficient to bring inflation back to, or probably below, target. Her analysis also suggests that even if the MPC was much more aggressive in this tightening cycle (a peak rate of 9.5%), the inflation rate would still peak at almost double digits but at the cost of much higher unemployment (+4ppts). This is modelling. But markets do expect more tightening to come.

So last year. Encouraging news from UK businesses on the (downward) path for inflation. Supply chain disruptions are becoming a thing of the past. In May, 68% of firms with 10+ employees were able to source what they needed in the UK, up 3ppts in a month, a 13ppts over the past year. And nearly 3 in 5 didn’t experience any supply issues globally. Fewer bottlenecks equal fewer price pressures. Right on cue, inflationary concerns are fading. Just 14% of businesses are concerned about price rises, versus one-quarter late last year. The catch? Falling demand is becoming a more pressing concern.

Finely balanced. Yet 22% of businesses with 10 or more employees reported monthly increase in wages, underlining the risks of wage-price inflation. There are, however, emerging signs of labour market slack too, with online job adverts declining by 1% in a week and 3% compared to a year ago. Adverts for ‘HR& Recruitment’ category have fallen by a whopping 40% since last year. Consumer spending was weaker too, with card spending falling by 1% and retail footfall by 2%. But if that was the sign of belt tightening, it wasn’t apparent in the UK flights data, which clocked the highest figures since Oct 2019.

‘It’s a costly life’. The public are being hit hard by the cost-of-living crisis according to the UK’s Public opinions and social trends survey. Despite fewer adults reporting a rise in their cost-of-living, 91% still cited the cost-of-living as an issue. This is driven by current food price inflation (19.1%), as 96% reported food shopping as the reason their cost-of-living had increased. In the month when interest rates increased to a 15-year high of 5%, 43% of adults reported it was very or somewhat difficult to afford rent or mortgage payments and 47% reported an increase in their rent or mortgage payments.

Edging up. National accounts data show that UK GDP rose 0.1% in Q1, despite the headwinds from higher prices of food and energy and rapidly rising interest rates. This was down to the strength of private-sector balance sheets, thanks to the extra savings buffers built during the pandemic. Households reduced their saving rate to 8.7% in Q1, from 9.3% in Q4, to support their expenditure, which was unchanged from Q4. Separately, business investments were up 3% over the quarter, boosted by the rush to take advantage of the super deduction scheme that was withdrawn at end of March. But government expenditure remained a drag, with output hampered by industrial action. Looking ahead, we are likely to see similar performances in the near term as the drag from higher borrowing costs is outweighed by support from falling energy prices.

A good start.  Northern Ireland’s economic output started 2023 the same way it ended last year, with quarter-on-quarter growth of 1.2%. That’s impressive! These two successive quarters of growth more than made up for the stagnation / falling output in the previous three quarters of 2022. Economic output in Q1 2023 was 1.7% higher than the corresponding quarter a year ago and is 6.3% above its pre-pandemic levels (Q4-2019). The driver of growth was private sector services, with the robust growth comfortably outweighing declines in industrial production and construction activity. More timely surveys suggest slower rates of growth in the second quarter. But in the face of sharp increases in interest rates, the economy isn’t expected to end the year as well as it started it.

Not yet. Inflation in the Eurozone eased to 5.5% in June (vs 6.1% in May), although core pressures persisted. Energy prices are falling, non-energy goods inflation declined by 0.3ppts and while services inflation picked up, this was largely due to base effects from last year’s transport discount in Germany. For the ECB though, this may not be enough to hold off tightening interest rates. Unit labour costs are a key consideration for the ECB, and with the labour market still very tight and the unemployment rate rate at a record low, another rate hike in September cannot be discounted.

Contraction. China’s factory activity declined for a third straight month in June. The official NBS manufacturing PMI rose marginally to 49 in June from 48.8 in May. The latest figures came amid growing signs that China’s post-pandemic recovery lost steam, with new orders (48.6 vs 48.3 in May), buying activity (48.9 vs 49) and export sales (46.4 vs 47.2) all underperforming. Though the world’s 2nd largest economy was expected to rebound swiftly post its zero-covid policy, it finds itself fight a battle on three fints: continued contraction of demand, both domestic and international; an accelerated slowdown in operations of small enterprises; and inherent imbalances and weaknesses.

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