Chief Economist’s Weekly Briefing – Beleaguered

Although the UK economy has fared relatively well in the first half of the year, several headwinds persist, both for short-term and medium-to-longer-term performance. Foremost amongst the latter is the sustained weakness in productivity. Meanwhile the inflation outlook is uncertain with wages and prices still chasing one another upward. With the final destination for interest rates unknown, the hoped for economic ‘soft-landing’ still can’t be banked on.

Mixed bag. Uncertainty around the outlook for inflation remains. And that’s reflected in the latest Decision Maker Panel survey from the Bank of England. First off, there’s evidence that the we’re emerging from the eye of the inflation storm. The realised output price inflation across the economy declined to 6.9% in June, from 7.6% in May. Firms’ perception of current CPI also declined to 8.9% from 9.8%. One-year ahead expectations fell to 5.7% from 5.9% in May. However, all was not well. Three-year ahead expectations increased to 3.7% compared to 3.5% in May while wage growth also inched up by 0.1ppts to 5.3%. In other words, more than enough to support the view that inflation is set to remain persistent.

Unproductive. UK headline labour productivity in Q1 2023 fell by 0.6% annually. This was the biggest fall since 2013, excluding the Covid-19 period. This is explained by post-Covid normalisation in the number of hours worked amidst a fairly flat economy. The cost-of-living has pushed up labour participation, with part-time jobs gaining prominence. So output per worker and output per job fell even more sharply. Headline productivity is up by a meagre 0.6% compared to pre-Covid. The biggest challenge facing the UK economy remains how to sustainably resuscitate lacklustre productivity growth.

Resisting headwinds. Spending is holding up, but for how long? The CHAPS card aggregate indicator as well as Revolut debit card spending showed increased activity in the latest week, rising by 1 ppt and 11 ppts respectively, and overall retail footfall at 102% of the previous week. Businesses are posting some good news too, with the share of UK firms reporting a decrease in turnover having come down notably for some sectors in May’23 vs Dec ‘22. However, labour demand is easing more notably. There was a reduction of 7% in job adverts for “all industries” in Jun ‘23 from Dec ’22. Bottom line, the economy still faces multiple headwinds from policy tightening and sticky inflation.

Dampener. Ideally, pent-up demand built over the past few years and the greater accessibility of EVs should spur car sales. But the data indicates otherwise. Private new UK car registrations totalled 79.8k in June, up from 69.5k in June 2022. But registrations still lag 18.9% below the 2015-19 June average. What’s halting the brakes on sales? Still weak consumer confidence and the high cost of finance. The average interest rate on a £10k loan is set to speed past its December 2022 6.01% peak, to 6.75% over the next couple of months. Set to stay around 10-15% below the pre-Covid level over the next year, car sales are on a slow road to recovery. Yet another example of interest rates will dampen consumption appetite.

Epochal.  Nathanael Benjamin, Prudential Regulation Authority Executive Director, sees recent bank failures as symptoms of transition to a new macroeconomic environment. The epoch is set to be defined by higher interest rates, digitisation and climate change. All throw-up risks. Interest rates dominated 2023. What next? Maybe counterparty risks. These could emanate from stresses in private credit markets, volatility in sovereign issuance or equity derivatives. Or from the green transition, which threatens drastic, overnight shifts in demand and supply conditions – especially for commodities. Amidst all the rapid change, one age-old financial risk remains: the threat of banks losing confidence. Some things never change.

Indexation matters. This year we had an unusual situation –working-age benefits increased more than wages. However, usually wages are growing faster than prices because of high inflation and the indexation rules). But take a longer-term view and basic benefit support is today at the same level in real terms as it was in 1992, despite a 51% growth in GDP per capita. In a new report Resolution Foundation argues that the UK should join New Zealand, Germany, Belgium, and the Netherlands and uprate benefits in line with wages (or GDP), similar to what is done with pensions. Otherwise the number of people in relative poverty will continue to increase.

Bounce-back? The refreshed UK measure of National Wellbeing has a range of concerning indicators but is starting to show a return to pre-pandemic levels. Unsurprisingly the most impacted was health with overall health satisfaction at 45% in ‘20-21. This is in addition to 54% of people being satisfied in our health care system in May-June ‘23. But adults with low self-worth have dropped to pre-pandemic levels of c.5%. We are also seeing more lifestyle changes for environmental reasons with 86% stating some or a lot of changes (May-June ‘23), however more is needed as total household recycled waste is on the decline, dropping to 44% in 2020.

Push and pull. The tug of war between the US economy and the labour market continues, but the latter remains historcally strong. The unemployment rate fell a notch by 0.1 ptts to 3.6% in June, in line with expectations. But momentum is waning slowly. The market added just 209,000 jobs  last month, nearly 100,000 positions below May’s stronger-than-expected print. It’s the lowest monthly gain since a decline recorded in Dec’20. This has fueled optimism that the economy is on course to nail that elusive soft landing of lowering inflation without triggering a recession.

Leave a Reply