Chief Economist’s Weekly Briefing – Wait and watch

Good news on the UK economy remains thin on the ground. Economic output is flat-lining, the labour market is cooling, and credit conditions are set to tighten. Nevertheless, the Bank of England remains focused on taming inflation, even if that means higher re-mortgage costs for households. Growth in the second half will be contingent on how aggressively households rein in spending. A drop in energy bills from this month should offer some solace, but the rest is left to be seen.

Coronation feat. UK GDP slipped by 0.1% in May, giving an all-round flat performance over the spring. That was better than expected given the extra bank holiday and if you’re a glass half-full sort then the UK economy is holding up well. If you’re more sort of half-empty, it’s struggling for traction. During May, arts and entertainment benefited while the education and health sectors rebounded (less days lost to strikes). The real estate and finance sectors are flat-lining, while the service sector’s relative outperformer remained information & communication. It’s reasonable to expect a similar overall trend in GDP in the coming months. Household income dynamics are set to improve, but the drag from higher rates is only building. 

Cool it. The UK’s unemployment rate beat expectations when it rose to 4.0% in the 3 months to May, from 3.8% in April (NI = 2.5%). Employment growth more than halved, vacancies continued to drop, and recruitment challenges are easing. So yes, the labour market is cooling but not fast enough for it to take the heat out of inflation. That’s because it will take some time for emerging slack to stem the contribution of job churn to wage growth, which continued to ascend in the 3 months to May. At 7.3%, total pay growth is painfully high for the MPC to tolerate, and more rate hikes are on the cards.

Past its peak?  There are signs that Northern Ireland’s resilient labour market is weakening too. The number of employees on local payrolls in June was 2,500 below March’s peak and we can expect a pick-up in P45s in the coming months. Last month saw 1,960 proposed job losses, a figure that has been exceeded only twice during the last 23 years. Firstly, following the initial lockdown (June 2020) and before the furlough scheme was unveiled. And secondly, in the wake of 9/11 in September 2001 when there were 2,280 proposed redundancies notified. It is worth noting that this surge is coming off a low base. 2022 recorded the fewest number of confirmed redundancies since the series began in 2000.

Trade Off. Inflation continues to occupy the mind of Bank of England governor Andrew Bailey. In his latest speech, he expressed optimism about falls to come, but sticky core inflation is keeping him from ruling out further interest rate hikes. And with sluggish GDP growth, he’s backing the Chancellor’s calls for more supply-side investment to fuel productivity. Reflecting on recent years, Bailey sees long-term investment as essential to prevent more supply-side issues and will be the key to overcoming the challenges of the future. But as businesses feel the pinch of higher borrowing costs, investment may have to wait. The Bank may need to pick its priority: bolstering GDP growth or taming inflation. For now, inflation seems to be winning.

Heating up. As much of Europe sweltered, it is rising interest rates that’s making the Financial Policy Committee of the Bank of England sweat. Its Financial Stability Report set out how the share of aggregate household income going on mortgage payments is projected to rise from 6% today up to 8% as more people remortgage over the coming years. A big jump, but well below the 10% reached in the 2000’s and early 90’s. Indeed, resilience is also a theme on the corporate side of the market, with fewer businesses as financially stretched as they were going into the financial crisis. Even so, the speed with which interest rates have risen remains a concern for many.

Tightening. Banks are expecting both supply and demand for UK mortgage lending to decrease in Q3’23. But the pinch might occur in unsecured lending, where banks expect that demand will continue to increase while availability is predicted to decrease. Corporate demand for lending is expected to decline slightly, with availability to broadly stay the same. Tougher conditions are being reflected in higher mortgage defaults, which are expected to increase further in Q3. Defaults on unsecured loans are also expected to increase. Corporate lending looks healthy so far, but from Q3 defaults on small businesses loans are expected to increase.

Normal service. Signs of activity continuing to flatline as 24% of UK trading businesses reported lower turnover in June. There was also a 1% drop in job adverts in the week to July 7th. Not ideal, as the UK economy is already lacklustre. Still, helpful for the BoE’s attempt to ease inflation. As was the 3% fall in system average gas prices. Despite continual cost-of-living pressures – the share of renter income spent on new tenancies rose marginally to 26.9% – people hanker after a dose of normality. Since July 2022 flights and footfall have risen 6% and 3% respectively.

No surprises. 15% of UK businesses expect to raise their prices in August, due to the still-elevated costs of energy, labour, and raw materials. This puts the BoE in a sticky situation as it highlights the need to push down on demand. But how much further can they push? Demand is already weakening, with 18% of businesses feeling the lack of demand over June (2% more than May). Is there a silver lining? Well, the number of businesses expecting to raise their prices was 26% in January 2023 (11 ppts higher than this month’s expectations).

The odd couple. Not only divided by a common language, the economic performances of the US and UK are also increasingly at odds. Take inflation, down to 3% annually in June over the pond. Unlike the UK, food prices have barely changed since February. And strip out the more volatile energy and food components of the consumer inflation basket and general prices rose by just 0.2% on the month. That’s the smallest rise since August 2021. In other words, there’s little evidence that inflation state-side has become sticky and entrenched. Again, that’s something we can’t be so sure of here in the UK.

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