Chief Economist’s Weekly Briefing – Falling Short

There was some respite for the UK economy last week, with headline and core inflation falling in June. The  news around broader economic activity was slightly less cheery, even if retail sales held up. It seems the private sector’s recovery is losing steam. Enough to limit the Bank of England to a 25bps rise next week, rather than 50?

Surprise! UK inflation watchers were pleasantly surprised for a change with June’s headline and core numbers coming in lower than expected. Overall CPI fell from 8.7% y/y in May to 7.9% in June – the lowest rate since March 2022. 8 of the 12 main categories saw their annual rates of inflation ease with Transport recording price declines (-1.8% y/y). Core CPI (excl. energy, food, alcohol and tobacco) eased from its 31-yr high of 7.1% y/y to 6.9%. Similarly, services CPI – which is sensitive to wage pressures – slipped from 7.4% to 7.2%. Significantly though, core and services CPI are still at their second-highest rates in 31 years. The inflation figures may have blown the froth off markets’ interest rate expectations, but further rate hikes are still on the cards.

Steady. It’s almost a year since the BoE decided to start actively selling gilts, so called Quantitative Tightening (QT). From a 2021 peak of almost £900bn, the BoE is on track to have reduced its vast bond portfolio by 11.6% by end-September. Much to the relief of policymakers, sales so far appear to have had little impact; raising long-term yields by perhaps 10bps. Expect BoE to stick with the ‘slow and steady’ approach, leaving QT in the shadows while Bank Rate hogs the monetary policy limelight. But with growing confidence over its muted effects, Dave Ramsden, Deputy Governor, now sees a case for upping the pace of QT a bit.

One-off wonder. That’s one way to describe June’s retail sales volumes, which rose 0.7% m/m and 0.4% q/q in Q2. Unusually warm weather drove up non-food store sales. Food sales went up mainly due to base effects – May saw a dip in food sales as some preferred to dine out/take out during the King’s coronation. Does that mean retail sales will return to a downturn in H2? Not quite, as this month’s 17% drop in a typical household’s energy bill will boost real incomes by 0.8% alone, offsetting the likely 0.2pp hit from mortgage refinancing in Q3. But resilience of consumer confidence is collapsing – the Gfk confidence index dropped by 6 points to -30 in July.

Downward path. Lower consumer confidence was to be expected given consumers are clearly feeling the squeeze from ongoing inflation and the higher cost of borrowing. Consumer spending follows suit and continues to weaken, with CHAPS-based indicators showing an 8% decrease in card purchases on 13th of July from the previous week. Staples recorded the biggest drop week over week, suggesting that consumers continued efforts to spend less on essentials. On the energy front the good news continued; gas prices fall sharply and are down by 86% from the peak in Aug 2022. The International Energy Agency, however warned about a risk of prices rising again given the possibility of a cold winter, together with a full halt of Russian piped gas, and the increased competition from North-East Asia due to colder than usual weather.

Defying gravity? In April UK house prices stopped its continuous downward slide, which started last September. According to the preliminary data (subject to change), in May they stayed almost at the same level (+0.03%). It is early to say if it is just a pause or a reversal of a trend. So far prices have declined by 2.3% after an increase of 26% since Feb 2020. April and May transactions were agreed some time before then and in recent months CoL pressures continued to mount while interest rates continued to increase. There are still reasons, and room, for further downward moves in house prices.

Help wanted. The rise in the UK’s working-age employment rate from 70% to 77% gave policymakers something to crow about in an otherwise lacklustre decade to 2019. The pandemic put that into reverse: working-age inactivity is 350k above Q4 ‘19 levels. The number of people citing ill-health is the most enduring source (early retirees and higher education have all mostly reversed). According to the OBR, the interplay of three main causal factors is at play: a slowdown, and partial reversal, in the rate of improvement in the health of the working-age population, the impact of the pandemic, and rising onflows to health-related benefits. And it’s concentrated among those who are older (50-64), relatively low-skilled, worked in lower-paid, service industries and are suffering from mental health (or other unspecified) conditions. Aside from the considerable social costs, the OBR highlight the higher welfare and health spending as well as foregone tax revenues of this urgent issue.

Taxman. Whilst public sector borrowing remains high – June’s net borrowing was £18.5bn – it’s down £0.4bn on last June and £2.7bn less was than predicted by the Office for Budget Responsibility. Government coffers welcome higher tax receipts and the decline in debt interest payment compared with June 2022. But fret about rising inflation-related costs, particularly benefit payments. September’s inflation figure set most benefit rises, including pensions, so expect focus on inflation to amplify. June’s now the month UK public debt broke the 100% ceiling (100.8%) for the first time since 1961, the year the Beatles first performed under that name at the Cavern Club.

Tip of the iceberg? China’s slowing GDP growth appears symptomatic of deeper troubles. GDP grew just 0.8% q/q in Q2 2023, down from 2.2% in Q1. A key reason is weakening global demand for Chinese exports, with advanced economies impacted by rising interest rates and demand shifting away from goods produced in China. In addition, China has struggled with a range of domestic problems. Youth unemployment has reached historic heights beyond 20%, house prices are lagging, and business investment has been hindered by regulatory crackdowns. With analysts still expecting the Chinese economy to grow above 5% this year, the Chinese state will be looking for ways to stimulate activity.

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