Chief Economist’s Weekly Briefing – 3-way split

The MPC delivered the expected rate hike last week, even if the committee itself was far from unanimous. There’s more agreement on the outlook however — muted growth, gradually increasing labour market slack, and continued disinflation are still the prediction. 

Restrictive. Following the lead of the US Federal Reserve and the European Central Bank, the Bank of England raised rates by a quarter-point, taking Bank Rate to a fresh 15 year high of 5.25%. The Monetary Policy Committee (MPC) pledged to keep Bank Rate “sufficiently restrictive for sufficiently long to return inflation to the 2% target”. There’s still a range of views on the committee about what that might mean as two members wanted a bigger increase and one wanted none at all. But the minutes of the meeting promised more rate rises if “evidence of more persistent price pressures” is seen.

Inflation infighting. The UK economy has been in excess demand over recent quarters, but an increasing degree of economic slack is expected to emerge after the middle of next year. The rates decision was taken in a bid to ensure that inflation, having fallen to 7.9% in June, keeps falling. The MPC expects the CPI will likely return to 2% target by 2025 Q2 and fall below target in the medium term. While MPC’s outlook for growth in 2023 has improved a touch from its May report, the quarterly growth path is expected to be weaker in 2024 and 2025. Further, unemployment is projected to rise modestly over ’24, peaking at under 5% by 2026. A meaningful slowdown in wages and inflation is needed for the MPC to rpess pause.

Deleveraging. Lending to UK businesses in June fell below levels of May 2020 as businesses paid down debt in the face of higher interest rates. Mortgage approvals were still 15% below the pre-covid levels and with ad-hoc mortgage repayments remaining high, net mortgage lending was close to zero. It was only consumer credit that increased by healthy £1.7bn. On the savings side households’ liquid assets rose by just £3.4bn, compared to pre-covid average of £4.6bn. Recent high inflation and this weaker trend mean that on some measures the Covid-induced “excess savings” pile has now been depleted.

Great Expectations. Firms have altered their future projections of the economic conditions following the CPI inflation fall to 7.9% for June. Asked in July, UK businesses now expect CPI inflation 1-year ahead to be 5.4%, down 0.3 percentage points compared with June perceptions. In addition, firms expect unit cost growth for the year ahead to decline from 6.9% to 6.7%. And wage growth, too, is now perceived to decrease to 5.0% compared with 5.3% when asked in June. Despite this, 53% businesses report that the overall level of uncertainty facing their business was high and very high in July – an intriguing increase from 47% in June. One in five firms also say that aggregate CPI inflation remains the most important factor influencing their pricing decisions. Caution remains.

Mixed Bag. An increasing degree of slack continues to develop in the labour market, probably faster than what the MPC currently expects. Total online job adverts were down 3% week-on-week on Jul 28th, and 10% down compared to last year. What’s more, the number of UK employers proposing redundancies was 63% higher than last year. Elsewhere, small business seem to be faring well—sales up by 5% in Jun compared to May. Revolut debit card spending rising by 9 percentage points and retail footfall also increasing by 4%, indicating the consumer resilience despite rise in interest rates, the question is for how long?

Loosening. US hiring has slowed in July, making the case for the Fed to pause the tightening cycle. Job growth has slowed a bit with payrolls rising 187k in July, with previous two months of data also revised down. However, unemployment rate fell to 3.5%, from 3.6% in Jun. On the other front, wage growth is still a bit too hot for Fed’s liking but is cooling. Average hourly earnings rose 0.4% MoM, and on a YoY basis by 4.4%. The upshort is that the job market is still strong but moderating, consistent with Fed efforts to bring inflation to heal.

Similar but better. Eurozone and the UK face similar inflationary challenges. Disinflation in energy prices are driving down the Eurozone’s headline rate, but sticky services inflation will keep the core rate elevated. And so, another rate hike by the ECB cannot be ruled out yet. In terms of growth, consumer spending has been the main driver. But at 0.3% quarter-on-quarter growth in Q2, EZ may have outperformed the UK, where stagnation is forecast for Q2. Though growth is likely to be subdued in H2, as softer bank lending pulls down investment, full-year forecast is still better than the UK.

Let down. China is experiencing a renewed downturn in economic activity, as its post-reopening rebound continues to disappoint. The NBS general PMI fell to 51.1 in July, the lowest point since Dec’ 22. The driver was non-manufacturing PMI which fell by1.7 points. Both new orders and foreign sales contracted. The manufacturing sector continues to struggle; the Caixin manufacturing PMI dropped by 1.3 points to 49.2, converging with the NBS equivalent. As excess capacity and sluggish demand weighs on the economy, it continues to push deflation. But with global demand set to remain feeble in H2 and underlying weaknesses in the economy persisting, the Politburo’s plans to avoid major demand stimulus may condemn China to a slow and unsteady recovery.

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