Chief Economist’s Weekly Briefing – Anchored

Policy tightening across the globe is nearing its end. The Bank of England (BoE) and Federal Reserve (Fed) paused their respective rates hiking cycles last week, while the ECB signalled a final hike the week prior. At home, the vote was rather close, 5-4, and the MPC’s guidance suggested they are maintaining optionality about future hikes. Globally, the prolonged monetary tightening phase has constrained the growth outlook for this year and next.

Done?  Probably, but… So, are we done? We could well be, is the answer. A downside surprise in the inflation data, and emerging weakness in the PMI, means the trade-offs between growth and inflation have shifted, greater weight is likely being placed on the economic outlook. But don’t expect much by way of cuts soon. BoE guidance was little changed from August: any upside surprises in inflation will have policymakers reaching for the rates dial. And they’re quite prepared to keep rates restrictive for a lengthy period. No premature loosening of financial conditions here, please. Markets continue to get the message, pricing the first cut late into next year.

Hat-trick. Forecasting inflation has made economists look like fools in recent months. Never mind precision, even guessing the right direction has been tricky. UK CPI fell unexpectedly to 6.7% y/y in August, down from 6.8% y/y the previous month. But it was the scale of the fall in core-CPI that raised eyebrows. Underlying inflation – stripping out volatile food and energy prices – eased from 6.9% to 6.2% making the UK less of an outlier vis-à-vis its peers. A third surprise occurred with the annual rate of services CPI – a proxy for domestically-generated inflation – slowing sharply from 7.4% in July to 6.8% in August. Together this hat-trick of good news poured cold water over future interest rate hikes.

Oops. In the words of Iceland’s greatest philosopher Bjork (Sugarcubes days), it wasn’t supposed to happen. The UK composite PMI, a pretty good indicator of most things economic (firm output, hiring intentions etc.) dropped to 46.8 in September. It’s a ‘flash’ indicator but may well have swayed the MPC’s slightly-against-the-odds decision to keep rates on hold last week. It’s the fall in services that stands out (manufacturing’s been lacklustre for months). Activity in the service sector dropped to 47.2, a 32-month low (that’s over 2 1/2 years to you and me). To close on better news, input price inflation saw the biggest fall so far in 2023. No doubt another factor behind the BoE’s decision.

Net positive. Retail sales volumes (incl. petrol) rose by 0.4% m/m in August, just below the consensus, 0.5%. Dryer, warmer weather enticed consumers back to the high street, benefiting clothing retailers the most (+2.3% m/m), followed by food stores (+1.2% m/m). The outlook is positive on balance; further growth in real wages should support recovery in retail sales over the rest of the year, notwithstanding headwinds to disposable income from mortgage refinancing. Though the boost will not be 1-to-1 as some households are looking to rebuild their depleted savings – Gfk’s savings intentions balance in September remained unchanged at its joint-highest level since early 2008.

Riddle. What’s getting more expensive just as it’s price falls? Right now, housing fits the brief. UK average house prices fell 0.5% in August, on a seasonally adjusted basis, leaving them £2,000 below last November’s peak. But as high mortgage rates put more people off buying, demand for a limited supply of homes to let is soaring. That’s driving-up private rents, which rose 5.5% in the past year, the fastest in recent memory. Northern Ireland continues to post the steepest rent rises at 9.1% y/y (Jun-23), followed by Wales (+6.5%) and Scotland (6.0%). So little sign that rent controls in Scotland are having the desired effect.

Wriggle room. With the Autumn Statement just two months away there’s extra scrutiny of the public finances. August’s tax and spend data showed there was a balance of good and bad news for the Chancellor. On the positive side, higher tax receipts from stronger wage growth, profits and inflation meant that the Government has borrowed about £11bn less than it expected to in the 5 months since April. If sustained, this could give the Chancellor some wriggle room to make spending pledges or tax cuts in November and still meet the fiscal rules. But better than expected doesn’t mean good. The bad news is that borrowing is still close to 40% higher than last year, underlining the long-term challenge of achieving fiscal sustainability.

Inflation and slow growth. OECD forecast global GDP growth will remain sub-par in 2023 and 2024, at 3% and 2.7% respectively, held back by the macroeconomic policy tightening needed to rein in inflation. Inflation is projected to moderate gradually over 2023 and 2024, but to remain above central bank objectives in most economies. The US, Eurozone, UK and China will all see slower growth. Risks are tilted to the downside; higher rates may yet shock demand while persistent inflation would require further tightening. Fiscal pressures mount with additional spending on ageing populations, climate transition and defence. Structural reforms are key to boost productivity and inclusion. More international cooperation is critical, including on reviving trade and carbon mitigation.

Freeze. The US Federal Reserve decided to maintain the benchmark rate at a target range of 5.25-5.5% last week but ruled out a quick loosening of monetary policy. The news comes as US CPI rose by 3.7% y/y – 0.5ppts increase since July – and sticky core inflation in part due to rising energy prices. In fact, rates are expected to rise again by the end of 2023 and only face two cuts in 2024. Caution ultimately prevails as the Fed aims to achieve a “soft landing” of decreasing inflation without a recession. Projections indicate the target of 2% inflation will be hit by 2026.

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