Chief Economist’s Weekly Briefing – Paltry prospects

Last week’s upbeat revisions to the UK’s economic performance in the first half of the year, whilst encouraging, brings little joy, as the impact of high interest rates on the economy continues to build. With the cost of credit rising, this is the best time for many households to rebuild their depleted savings. Mix in some election uncertainty and businesses too will likely postpone their investment decisions. All combined, it’ll keep growth subdued. 

Onwards and upwards. The Bank of England might have paused its rate hikes, but the process of credit getting more expensive still has road to run. New mortgages taken out in August were issued at an average rate of 4.8%, up from 2.5% last year and 1.8% back in August 2021.  The prevalence of fixed rates in mortgages means that the average rate on the outstanding stock of mortgages rises rather more slowly, only having breached 3% in August, up more modestly from 2.2% a year ago.  Meanwhile its savers who have something to shout about finally, with fixed rate accounts finally yielding more than 5% on average, for the first time in 15 years.

Broad-based sluggishness. That’s the verdict for the UK growth outlook in KPMG’s latest report. Their 0.4% growth forecast for 2023 is in line with consensus and is underscored by the erosion of households’ excess savings and the effect of higher interest rates feeding through to household and housing sectors, investment intentions, and transaction volumes. Fiscal policy in the run up to the general election is likely to entail new spending pledges to address more immediate demands, but uncertainty over the direction of policy beyond the general election will prolong the long-term challenges of low productivity and investment, through delayed business decisions.

Laggard no more. ONS revisions to economic output data shows that the UK economy grew faster than Germany and France in the post-Covid period. What’s even better, growth in Q2 was led by resilient spending by both consumers and businesses. Household spending rose 0.5% over the quarter thanks to the 1.2% rise in real disposable income (driven by surging wage growth and benefits uprating). Business investment rose a healthy 4.1%, despite the withdrawal of the super deduction and rising borrowing costs. Some support also came from a rise in government spending amid an easing of industrial action. But weakness in trade remained the UK’s ‘Achilles heel’. Looking ahead, growth is likely to remain subdued as both households and firms will look to rebuild some of their lost cash buffers, the former evident in the rising household savings ratio for Q2.

Contraction. Two steps forward one step back sums up Northern Ireland’s economic growth trajectory of late. Following two successive quarters of expansion, the Northern Ireland Economic Composite Index (NICEI)  – the nearest thing we have to quarterly GDP – contracted by 0.5% q/q in Q2 2023. But output was up 1.7% y/y and still 5.8% above pre-pandemic levels. The latest quarterly decline was driven by the private sector, notably services and construction. Private sector output may still be above its’ pre-pandemic level but the latest 0.8% q/q fall takes output back below the peak recorded almost 16 years ago in Q3 2007. A sobering thought.   

No QEasy way out.  Quantitative Easing saw the Bank of England amass £900bn of bonds by 2021. Since then, the BoE has been steadily selling-down those holdings and plans to reduce them by another £100bn over the coming year, to £658bn. The downside? This means crystalising big losses. Continuing down this road could end up costing taxpayers £100bn according to the Institute for Economic Affairs. Author, John Redwood MP, is calling on the BoE to change course; holding bonds to maturity to cut the final bill. A more gradualist approach and keener focus on the money supply would also, he claims, reduce recessionary risks and benefit inflation forecasting.

Inflation still on the horizon? Consumer spending habits and business confidence levels have trended more highly this week compared to last: UK debit card spending rose 2ppts (+10ppts retail sector) and firms are reporting fewer concerns. Both positive signs for economic activity. Job adverts appear to be stabilising at healthy levels too, rising for the third consecutive week. Of course, these signs of strength may indicate that price pressures are perhaps not a thing of the past. Especially since petrol and diesel prices increased for the ninth week in a row. Despite the recent decision of the MPC not to raise interest rates for a fifteenth time, these data suggest there may still be a need to keep rates ‘higher for longer’ to further combat and control continued inflationary pressures.

Dynamo? Economic change can be uncomfortable, but it is necessary to improve the UK’s productivity performance, which has been dire for quite some time. That’s the message of a new report, ‘Ready for change’, from the Resolution Foundation, which emphasises a neglected source of growth: reallocation of resources, especially labour, from low to high-productivity firms and sectors. As things stand, the rate of labour reallocation between sectors is at a 90 year low. The report advocates eliminating barriers to change and addressing some perverse incentives that may prevent firms growing. Can the government boost dynamism? Maybe the Treasury will be interested in the report’s proposals across tax, planning and social security..

Payday. Thanks to a sharp drop in energy prices compared with last year, the Eurozone (EZ) inflation rate is expected to fall substantially in September, to an almost respectable 4.3% y/y. But like an annoying guest, the effects of past rises hang around for too long. Food and alcohol prices are still rising by an estimated 8.8% y/y. But the Netherlands, Europe’s (energy) intensive market garden, is set for a bout of outright deflation in September (-0.3%). That should support further easing on food price rises, in both the EZ and here in the UK. That leaves pay as the last big unknown in the fight against inflation.

Traction. China’s official PMI showed some encouraging signs the economy is improving, in certain areas at least. The manufacturing survey rebounded to 50.2, its first 50 plus reading since March. Authorities have been drip-feeding stimulus into the economy of late, so some of that monetary easing and fiscal support in the shape of public investment look to be helping. The vehicle industry is also showing signs of strong demand. But it’s too early to declare the economy out of the woods, not with the scale of problems in the property sector. Other surveys tell a story of fragility and cautious businesses with the separate Caixin PMI falling in September, both in manufacturing and services. More stimulus on the way?

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