Chief Economist’s Weekly Briefing – Facing Uncertainty

Inflation is still running at more than three times the 2% Bank of England target, interest rates are biting, and consumer confidence has fallen, perhaps in response to the emergence of new geopolitical turmoil. While there is optimism that inflation will decline in the months ahead, the Bank of England is watching closely for signs of domestically generated price pressures. And like the rest of us they nervously follow headlines from the Middle East.

Time for healing. Pay growth is still healthy, but is cooling, according to the first half of the labour market report (we’ll get the unemployment reading this week). UK average weekly earnings rose 7.8% y/y in August, edging down from 7.9% in July. Month to month pay rose 0.34%, almost half the pace of the first seven months of 2023, supporting many economy-watchers who had been signalling an impending slowdown in wage growth as the broader jobs market cools. It’s not the only sign. A separate measure of pay settlements shows an average rise of 5% in the three months to August, down from 6% in the first half of the year. Cooling, albeit slowly, might be the more apt description. And in the race with inflation, pay has its nose out in front.

Still sticky. September’s CPI figures were firmer than anticipated following the previous month’s downside surprise – unchanged at 6.7% y/y. September’s print normally determines the uprating of certain welfare benefits in the following April. If that convention holds beneficiaries should see rises well above the prevailing inflation rate. Seven of the twelve main price categories saw the rate of increases ease. This included food and non-alcoholic beverages, with price rises slowing to a 15-month low of 12.1% y/y. Core-CPI (excludes food and energy) and services CPI remain cause for concern. The former fell marginally to 6.1% while the latter accelerated to 6.9% y/y. Inflationary patience is wearing thin.

Take your pick. What’s happening to the housing market in the UK? Well, it very much depends on where you look. House price indices from the likes of Halifax and Nationwide both show falls approaching 6%, whereas the official ONS measure is flat on the year, and actually a few percent higher than the low it reached in March. Those gains seem likely to reverse, however, as higher interest rates on mortgages continue to bite. What’s not slowing down is rental price growth. Average UK private sector rents are up almost 6% (or over 9% in NI), so you might not be better off as a renter, even in a falling market.

Warm (un)welcome. UK shoppers delayed their Autumn clothing purchases due to warmer than usual weather in September, cited non-food store retailers as well as non-store retailers, who saw sales volumes drop materially. Headline retail sales volumes fell by 0.9% MoM (worse than consensus expectation of -0.4%). But a rebound in retailing is likely in Q4. Households should see their purchasing power expand as wage growth outpaces the inflation rate (notwithstanding the anticipated erosion from mortgage refinancing). Granted, households’ confidence is still on shaky ground with the Gfk index falling to -30 in Oct from -21 in Sep. But this partly reflects some pessimism about the spillovers from the Israel-Hamas war.

Low, low, low. The UK government continues to borrow less than the Office for Budget Responsibility anticipated back in March. Public sector net borrowing, excluding public sector banks, was £14.3bn in September, £4.1bn less than the OBR forecast. Despite spending increasing, the difference was due to increased tax revenue and decreasing interest. Due to higher inflation and frozen tax thresholds, government coffers got a boost with tax receipts equalling £57.4bn. While a 0.6% fall in the Retail Price Index between June and July cut payments on inflation-linked gilts. Interest payables amounted to just £0.7bn (far less than the £4.1bn forecast by the OBR). Fiscal giveaways at next month’s Autumn Statement still look challenging, given the anticipated rise in forecast annual debt interest payments (a higher for longer rate environment has many costs!).

Futureproofing. An economy in crisis fights fires, but also needs to think long term. That’s the message of a new Resolution Foundation report, “Built to Last”, which grapples with the unsustainable path of debt accumulation, suggesting that the UK’s macroeconomic policy framework needs a big rethink. Markets expect high rates for many years, but a lot of economists take a different view. Given that uncertainty, the report argues, we need new fiscal and monetary policies: prepare for targeted rather than universal fiscal support; raise the inflation target to 3%; run a politically realistic 1% surplus in good times. But will policymakers find the bandwidth to address such difficult topics?

Upbeat? China’s economy grew 4.9% y/y in Q3 this year, beating market expectations, and signalling some regained momentum. September’s growth in industrial output and retail sales (up 5.5% y/y) also beat expectations. Output rose 1.3% quarter-to-quarter, following 0.5% growth in Q2. Focused support is buoying manufacturing and infrastructure investment, while household expenditure maintained robust growth in Q3. All is well then? Well not quite. China has many medium-term drags on growth, such as deteriorating demographics and rising youth unemployment. While the property market is very fragile, as the recent plight of property developers attests.  

Steady does it. The Fed chairman, Jay Powell, set the tone in his recent speech that the central bank will probably keep interest rates unchanged in upcoming monetary policy decisions. But the balancing act remains tricky. Elevated geopolitical tensions are posing renewed risks to the global economy, referring to the ongoing Israel-Hamas war. What’s more, the impact of rates tightening is yet to be fully felt. The recent rise in Treasury yields was also part of the discussion and the Fed Chief acknowledged that a surge in yields could play its part in slowing down the economy. That said, the fight against inflation is not yet over, with Powell leaving the door open for future rate hikes, keeping a close eye on signs of economic resilience.

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