No end in sight

Last Friday, UK GDP came in a tick higher than expected. Instead of the stagnant 0% expected by economists, the UK economy expanded by 0.2% over the three months to June. In this case, a 0.2% surprise is by no means insignificant. The fact that the economy was able to eke out growth in the face of already aggressive interest rate hikes will galvanise the Bank of England’s zeal to continue tightening monetary policy. Persistent inflation and runaway wage growth will be the BOE’s Public Enemy No.1, while faltering consumer confidence and business surveys will become an afterthought.

Employment data points towards a slackening labour market, with staff availability rising, fewer staff appointments, and the number of redundancies growing. While new vacancies are still growing, the rate of growth is as low as it has been for 2.5 years. BOE Survey data supports a softening employment market. However, because of low unemployment, wage inflation will likely remain robust, given the dynamics across both public and private sectors. Industrial action in the public sector is proving effective and has emboldened trade unions, whilst the private sector is submitting to higher wages to avoid having to recruit from a tight labour market. This latter example of labour hoarding is a feature of companies being pragmatic in an economy where the labour force growth has levelled off over recent years due to the pandemic and a smaller pool of immigrant labour. This is a delicately balanced dynamic which is currently in favour of labour, but which could turn quickly in the event of slowing economic activity.

This week’s UK CPI print will likely come in lower than last month, due to base effects and survey reports which point to more fluid supply chains. We do not expect that the higher GDP data to be enough to derail that. It is true that corporates are enjoying an environment where input prices can be passed through to consumers more easily, but the cost of debt servicing means that households are being forced to be more circumspect about their discretionary spending which may cause inflationary pressures to ease. However, given the structural resilience we see in the labour market and services sector, the test will be whether the number is low enough to take the pressure off the Bank of England to keep raising rates, particularly as we do not see inflation falling back to anywhere near 2% this year.

The age-old question of just how long it takes for rate rises to impact the real economy is now more pertinent than ever. But now that the economy is showing some resilience, we suspect that we will not have seen the end of rate rises.

David Baker – Chief Investment Officer