Policy Weighs Wages Versus China
UK labour market data were the week’s highlight for us. A surprise 0.2pp unemployment rate jump to 3.98% was its highest since Dec-21. This time the rise looks genuine rather than being a sampling issue. Wage growth was surprisingly strong owing to revisions again, while the monthly impulse matched our view. It will probably peak in the next month’s release. The BoE may await slower wages and CPI inflation’s step down before reverting to 25bp increments as the Governor didn’t resist pricing. We expect 50bps in August (see UK: Slackening Too Slowly for the BoE ).
Government plans to raise public sector pay by 6% (or more) are a timely reminder of the BoE’s problem. Such increases are neither matched by productivity nor offset by disinflationary pressures. They demonstrate the real wage resistance that needs breaking to end the second-round effects stoking excessive inflation. It will embolden demands in the private sector, which sometimes compete for these workers. Paying for this rise within already bloated department budgets does not change the inflationary effect. It is merely a fig leaf for the government’s rhetoric.
The government arguably couldn’t resist the political attraction of bribing a million public sector workers with bumper pay deals ahead of five by-elections (the first three on 20 July). It is unlikely to change their outcomes amid toxic circumstances and public disillusionment with the current government. Losses would exacerbate existing feuding within the Conservative Party, especially over tax cuts and immigration, even though the electorate will almost certainly react badly to still more internecine squabbling (see UK Politics: Woe Is Rishi ).
Elsewhere on the political front, the 8th OPEC International Seminar in Vienna projected an upbeat outlook for the organisation, with the Secretary-General expressing confidence in gaining new members and projecting OPEC members accounting for 40% of the world's oil production by 2040-45. However, despite efforts to sustain an oil price floor of $80 per barrel through output cuts, the price has not risen significantly, prompting concerns about the organisation’s influence and survival. A potential tipping point could be the exit of a major producer like the UAE, which is currently grappling with the decision to stay or leave OPEC due to economic interests and fears of stranded assets in a world where oil demand is set to decline (see Opec: Is The End (Finally) Nigh? ).
Central Bank decisions
There were four central bank decisions this week, only one rate hike, and no surprises. Countries vulnerable to China’s demand are on hold in anticipation of trade weakness. Exposure to the US is more resilient and inflationary, which kept the Bank of Canada hiking. The Euro area has less resilience but more inflation, keeping it going, while the UK’s inflation problem is fierce.
The Bank of Korea maintained its base rate at 3.5%, as expected, amid anticipated inflation rate increases and varying global economic trends, pointing to a cautious stance on monetary policy. Economic indicators, such as the reduction in the decline of exports and improved employment rates, suggest a shift into a more favourable phase of the economic cycle, potentially influencing future monetary policy decisions. The emphasis on price stability and financial stability indicates that the MPC's future decisions will be guided by the interplay of domestic and global economic trends, inflation trends, downside risks to financial stability, and potential changes in major countries' monetary policies.
The Central Reserve Bank of Peru (BCRP) maintained its reference rate at 7.75%, influenced by downward inflation trends but notes that future adjustments depend on incoming data related to inflation and its drivers. Despite a decrease in one-year-ahead expected inflation and the anticipated continued decline in year-on-year inflation due to moderating impacts of global food and fuel prices, risks still exist, particularly those related to climate factors and global monetary tightening. Economic activity indicators have shown signs of deterioration, reinforcing the need for a cautious approach and readiness to recalibrate monetary policy to ensure inflation returns to the target range.
The Reserve Bank of New Zealand’s unsurprising decision to hold the Official Cash Rate (OCR) at 5.5% reflects a commitment to restrain inflation and sustain maximum employment, signalling a likely continuation of this restrictive interest rate level for the foreseeable future. Future MPC decisions will be shaped by global economic growth trends, especially monetary policy tightening by central banks internationally and economic conditions in key trading partners like China. Domestic factors such as declining inflation expectations, easing of capacity constraints, reduced labour market pressures, and lower house prices, along with mortgage rate trends, will also significantly influence future MPC decisions.
The Bank of Canada increased its overnight rate to 5% and continues quantitative tightening, as expected, in response to persistent inflationary pressures, robust domestic demand, and resilient economic performance. Despite a drop in inflation to 3.4% in May, underlying price pressures persist. The Bank foresees a slower return to the 2% inflation target, underlining potential risks to price stability. The inflation dynamics will shape future policy decisions, focusing on excess demand, inflation expectations, wage growth, and corporate pricing behaviour’s alignment with the inflation target.
Other data releases
The United Kingdom's GDP contraction for May 2023, though slight at -0.1% m-o-m, signals a remarkably resilient economy considering the additional bank holiday, which mechanically weighs on output. Our Q2 GDP forecast is still for no growth. Ongoing employment and wage growth translate into uncomfortable unit wage cost pressures far more relevant to policymakers than stagnant GDP.
Across the Atlantic, the US economy presented a less inflationary though still resilient narrative. The decline in initial jobless claims to 237k for the week ending July 3rd, the lowest since June 19th, indicates an increasingly robust labour market. Meanwhile, the softer-than-expected readings on both CPI inflation at 3.0% y-o-y (consensus 3.1%) and PPI inflation at 0.14% m-o-m (consensus 0.2%) for June 2023 indicate inflationary pressures are easing. This provides some breathing space for the Federal Reserve, although it is unlikely to derail a July rate hike.
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Preview: UK inflation in Jun-23
UK inflation’s resilience has shocked the consensus, disgruntled politicians, and market pricing by extension. This pressure ultimately pushed the BoE into a 50bp rate hike in June, when the consensus was still for no change even after the BoE’s May decision (we expected 25bps). The June CPI print is the last release with the potential to dent the August vote. However, with the Governor seemingly content to let the market tail wag the policy dog, and market pricing confident of a 50bp jump, we doubt that outcome can be derailed.
We expect a slight downside surprise in the June print and a 50bp rate hike. A downside surprise seems like a bold call after so much upside, but we see two reasonable reasons for it occurring.
Firstly, economists have been “kitchen sinking” their forecasts, in the sense that they’re looking for excuses to lean higher to reduce the risk of another error. There is an element of that in our forecast, but perhaps a less extreme one. Specifically, the net effect of our tuning for component-specific factors adds about 7bps to headline inflation. The push from slower cost transmission (our “macro overlay” for price disequilibrium) takes the combined effect up to 15bps.
Secondly, we saw the May outcome as close to our forecast, except for airfares. The late April collection date missed the usual Easter effect, and the 16 May index fell after the coronation, yet prices belatedly surged by 20% m-o-m. To gauge the airfares outlook, we note that 2013 and 2005 are the only historical occasions with similar May surges. Both followed April declines of roughly 7% m-o-m related to Easter falling in late March, unlike the 3% rise this year. Nonetheless, we assume the unseasonable June declines of those years repeat in 2023 while mindful that it could fall even further under the circumstances (see UK: Flying Inflation is Landing Slowly ).
Transport prices are the dominant driver of our forecast slowing in inflation during June. It is worth 39bps of the 61bps slowing we expect on the CPI to 8.1% (10.7% on an RPI of 376.4). Food prices should also support this move as the UK catches up with the global trend. It also lagged the move last spring and then caught up in the summer as contracts caught up. Airfares are both services and “core”, despite being notoriously volatile in the UK, so those metrics should also slow in June.
Figure 1: Contributions to m-o-m CPI inflation
Preview: EA inflation in Jun-23 (final)
EA inflation undershot consensus expectations again in the June flash by falling 59bp to 5.51% y-o-y (see EA: HICP Trends Extend in Jun-23 ). Core inflation ticked up almost as far as expected, but energy prices are falling faster than forecast. National releases since then have broadly corroborated the flash estimates, so we do not expect a revision in the final print. The ex-tobacco rate should similarly slow to 5.49% y-o-y.
Figure 2: Contributions to m-o-m EA HICP inflation
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