Resilience Still Needs Breaking

• Over the past week, resilient EA labour market and UK GDP data have reinforced the case for another forceful interest rate hike. The BoE also needs to lean against wage settlements drifting well above target-consistent levels.
• Next week’s calendar is packed with UK events including the labour market report, inflation, and retail sales. We expect inflation to slow to 10.6% on the UK CPI and 13.4% on the RPI, while the final EA inflation print should be confirmed at 9.2%.
• In Heteronomics news, our website now contains Robo-written commentary for all headline global economic releases . This provides live context about the quantitative relevance of all outcomes alongside the existing newsfeeds we offer for each release.

Eurostat kicked off the weak with unemployment data confirming it remained at the record low of 6.5%. A lack of rises among member states suggests a sharp turn isn’t imminent nor justified with vacancies high. The relative resilience of the EA labour market is extending its outperformance in the recovery. Still tightening conditions here sustain hawkish policy pressures. Wage settlements are rising from levels already inconsistent with 2% inflation, raising underlying inflation, which is more critical to policy-relevant horizons than spot HICP (EA: Tight Economy Requires Hawkish ECB ).

Second-round effects seem even worse in the UK, despite forceful rate hikes pushing inflation swap rates towards normal levels. Consumer and business expectations are extremely elevated, and the associated real income resistance prolongs excess inflation. Indeed, 5% wage settlements are worryingly becoming the norm. At least the BoE recognises the forces necessitating real losses, so we still expect it to reinforce its credibility with another 50bp hike in Feb ahead of April’s critical wage round (see UK: Expectations Still Need Re-anchoring ).

UK GDP data strengthened that case. They were surprisingly resilient in Nov-22 at 0.1% m-o-m, about 0.3pp above forecasts. The World Cup helped, but services trends are broadly less bleak. Further downward revisions from the national accounts don’t negate existing evidence of excess demand. Instead, delayed GDP falls mean inflationary pressures persist for longer. The BoE will need to squeeze demand more if second-round effects prevent inflation from achieving that itself. More rate hikes and a recession are still coming (see UK: Resilient GDP Raises Work for BoE ).

The bullish market sentiment dominated these macro fundamentals this week, with end-24 rates falling roughly 0.5pp in the UK and US, with the EA nearer 25bps. About half of that comes from a lower peak, with the rest from cuts. Neither seems consistent with more resilient activity and the US CPI’s failure to corroborate low pricing. Nonetheless, the repricing rewards those who may have positioned for a frontloaded BoE with flatteners against the peak. However, it consumes the attractiveness of that strategy now the terminal rate trades slightly below our 4.5% forecast.

Meanwhile, on the political front, Alastair identified parallels over three decades between the US Republican Party and UK Conservative Party. Underlying tensions support the widely held view that negotiations over the US debt ceiling this year stand to be the most fraught yet. Indeed, he sees a real risk of finally stepping over the brink into default (see US: In Office But Not In Power ).

Elsewhere, and despite a “bumpy” few months ahead, Alastair sees China’s decision to ditch its zero-covid policy as justifying cautious investor confidence in an economic uptick kicking off in 2023Q2. However, it should not distract from the other severe headwinds the economy faces (see China: Reasons to Be Careful… Still ).

Preview: UK inflation in Dec-22

The news in global inflation releases for Dec-22 has been more mixed again, albeit with the EA’s crash coming as a surprise. That was primarily related to energy, which the UK energy price guarantee controls within housing utilities (and petrol prices are well-identified), so there isn’t any read across from that. Lower food prices seem more relevant and reinforce our view of a slight additional slowing in Dec-22 rather than a return to something more like Oct-22’s rapid pace. If anything, the core news was to the upside (see EA: Germany Pays for Dec-22 Disinflation ).

Overall, we still expect UK inflation to slow to 10.6% on the CPI and 13.4% on the RPI. The latter’s 57bp drop may seem strange against a 5bps slowing in the CPI, but it is well justified. House prices should at least stall as they get dragged toward other metrics that tend to lead slightly. Meanwhile, mortgage interest payments should only provide a partial offsetting effect on the CPI-RPI basis because the 50bp rate hike on 15 Dec was two days after the snapshot used in this release. These effects balance to explain about 5bps of the narrowing in our forecast.

The vast majority of the narrowing left is instead related to what the ONS reconciles as “other differences including weights”. Some economists (poorly) forecast the RPI as a wedge to their CPI view and struggle with predicting this component. We reconcile our bottom-up forecasts into these contributions instead. In this case, the substantial narrowing is primarily affected by differences within the transport sector. This sector subtracts about 15bps from our CPI forecast while motoring and travel collectively knock nearer 40bps from our RPI view.

It isn’t just the difference between CPI and RPI airfares that matters in 2023, as the ONS hacked the RPI weight from 1.6% to 0.9%. Our surging airfare view (a 13 Dec index date is historically high) packs a smaller punch because of it. This source of disinflation may also be missing from some economist forecasts and exceeds the effect of unwinding possible bias from the early Nov index.

Figure 1: Contributions to m-o-m UK RPI inflation

Preview: EA inflation in Dec-22 (final)

Eurostat’s flash inflation estimates have been unusually prone to revision recently. The past three have damped some of the initial surprises. More specifically, Nov-22 ’s low outcome rounded higher, while the boisterous Oct-22 and Sep-22 ones were lower in the final prints. Although Dec-22 was another surprisingly low flash, we do not expect the pattern to hold in the final on 18 Jan. Unlike the rest, the 9.2% flash was about as far away from the rounding point as possible.

Local releases were higher in Lithuania and Latvia (+0.4pp and 0.1pp), but Spain was revised 11bps lower. Germany’s final print on 17 Jan may prove more interesting than the Euro area one for us, assuming no revisions as we do. That is because De Statis will reveal the breakdown of the crash in Dec-22, and this serves as the base for significant shifts in fiscal policy’s energy support. The early economic consensus appears only to see the effects normalising higher rather than the new schemes pushing lower. That could change after this print as economists digest the guidance in the context of a clarified starting point. Or maybe that’s just me being an excitable nerd!

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