Economic Outlook Seminar 4th October 2023 at Bath Racecourse
Key Messages (prepared by Mark Berrisford-Smith)
The going turns soft (again)
- The global economy has run out of puff in the past few months, just as it did after a bright start in 2022. Last year, the war in Ukraine was the culprit; this year it’s the dampening effects of higher borrowing costs.
- The manufacturing sector is suffering more than the services sector. Around the world, many households are still stuffed with those barbecues and kitchen gadgets acquired during the pandemic which won’t need replacing for some time, while many businesses have understandably decided that the current juncture is not right for embarking on major capital expenditure. As a result, the volume of goods being transported around the globe has been running at 3-4% below last year’s level.
- Geographically, the brunt of the slowdown is being borne by western Europe and China. For the former it’s high interest rates that are doing the damage, while in the latter it’s the ongoing slump in the real estate sector. Meanwhile, in the United States it looks increasingly likely that the Federal Reserve is about to accomplish that holy grail of monetary policy – a soft landing for the economy.
Some wins in the war on inflation
- Outside of China and Japan, neither of which have problems with inflation, re-establishing a semblance of price stability has proved to be much harder than was expected a year ago, with policy interest rates now back to levels not seen since 2007-08. The medicine has worked, inasmuch as headline and “core” rates of inflation have come down significantly; but they’re still well above the mandated targets,
- With last year’s surge in commodity prices now falling out of the annual calculations, the trajectories of headline inflation rates will be largely dictated by trends in labour markets. Taken as a whole, commodity prices have been fairly stable in recent months, albeit that they remain more than a third above their pre-Covid level.
- On the strength of recent falls in inflation rates and the growing evidence that economic activity and labour markets are softening, at their September policy meetings the major central banks were finally able to signal that the long period of painful rate hikes is about at an end. The odd further increase can’t be ruled out, and indeed the Bank of England’s decision to keep its base rate on hold at 5.25% was a knife-edge 5-4 vote.
“higher for longer”
- For the UK and western Europe, the coming winter is set to be a re-run of the last one, with economies at risk of falling into shallow recessions. For even if interest rates have peaked, it’s during the next six months or so that borrowers will feel the maximum pain from the extended period of monetary tightening. Even in in the US, the pace of economic growth is set to slow to a crawl, albeit that a dip into recession looks unlikely.
- With “higher for longer” being the new mantra from the central banks, it will be the middle of next year before any of them start to think about cuts. They’ve all been badly burnt by the recent surge in inflation, with their inability to see it coming leading to uncomfortable post-mortems. In this environment, they won’t want to run the risk of magnifying their recent errors by easing off the brakes too soon.
The UK treads water
- Turning to the UK, despite some favourable data revisions, there’s no getting away from the fact that it’s had a torrid time since the Covid pandemic. The economy has expanded by less than 2% since the closing months of 2019, and it’s the only major advanced economy where the rate of economic inactivity has increased. The acute shortage of labour, which emerged in 2021, has not only crimped growth but has helped to drive inflation higher.
- After last year’s trials and tribulations precipitated by the surge in gas and electricity prices, not to forget the brief and disastrous Truss/Kwarteng episode, this year got off to a brighter start as fuel bills fell back and as many employees were able to bid up their earnings. But thanks to some nasty data surprises, interest rates ended up rising further than many people had hoped, so that the various business surveys now suggest that growth has again stalled. Retail spending, the housing market, housebuilding, and commercial real estate are just some of the areas which are clearly suffering.
- But there has also been some better news in recent weeks. The headline rate of inflation dropped sharply in July, while the underlying, or “core” rate fell more than expected in August, paving the way for the BoE’s knife-edge decision on 21st September. As a result, five-year fixed rate mortgages can now again be had for under 5%. It won’t be enough to galvanise the housing market, but it should take some of the edge off the recent gloom.
- With the BoE still holding out the threat of further rate hikes if inflation misbehaves again, and with little likelihood of cuts being considered until the autumn of next year, the UK’s economy is set to continue to tread water for some time yet. There’s little chance of meaningful growth until the prospect of interest rate cuts hoves into view. For although households’ real incomes have started rising again, and while many people are still sat on savings built up during the pandemic, it’s younger cohorts who tend to be the biggest spenders, the same people who are having to cut back on non-essentials in order to afford higher mortgage and rent payments.
Lower inflation will pave the way for more growth
- In the absence of further commodity price shocks, headline and “core” inflation rates will both continue to trend lower throughout 2024 as the labour market loosens. The key metric to watch will be the number of vacancies, which should be back to it’s pre-pandemic level of around 850,000, by the spring of next year. Employees will therefore gradually see their bargaining power erode, which will help curb “core” inflation. Nonetheless, it’s likely to be some time in 2025 before the headline rate of inflation approaches the 2% target.
- This subdued growth environment will inevitably pose challenges for many businesses, with a return to anything like pre-pandemic conditions unlikely before the first half of 2025. Yet the fact that inflation is receding will also bring greater certainty to costs and revenues. It will therefore become easier for firms to make a reasonable assessment of the costs of potential capital expenditure schemes.
- Higher borrowing costs and negligible growth have already taken their toll on businesses, with a sharp increase in the number of failures and restructurings. This situation is not likely to improve noticeably for 12-18 months, during which time those firms which need to refinance borrowings could find lenders in a cautious frame of mind. At the same time, businesses will welcome the greater certainty which a peak in the Bank of England’s base rate will bring to their debt servicing calculations.
Navigating turbulent times, always requires professional support to help interpret a changing fiscal and monetary landscape and we would always recommend that you engage with your trusted advisors early on. If you would like to discuss any aspects of your business finances, please don’t hesitate to get in touch:
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