Your weekly economic update from the team at FXD Capital
Reports of inflation, defection and the expiration of Plan B Covid measures in England on 24 March filled our news feeds this week. With the Omicron wave having peaked nationally, the economy faces the notion of learning to live alongside the virus as pandemic restrictions will start to be lifted next Thursday. With growing confidence that we may be moving into the pandemic endgame, the government set out its long-term strategy for living with coronavirus, reminding us that Covid-19 will most likely join the multitude of endemic diseases. On the theme of recovery, sterling has broken a 23-month high against the euro and is back around the 1.20 mark, on the back of a marked hardening of rate hike expectations in the UK. Swiftly moving across to the US, they faced a shortened week, with markets closed on Monday in observance of Martin Luther King Jr. Day.
In other news, Monday started with China’s unexpected key interest rate cut for the first time in almost two years. GDP grew by 4% for the last quarter of 2021 from the previous year, whilst exceeding economist predictions was in fact far slower than the previous quarter. To help boost the economy, China’s central bank cut its benchmark rate for mortgage lending, moving them further apart from other major central banks around the world.
On Tuesday, for the first time in over a year from November, pay increases were unable to match the accelerated cost of living. Whilst this saw the first fall of average earnings in real terms since July 2020, some economists take the view this may be short-lived with the jobs market heating up. Other labour market updates included the unexpected fall in the unemployment rate from 4.2% to 4.1% in the three months prior to November. Despite this change, sterling appeared to remain unreactive. In contrast, the dollar was able to edge slightly higher, succumbing to last week’s downward pressure.
Significantly on Wednesday, UK price pressures continued to climb with annual inflation rising to 5.4% in December from 5.1% the previous month, while the core inflation rate YoY rose to 4.2% from a former reading of 4.0%. Both readings exceeded market forecasts. Another of the Bank of England’s preferred inflation readings showed CPIH increase by 4.8% over the last 12 months, the highest rate since May 1992 when the rate stood at 7.1%. Food prices again grew strongly, along with increases in furniture and clothing. Despite petrol prices remaining stable this month, with gas and electricity costs set to increase further soon, analysts warn it could reach that level again.
From a mainstream perspective we are edging close to the peak of inflation and many now look to the government to help households respond to this surge in the cost of living. With higher inflation and tax rises still to come, the year ahead will undoubtedly be focused on the cost-of-living crunch and labour shortages.
As it stands, households have seen their energy bills kept in check by the government’s price cap, which limits the amount suppliers can charge. However, if as expected the energy price cap rises in line with current wholesale prices, millions could see their fuel bills hiked by 50% in the next few months. The cap is set to be revised on 1 April, leaving households to anticipate their expenditure on heat and power exceeding the peaks of the 1980s by the end of the year.
With inflation now expected to hit 7% by April, the MPC will likely raise interest rates faster than most expected, with markets fully pricing in the next increase to 0.5% on 3 February. Understandably, there is concern that an aggressive response to rising inflation will derail recovery and hurt growth of the economy. Following closely behind the UK and Biden’s statement of support on Wednesday, the US Federal Reserve are likely to start tightening monetary policy and raising rates in March as the first of three prospective rate hikes this year.
To round off the week, on Friday morning UK retail sales missed the predicted mark by a long way falling by 3.7% in December as the threat of Omicron discouraged shoppers from visiting in-store. Although retail sales continue to stay higher than pre-pandemic levels, with the awaited cost of living crisis and planned tax rises in April, we can expect to see further sinking of retail sales figures in the months to come. Finally, after the BOE surprising us at the tail end of last year, all eyes will be on the Fed and their interest rate decision on Wednesday next week. Will they leave the interest rate where it currently stands, or will we see their first rate hike in over three years?
For those returning to the office and those continuing to work from home, have a wonderful week!
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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