Good news for the economy should come in the form of a dip in consumer price inflation to a six-month low of 2.5% in October and a further, appreciable drop in unemployment. Retail sales may have been only flat in October after rising sharply in the third quarter as consumers took a breather ahead of Christmas. Reflecting the improved growth outlook and recent marked falls in unemployment, the Bank of England’s quarterly Inflation Report for November is likely to lower its unemployment forecast, thereby indicating the central bank could start raising interest rates in late 2015 or early in 2016 rather than holding off until mid-2016.
Consumer price inflation in October
Data out Tuesday should show consumer price inflation moderated to a six-month low of 2.5% in October, from 2.7% in both September and August, 2.8% in July, and a 14-month high of 2.9% in June. Inflation had earlier risen to June’s peak from a seven-month low of 2.4% in April (when it was limited by the fact that Easter had occurred in March in 2013 but in April in 2012).
Favorable base effects, resulting from the marked increase in the maximum undergraduate university tuition fee that occurred in October 2012, likely helped consumer price inflation move lower in October. Lower petrol prices and an easing in food prices may also have helped matters while, evidently, retailers engaged in significant promotional activity and discounting in October. Specifically, the British Retail Consortium (BRS)’s shop price index shows prices were down 0.5% year on year (y/y) in October compared with a drop of 0.2% in September. Food price inflation edged down to 2.7% in October from 2.9% in September, while the y/y fall in nonfood prices increased to 2.4% from 2.0%.
Consumer price inflation seems likely to hover around 2.5% for the next few months. Much will depend on oil price and energy tariff developments, and whether a significant number of retailers, manufacturers, and service companies look to take advantage of the recent marked improvement in economic activity by trying to raise their prices to improve their margins. Having traded as high as USD117/barrel in late August/early September, oil prices have retreated to trade as low as USD104/barrel in November; and while they will remain prone to spikes on geopolitical events (Syria, Libya), we expect them to largely retain their recent, softer tone.
Centrica, SSE, RWE npower, and ScottishPower, four of the “big six” energy suppliers, are to increase their gas and electricity prices by an average of 8.2–10.4% from November, but it needs to be borne in mind that all six major utilities hiked their tariffs in late 2012/early 2013, with the increases being in a 6–11% range. So the overall impact on the annual rate of inflation should be limited.
We believe underlying price pressures will be limited through the rest of 2013 and beyond by significant excess capacity, only gradually rising wage growth amid still appreciable labor market slack, and limited scope for retailers to raise prices, given still-significant pressures on consumers’ purchasing power. Although the economy has strengthened markedly recently, it seems unlikely to generate significant underlying inflationary pressures for some time to come, given the slack in the economy after extended very weak economic activity.
Consumer price inflation is seen trending down gradually through 2014. While GDP growth is expected to strengthen to 2.5% in 2014, from 1.4% in 2013, it is still unlikely to be strong enough to lead to any marked pickup in underlying inflationary pressures, while earnings growth is seen picking up only gradually and remaining moderate compared with past norms. Furthermore, oil prices are expected to be softer overall compared with 2013. Specifically, Brent oil is projected to average USD103.9/barrel in 2014 compared with USD108.3/barrel in 2013. In addition, sterling is expected to be firmer overall in 2014 compared with 2013. Consequently, consumer price inflation is seen ending 2014 at 2.2% and it could very well dip to 2.0% during the first half of 2015.
Unemployment in October
Recent employment and unemployment data have shown appreciable improvement and we expect further labor market strengthening to be evident in the figures out Wednesday, as a consequence of the economy’s overall robust performance since the second quarter. Certainly, latest survey evidence point to further labor market improvement. In particular, the Markit purchasing managers’ surveys showed overall employment in the services, manufacturing, and construction sectors rose for a 10th successive month in October, and at the fastest rate since the index began in May 1998. Meanwhile, the Recruitment and Employment Federation reported further “considerable” rises in both permanent and temporary job placements in October, although the increases were slightly down from September.
We expect employment to have risen by 133,000 in the three months to September to reach a new record high of 29.910 million. Employment had earlier dipped to 29.698 million in the three months to February from the previous record high of 29.751 million in the three months to December.
The number of unemployed on the International Labour Organization (ILO) measure is forecast to have fallen by 57,000 in the three months to September to stand at a 25-month low of 2.457 million, causing the unemployment rate to dip to 7.6%. This would be the lowest unemployment rate since the three months to May 2009. The ILO unemployment rate fell to 7.7% in the three months to July 2013 from 7.8% in the three months to June and 7.9% in the three months to February 2013. It peaked at a 16-year high of 8.4% in the three months to November 2011.
Claimant count unemployment is forecast to have fallen by 35,000 in October, which would take it down to a 57-month low of 1.3161 million. Latest data show drops of 41,700 in September (the sharpest monthly drop since June 1997).and 41,600 in August. Claimant count unemployment is down from a 27-month high of 1.6099 million in February 2012. The claimant-count unemployment rate is seen falling to 3.9% in October, which would be the lowest level since January 2009. It fell to 4.0% in September from 4.2% in August, 4.3% in July, 4.4% in June 4.6% at the end of 2012, and 4.9% at the end of 2011.
We expect unemployment to head down steadily over the coming months, although the rate of decline will likely limited by rising productivity (as a number of companies are able to make greater use of the workers they already have) and by an increasing workforce as some previously discouraged workers return to the jobs market. Further job losses will also occur in the public sector (they fell by a further 34,000 in the second quarter). Also significantly, we suspect that growth will ease back from current robust levels, although we do expect activity to remain decent (specifically we forecast GDP growth to improve to 2.5% in 2014 from 1.4% in 2013).
We see the unemployment rate coming down to 7.2% at the end of 2014 and we expect it to fall to 7.0% in the second quarter of 2015. This a critical level as the Bank of England has stated that it does not intend to raise interest rates from the current level of 0.50% before the unemployment rate gets down to 7.0% barring certain caveats relating to the inflation performance and financial stability.
Average earnings in September
Underlying average earnings growth (Wednesday) is expected to have risen modestly in September. Even so, earnings growth is seen remaining very low compared to past norms as a consequence of still appreciable labor market slack, an ongoing desire of companies to limit their costs in a very competitive environment and many workers’ unwillingness to push for higher pay following an extended difficult environment. Restrained earnings growth was clearly an important factor supporting employment during the economy’s extended struggles and limiting job losses. While the economic environment has seen marked overall improvement in recent months and earnings growth seems set to strengthen, the pick-up in pay is likely to be gradual.
Specifically, underlying average weekly earnings growth (regular pay excluding bonus payments) is seen rising back up to 1.0% in September after dipping to just 0.6% in August from 1.0% in July. This would mean that underlying annual average earnings growth was still only 0.9% in the three months to September, up marginally from 0.8% in the three months to August.
Growth in annual average weekly earnings (total pay) is also seen rising to 1.0% in September; it fell to just 0.4% in August from 0.8% in July and 1.8% in May. This would mean that total annual average earnings growth would be 0.7% in the three months to September, which would match the rate in the three months to August.
Still very low earnings growth in September would maintain substantial pressure on consumers’ purchasing power. Earnings growth is currently well below consumer price inflation, which stood at 2.7% in September.
Bank of England quarterly Inflation Report for November
The Bank of England’s Quarterly Inflation Report for November (Wednesday) will offer key insights to the markets and to analysts as to whether the central bank is changing its view on when interest rates are likely to have to start rising from the current record low level of 0.50%. Under the forward guidance policy that the Bank of England adopted in August, the Monetary Policy Committee (MPC) does not intend to raise interest rates at least until the unemployment rate has fallen to a threshold rate of 7.0% as long as three knockouts have not been breached. These knockouts relate to inflation levels, inflation expectations and financial stability.
It seems highly likely that the November Inflation Report will see a raising of the Bank of England’s growth forecasts and a lowering of its unemployment forecasts, which will open the door to the bank starting to raise interest rates before mid-2016. Under the unemployment forecasts contained in the August Inflation Report, the Bank of England’s forward guidance implies that it will not be cutting interest rates before mid-2016. Specifically, the August Inflation Report saw GDP growth at 2.2% y/y in the fourth quarter of 2013 then averaging 2.3% in 2014 and 2.2% in 2015. Meanwhile, the unemployment rate was seen only down to 7.4% by mid-2016. However, the Bank of England considered that “the unemployment rate is as likely to reach the 7.0% threshold before the forecast horizon as after it”. Consumer price inflation was seen at 2.9% in the fourth quarter of 2013, then trending down to 2.2% at the end of 2015, 2.0% in mid-2015 and 1.9% at the end of 2015. Inflation was seen remaining around 1.9% through the first three quarters of 2016.
Significantly, the minutes of the October Monetary Policy Committee meeting revealed that the MPC expected growth to be faster and unemployment lower in the second half of 2013 than had been expected at the time of the August Inflation Report. We expect the Bank of England to modestly raise its growth forecasts for 2014-2015 in addition to a certain increase for the second half of 2013. Meanwhile, the Bank of England seems likely to cut its consumer price inflation forecast for 2013 given that the third quarter outturn came in below expectation, but to leave the inflation projections for 2014 and 2015 broadly unchanged. Reflecting, the improved growth outlook and recent labor market developments, we expect the unemployment rate forecasts to be brought down with the Bank of England perhaps now seeing unemployment getting down to 7.0% in late-2015/early-2016.
Despite the ongoing encouraging news on the economy, any change in interest rates still looks a long way off whether or not unemployment ends up falling more rapidly than the Bank of England had expected in August. There have been frequent indications from bank of England Governor Mark Carney and MPC members that the Bank of England wants to give the economy every chance to develop sustainable decent growth and not to risk choking it off by any premature increasing of interest rates. In a an interview in late-October, Carney specifically stated "We're not going to look to tighten monetary policy until we see real traction and momentum in this recovery that has been sustained for some time"
We favor a gradual increase in interest rates starting in the latter months of 2015. This is based on our assumption that UK economic growth will ease back from current robust levels but will remain decent with GDP growth coming in around 2.5% in both 2014 and 2015. We see the unemployment rate getting down to 7.0% in the second quarter of 2015. We do not expect the Bank of England to raise interest rates because of any triggering of the “knockout” clauses relating to inflation and financial stability.
Meanwhile, any further quantitative easing (QE) now looks highly improbable. Further QE will likely only occur if the economy loses substantial momentum over the coming months, or if there is major financial turmoil and a sharp upward move in market interest rates when the US Federal Reserve finally starts to taper (which we doubt will occur before March 2014). Our central scenario is that neither of these events will happen, but neither can be ruled out.
Retail sales in October
Retail sales volumes (Thursday) are expected to have been flat month-on-month in October after seeing strong growth of 0.6% month-on-month in September and 1.5% quarter-on-quarter in the third quarter of 2013. Even so, retail sales volumes would be up 3.1% y/y in October, lifted by the fact that they fell markedly month-on-month in October 2012.
Survey evidence on retail sales in October from the British Retail Consortium (BRC) and the Confederation of British Industry (CBI) was lackluster overall. The BRC retail sales monitor showed that y/y growth in total retail sales values improved modestly to 2.8% October after slowing markedly to 2.4% in September from 3.6% in August and 3.9% in July (it is worth noting that the muted BRC survey for September contrasted with the robust hard data). Meanwhile, the CBI’s distributive trades survey showed that the balance of retailers reporting that sales volumes were up y/y fell back sharply to +2% in October from a 15-month high of +34% in September. The balance had previously limbed to a 15-month high of +34% in September from +27% in August, +17% in July, +1% in June and a 16-month low of -11% in May.
The relatively muted BRC and CBI surveys for October suggested that many consumers are taking a breather in their expenditure after spending at a robust rate during the third quarter. With purchasing power currently being limited by consumer price inflation running well above earnings growth, it is likely that many people are feeling the need to rein in their spending at least temporarily, particularly if they want to build up their funds for spending over the Christmas period. Specifically, latest data show that consumer price inflation was 2.7% in September while average annual earnings growth was limited to 0.7% in the three months to August. Furthermore, recently announced appreciable energy price hikes will add to the serious squeeze on many consumers. It is also notable that consumer confidence edged back in October, although this small dip was from a near six-year high in September following strong gains over the five months to September.
On the positive side, rising employment and a strengthening housing market seem set to provide support to retail sales over the coming months, while consumer confidence is still at a much stronger level than earlier this year. In addition, earnings growth seems likely to pick up, but the increase may well be gradual as companies remain keen to contain their costs in a still competitive environment while still appreciable labor market slack limits workers’ ability to push for large pay increases. Meanwhile, consumer price inflation seems likely to hover around 2.5% over the coming months. Consequently, earnings growth currently seems unlikely to move above inflation before mid-2014.
As the critical Christmas season looms, it will be interesting to see how confident retailers are about their sales prospects and what strategy they adopt. Given the pressure on consumers’ purchasing power, will retailers feel there is a need to engage in major discounting and promotions to entice consumers to spend, or whether they feel there is less need to this year given higher consumer confidence and the improved economic environment? And it will also be interesting to see if consumers generally limit their Christmas spending early on in the hope of getting better deals nearer the big day.
By Howard Archer
12 Nov - Consumer Price Inflation, October (Month-on-Month): 0.4%
12 Nov - Consumer Price Inflation, October (Year-on-Year): 2.5%
12 Nov - Core Consumer Price Inflation (ex Food, Drink, Tobacco), October (Year-on-Year): 2.0%
12 Nov - Retail Price Inflation, October (Month-on-Month): 0.5%
12 Nov - Retail Price Inflation, October (Year-on-Year): 3.1%
12 Nov - Producer Price Input Inflation, October (Month-on-Month): not forecast
12 Nov - Producer Price Input Inflation, October (Year-on-Year): not forecast
12 Nov - Producer Price Output Inflation, October (Month-on-Month): 0.1%
12 Nov - Producer Price Output Inflation, October (Year-on-Year): 1.1%
12 Nov - Core Producer Price Output Inflation (ex Food, Tobacco etc.) October (Month-on-Month): 0.1%
12 Nov - Core Producer Price Output Inflation (ex Food, Tobacco etc.) October (Month-on-Month): 0.7%
13 Nov - Claimant Count Unemployment Rate, October: 3.9%
13 Nov - Claimant Count Unemployment Change, October (000s): -35
13 Nov - International Labour Organization Unemployment Rate, Three Months to September (%): 7.6
13 Nov - Employment, Three Months to September (000s): +133
13 Nov - Average Weekly Earnings - total pay, September (3-Month/Year): 0.7%
13 Nov - Average Weekly Earnings - regular pay excluding bonus, September (3-Month/Year): 0.9%
14 Nov - Retail Sales, October (Month-on-Month): 0.0%
14 Nov - Retail Sales, October (Year-on-Year): 3.1%