Inflation, labor market, and retail sales feature in bumper week of UK economic releases starting 15 June

Consumer and producer price inflation in May

Data out on Tuesday will likely show the United Kingdom exited deflation in May, with consumer prices edging up 0.1% year on year (y/y). In April, consumer prices dipped 0.1% y/y, the first decline since 1960, according to comparable calculations by the Office for National Statistics. Consumer price inflation had previously been zero in both March and February.

The United Kingdom is likely to have exited deflation in May because of a rise in fuel prices during the month, a move back up in air/sea transport prices, and an increase in some holiday prices after those were dragged down y/y in April by the earlier Easter in 2015. The earlier Easter resulted in some of the hikes in air/sea transport and holiday prices occurring in March this year, whereas all the hikes occurred in April in 2014. Consequently, air transport prices fell 5.3% y/y in April after an increase of 6.8% in March, while the y/y increase in sea prices moderated to 1.4% in April from 8.2% in March.

Nevertheless, inflationary pressures clearly remained extremely limited in May. The British Retail Consortium (BRC) has reported that its shop price deflator was still down 1.9% y/y in May, which matched April’s drop and was only slightly less than the record 2.1% drop in March. The y/y drop in food prices stood at a record 0.9% for a third month running in May, while the y/y fall in nonfood prices remained at 2.5% in May, after dropping to this level in April from a record 2.8% in March.

Consumer price inflation is likely to hover close to zero through the summer, then start heading up in the autumn. This should be the consequence of base effects becoming less favorable, firmer oil prices overall, earnings growth picking up, and excess capacity in the economy diminishing. Nevertheless, the rise in consumer price inflation should be relatively gradual, and we see it only seen reaching 1.0% by the end of 2015 and 1.9% by the end of 2016. While Brent oil prices have strengthened from their nearly six-year low of USD45.2/barrel in mid-January to trade as high as USD69.6/barrel in May, IHS expects them to be relatively muted for a prolonged period, averaging USD58.9/barrel in 2015 and USD65.5/barrel in 2016. Meanwhile, supermarkets remain heavily engaged in a food-price war. Furthermore, a strong pound overall has limited inflationary pressures, and sterling should remain relatively well supported now that political uncertainty has waned. Inflationary pressures are very weak in the United Kingdom’s main trading partners, as well, which should further limit import prices.

Meanwhile, underlying price pressures should be limited for much of 2015 before firming gradually. While GDP growth is seen improving during the rest of 2015 and holding up well in 2016, this situation should lead to only a gradual pickup in underlying inflationary pressures. Although earnings growth is now trending up and should continue to rise, it will probably be a relatively gradual process, given there is still some slack in the labor market. Furthermore, an improvement in productivity could limit the inflationary effects of rising earnings. Meanwhile, retailers, manufacturers, and services companies will likely find their pricing power limited for some time, given the past prolonged squeeze on households’ purchasing power has made consumers much more price conscious.

Unemployment and employment

Data out on Wednesday are expected to show that the labor market continues to improve. However, it is possible that there may have been some moderation in job creation, owing to increased business caution around May’s general election and a marked slowdown in growth in the first quarter. Notably, the purchasing managers reported that overall employment growth in the services, manufacturing, and construction sectors slowed modestly for a third month running in May to be at a five-month low, although growth was still healthy.

We expect claimant-count unemployment to have fallen by 15,000 in May to a record low of 748,800, following a drop of 12,600 in April (the smallest drop since March 2013). This would still be down from declines of 16,700 in March, 29,100 in February, and 39,400 in January. Nevertheless, it would take claimant-count unemployment down to a record low of 752,400. The claimant-count unemployment rate is seen edging down to 2.2% in May, after having been unchanged at 2.3% in April.

The number of unemployed on the Labour Force Survey/International Labour Organization (LFS/ILO) measure is seen falling by 54,000 in the three months to April to stand at 1.802 million, which would be the lowest level since the third quarter of 2008. This would be up from a drop of 35,000 in the three months to March, but still down from drops of 76,000 in the three months to February and 102,000 in the three months to January. The LFS/ILO unemployment rate is expected to have remained at 5.5% in the three months to April, after edging down to this level in the three months to March from 5.6% in the three months to February.

Meanwhile, we expect employment to have increased by 181,000 in the three months to March to a new record high of 31.120 million. This would be down from increases of 202,000 in the three months to March and 248,000 in the three months to February. LFS/ILO unemployment falling 35,000 in the three months to March combined with the employment jump of 202,000 reflects an increase in the labor force of 167,000.

We expect the number of jobless to trend steadily downward during the coming months, taking the unemployment rate down to 5.2% by the end of 2015 and 4.9% by the end of 2016.

Ongoing healthy economic activity should support demand for labor, with GDP growth forecast at 2.4% in 2015 and 2.6% in 2016.

However, employment growth may be increasingly limited by improving labor productivity, as many companies look to make greater use of the workers they already have. Admittedly, there is major uncertainty about how labor productivity will develop, given the recent disappointing performance. Nevertheless, as the economy sustains healthy growth, it could become less resource intensive to gain or retain business. Also, a large number of part-time workers would like to work longer hours. Moreover, some companies likely took on workers early to ensure they get the best staff available. Consistent with this view, the February survey of the Bank of England’s regional agents revealed that “many firms had reached appropriate employment levels following recruitment last year” and there is an increased “focus on gains in efficiency or productivity.”

In some sectors, a number of companies are now finding it harder to get the skilled and experienced workers they need. The Bank of England’s agents reported in May that “recruitment difficulties had remained elevated for many contacts. Skill shortages still tended to be role or sector specific, but they had become more broad based as economic activity had risen…Some contacts reported increasing difficulties in finding good quality candidates for lower-skilled jobs as the labor market had tightened.” The fall in unemployment could also be limited by a further rise in the number of older people continuing to work, partly owing to financial necessity. Meanwhile, the benefits system is putting increased pressure on people to work. There may also be a substantial number of people who have recently become self-employed who would like to move into salaried jobs, should the chance arise. Furthermore, the workforce may be lifted by people returning to the job market after an extended absence, as the improved economic environment makes them more optimistic about finding employment.

Earnings growth in April

Underlying earnings growth is expected to have improved further in April after a marked pickup in March and February. Specifically, we forecast underlying annual average earnings growth (which excludes bonus payments) to have climbed to 2.8% in April, which would be the strongest increase since December 2008. It rose to 2.7% in March from 2.2% in February, 1.6% in January, and a low of just 0.5% in April 2014. Underlying earnings growth in the private sector improved to 3.3% in March from 2.8% in February, 1.9% in January, and a low of 0.8% in April 2014. This may have been influenced by some higher regular pay increases in the finance sector to offset lower bonus payments. Consequently, underlying annual average earnings growth is seen strengthening to 2.6% in the three months to April from 2.2% in the three months to March, 1.9% in the three months to February, and a low of 0.7% in the three months to June 2014.

Total annual weekly earnings growth is expected to have eased back to 2.8% in April after surging to 3.3% in March from 1.3% in February. These swings have been heavily influenced by the timing of bonus payments, as well as their levels. Total annual average earnings growth is seen rising to 2.2% in the three months to April from 1.9% in the three months to March and 1.7% in the three months to February.

We expect earnings growth to trend up during the coming months as ongoing decent economic growth, narrowing slack in the labor market, and relative optimism in the outlook causes a growing number of employers to lift pay.

With earnings growth likely to strengthen as 2015 progresses and consumer price inflation being extremely low (we see it averaging just 0.3% during 2015), workers should see marked improvement in their purchasing power, which bodes well for consumer spending.

How earnings develop during the coming months will play a crucial role in just when the Bank of England starts to raise interest rates. Should earnings growth pick up markedly during the coming months, the Bank of England would be more likely to raise interest rates sooner rather than later in 2016. An interest-rate hike in 2015 currently looks unlikely, but it could become a possibility if earnings picks up sharply.

Minutes of June Bank of England Monetary Policy Committee meeting

The minutes of the June meeting of the Bank of England’s Monetary Policy Committee (MPC), out Wednesday, will most likely show that there was once again a 9–0 vote within the MPC for keeping interest rates at 0.50%. While they are clearly close to voting for a rate hike to 0.75%, it seems unlikely that Martin Weale and Ian McCafferty did so in June (a speech this week by Ian McCafferty suggests he held off from voting for a rate hike, although he believes the time for a first rate hike is nearing). We doubt any other MPC member was close to voting for an interest-rate hike at the June meeting, given UK deflation of 0.1% in April, GDP growth slipping to 0.3% quarter on quarter (q/q) in the first quarter, and somewhat mixed recent news on economic activity in the second quarter.

While there may still be a fair degree of uncertainty as to when exactly the Bank of England will act, there seems little doubt that the bank’s next move will be to raise interest rates. Despite the United Kingdom seeing mild deflation of 0.1% in April and GDP growth moderating to 0.3% q/q in the first quarter, there seems to be little interest within the MPC in trimming interest rates. The Bank of England considers that deflation in the United Kingdom will be brief and limited, and will actually stimulate the economy by boosting consumers’ purchasing power. The bank also stresses the importance of looking through weak inflation developments recently and in the near term—primarily resulting from sharply reduced oil and food prices—and focusing on the medium-term inflation outlook. With future growth seen healthy overall and earnings forecast to pick up, the central bank expects consumer price inflation to start moving up in the third quarter of 2015 and to reach its 2.0% target rate by mid-2017.

The minutes of the MPC’s May acknowledged that there “was a range of views within the committee over the most likely future path for bank rate,” which seems to largely reflect members’ differing views of likely developments in productivity and earnings growth, and about the amount of slack in the economy. Significantly, it was recorded that “all members agreed that it was more likely than not that bank rate would rise over the three-year forecast period.”

We expect the Bank of England to start edging up interest rates in the first half of 2016, and believe it is currently touch-and-go as to whether the MPC acts in the first quarter or delays until the second quarter. Current robust consumer activity and signs that housing-market activity is picking up suggest an interest-rate hike early in 2016 is highly possible, although the softer set of purchasing managers surveys for May are fueling uncertainty about the economy’s current underlying strength. Much will clearly depend on how economic growth, earnings, and productivity develop during the coming months, as well as just how quickly inflation moves up later on this year.

We see interest rates only inching up to reach 2.0% by the end of 2017. It was always evident that the Bank of England would raise interest rates gradually owing to relatively high consumer debt levels and the potential effects on sterling. A gradual pace of monetary tightening looks even more likely, now that a majority Conservative government is set to press ahead with major spending cuts in the next two to three years. Any hit to economic activity coming from increased uncertainty about a referendum on EU membership (whether in 2016 or 2017) could also cause the Bank of England to temper interest-rate hikes.

Retail sales in May

Data out on Thursday are expected to show that retail sales volumes rose by 0.2% month on month (m/m) in May, causing them to be up 4.8% year on year (y/y). This would be a healthy underlying performance, given that retail sales volumes spiked up 1.2% m/m in April when clothing sales were lifted substantially by warmer weather boosting demand for summer wear and fashions.

Survey evidence for retail sales in May was very strong from the Confederation of British Industry (CBI), but less so from the British Retail Consortium (BRC). The CBI’s distributive trades survey showed that the balance of retailers reporting a y/y increase in sales volumes jumped to +51% in May from +12% in April. The CBI reported that most retail sectors saw growth in May, including a record performance for recreational goods, as well as healthy expansion for nonspecialized stores and grocers. However, there was a weakened performance from hardware and do-it-yourself (DIY). The BRC’s retail sales monitor showed that retail sales values rose 1.1% y/y in May after a drop of 1.3% in April and an increase of 6.8% in March (the April/March performances were distorted by Easter occurring earlier in 2015). In volume terms, there was an increase of 3.0% y/y in May, given that the BRC shop price deflator was down 1.9% y/y in May (which matched April’s drop). The BRC reported that one of the weakest-performing sectors in May was clothing and footwear (likely a consequence of some sales being pulled forward to April). In contrast, there was a strong performance for furniture sales, which ties in with recent evidence of a pickup in housing-market activity.

The prospects for retail sales and consumer spending look largely bright. Consumer confidence is elevated, employment is high and rising, inflation is negligible, and earnings growth is improving. There was actually deflation of 0.1% in April; while deflation is likely to be fleeting, inflation should be limited for some time. Furthermore, underlying annual earnings growth picked up in March (to 2.7% from 2.4% in February, 1.6% in January, and a low of 0.5% in April 2014) and pay should strengthen during the coming months, given the tighter labor market. Employment was up 202,000 in the three months to March, further supporting consumer spending. Meanwhile, interest rates currently look highly unlikely to rise until 2016. Finally, an expected firmer housing market during the coming months should support consumer spending.

We believe there is little to worry about from the United Kingdom’s dip into mild deflation in April; it should primarily help the economy by further boosting consumers’ purchasing power. Furthermore, deflation is likely to prove brief and marginal; it seems highly unlikely that consumers will be tempted to start delaying purchases in anticipation of falling prices. A May quarterly survey from the Bank of England showed that the public’s inflation expectations rose modestly from February lows, and there is no evidence that consumers expect prolonged falling prices.

Public finances in May

The public finances (out Friday) are expected to have seen ongoing year-on-year (y/y) improvement in May, thereby extending the positive start to fiscal year (FY) 2015/16. Specifically, we expect public-sector net borrowing excluding banks (PSNBex) to have narrowed to GBP11.0 billion in May from GBP12.2 billion in May 2014. We also estimate that the total public-sector net borrowing (PSNB) narrowed to GBP10.2 billion in April 2015 from GBP11.6 billion in May 2014. However, there is the risk that recent slower UK growth could have affected government receipts in May and hurt the public finances.

The public finances improved in each of the first four months of calendar year 2015, partly because they are now benefiting from markedly improved income tax receipts after these disappointed for an extended period. This is a consequence of earnings growth trending up from the lows seen in the second quarter of 2014, as well as increased employment.

In April, the first month of FY 2015/16, PSNBex narrowed markedly to GBP6.8 billion from GBP9.3 billion a year earlier. In addition, total PSNB narrowed to GBP6.0 billion in April 2015 from GBP8.7 billion in April 2014. The Office for National Statistics reported that income-tax related payments rose 3.7% year on year (y/y) in April. Corporate tax receipts jumped 11.3% y/y in April and there was also a marked rise in value-added tax receipts (up 3.4% y/y), which clearly reflected the month’s strong retail sales growth. Also helping matters, government spending fell 4.2% y/y in April, since interest payments (down 6.9% y/y) were limited by very low gilt yields.

Chancellor George Osborne is aiming to cut PSNBex to GBP75.3 billion (4.0% of GDP) in FY 2015/16 from the FY 2014/15 outturn of GBP87.7 billion (4.8% of GDP), so he will have been very pleased with the good start to the fiscal year. However, there is obviously an awful long way to go, and much will obviously depend on how well the economy bounces back from the first-quarter slowdown, when GDP growth was limited to 0.3% quarter on quarter. Further out, PSNBex is seen coming down to GBP39.4 billion (2.0% of GDP) in 2016/17 and GBP12.8 billion (0.6% of GDP) in FY 2017/18, before achieving a surplus of GBP5.2 billion (0.3% of GDP) in FY 2018/19.

Ahead of the extra budget called for July 8, major questions remain about the new Conservative government’s ability to meet its ambitious fiscal targets over the longer term, despite April’s improved performance. This is especially true, since the government is yet to clarify where the planned cuts to departmental spending (GBP30 billion) and welfare spending (GBP12 billion) will be made. IHS has significant doubts that the Conservatives will be able to achieve these cuts, and suspects the government will ultimately either have to increase revenues (i.e., raise taxes, despite its election pledge not to increase income tax, value-added tax, or national insurance) or accept slippage in its fiscal targets.

By Howard Archer