After a less than stellar set of recent GDP data (disappointing growth in Q3 and September growth that seemed to mostly reflect an upsurge in face-to-face GP appointments), we have since seen a succession of data points that have raised the probability of a December rate hike: The labour market report painted a more robust employment picture; inflation was stronger than expected; retail sales beat expectations; and consumer confidence improved.
My central case is still that the Bank of England wait until February to raise rates, but a pre-Christmas rate hike is a rising probability.
Near-term labour market data matters a lot to the prospects of a near term rate rise…
According to the minutes of the November meeting, “there was value in waiting for additional information on near-term developments in the labour market, including official data relating to the period following the end of the CJRS, before deciding when a tightening in monetary policy might be warranted.”
The unemployment rate fell from 4.5% to 4.3% in the three months to September, i.e. to the eve of the furlough scheme (Coronavirus Job Retention Scheme) closure on 30 September, unemployment was already lower than anticipated. Payroll employment rose in October, despite the end of the furlough scheme (though the ONS suggest that some employees may have been working their notice period). Job vacancies rose to a new record too over the August to October period. This is the first of two labour market reports that the Bank of England (BoE) will get before their rate decision in December. The data, so far at least, suggests that the end of the furlough scheme has been absorbed without much dislocation. The data now look consistent with – at worst – a small rise in the unemployment rate in coming months.
…but the real income squeeze does too
Having more labour market data wasn’t the Monetary Policy Committee’s (MPC) only consideration in keeping rates steady in November. That decision also appears to have reflected downside risks to demand that might be “accentuated by the impact of higher prices on households’ real incomes” but with global cost pressures “still most likely to prove transitory”.
UK consumer price index (CPI) inflation was certainly strong in October. UK CPI came in above expectations at 4.2%Y after 3.1%Y (consensus was for 3.9%Y). That’s the highest rate since November 2011 and clearly a long way above the BoE’s 2% CPI target. Core CPI was also stronger than expected, rising from 2.9%Y to 3.4%Y, as was the retail price index (RPI) which hit 6.0%Y after 4.9%Y.
The bulk of the rise in inflation was expected however. The main driver of the jump came from energy prices:
- From the 12% increase in the Ofgem price cap (the regulator sets a cap on the default tariff rates that energy firms charge people for power, and these are reviewed twice a year). That 12% rise reflected the increase in natural gas prices and related increase in electricity prices seen earlier this year
- Higher transport costs (petrol and diesel prices)
There also seems to have been an impact from the start of the phasing out of last year’s VAT cut on hospitality.
Inflation driven by these things is very much part of the increase you’d describe as transitory. However, with the Ofgem price cap likely to be raised again next April, we are set to see a further hit to household real incomes. I am currently expecting UK CPI inflation to peak around 5.2%Y at that point but still be 3.0%Y by the end of 2022 and not back around target until 2023.
Can the BoE label the rise in inflation as transitory?
Given that the Bank of England were expecting 3.9%Y CPI inflation in this release and already expect it to peak at around 5%Y in April 2022, the new information that will likely have been more important for the BoE in the October inflation release was whether we have seen a broadening out of inflation pressure beyond things easily labelled as transitory.
Most main inflation categories contributed positively to the rise in inflation in October and the rise in core inflation was stronger than expected. However, only a small proportion of the October rise in inflation looks ‘non-transitory’, even once you put the contribution of energy prices and VAT to one side. In other words, much of the additional upward pressure on CPI inflation in October came from things better seen as one-off adjustments in the price level rather than things likely to keep rising at the same pace. Upward contributions of note included those from transport fares (which can be volatile), used car prices (likely supply chain effects again), food prices (possible supply chain effects again) and university tuition fees.
It is also worth pointing out that pay growth data in the recent labour market report was less worrying from an inflation perspective, with regular pay growth falling a touch more than expected and no change in the level of pay on the month.
Consumer data look resilient, but some MPC concern still justified
Recent consumer data, on the face of it, suggested that there is little need for MPC members to worry about a hit to real household incomes: Retail sales volumes in October were stronger than expected and consumer confidence rose. The 0.8%M gain was driven by a strong 4.2%M rise in non-food, itself driven by ‘other non-food stores’ (second-hand stores, toy stores and sports equipment) and clothing stores. Although that is robust and reassuring on the surface, digging a bit deeper suggests room for caution:
- Second-hand goods stores (charity shops and auction houses) were the largest contributor to ‘other non-food stores’ and may suggest that consumers are trying to save money in some areas. There was a surprise improvement in the November consumer confidence, but ‘personal finances over the last 12 months’ deteriorated and ‘personal finances over the next 12 months’ ticked up only slightly. Second-hand goods sales also don’t count towards GDP in the same way as new items.
- Retailers in the clothing sector reported early Christmas trading as boosting sales. If consumers are bringing forward purchases (fear of higher prices by Christmas? Fears of Christmas shortages?) that doesn’t bode particularly well for sales later in the year.
Still worth waiting to “take out insurance” against high inflation
A third argument made by MPC members against raising rates in November was that the costs of “taking out insurance” against higher inflation (i.e. tightening monetary policy) must be considered – that while the ability to ease monetary policy in response to a negative demand shock was limited, “interest rates could be increased by as much as was needed to bring inflation back to target sustainably should any second-round effects materialise”. This line of argument effectively argues against rushing into any rate rise and having rejected the case for raising rates in November would argue (in my view) that February, not December, was the most likely date.
Overall, December a ‘close call’
However, the recent batch of UK economic data look enough to seal at least a couple more votes on the Monetary Policy Committee for a rate rise, including Governor Bailey’s, although there are several key data releases to go before then including another set of business surveys and labour market data. My central case is that the MPC raise rates in February when the decision will be accompanied by another full set of forecasts and a press conference. But, as Governor Bailey said regarding the November meeting, it’s a close call.
UK economy forecast table
|GDP growth (real, %YoY)||-9.7||6.9||4.0||1.5|
|Unemployment rate (%)||5.1||4.6||4.2||4.3|
|Inflation (CPI, Q4, %YoY)||0.5||4.5||3.1||2.1|
|Policy rate (%, year-end)||0.10||0.10||0.50||0.75|
The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice. Source: Office for National Statistics and Refinitiv Datastream (2020 data). 2021 and all other future forecasts are those of the author at the time of writing.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.