CPI eased to 7.9% in June from 8.7% in May. Core inflation, eased to 7.1% from 6.9%. Inflation remains “sticky”. Energy costs increased by 23.3%. Food inflation increased at over 17%. Service sector inflation eased to 7.2%. Goods inflation slowed to 8.5% from 9.7%.
Producer Prices are moving in the right direction. Input prices fell to -1.9% in June from 1.6% in May. Output prices moved to 0.1% from 2.7% prior month.
US inflation peaked in June last year. Inflation in the UK peaked in October. US CPI has fallen to 3% from the 9% peak. Pessimists may be impatient with progress. We expect input and output prices to be negative in Q3 and Q4. Headline consumer price inflation will drop below 5% in the final quarter of the year.
Markets and the MPC have been spooked by the latest data on inflation and earnings. Earnings increased by 7.4% in May. The government has said it accepts in full recommended public pay rises of 5 - 7% for police, teachers and doctors. The latest guarantees on public sector pay will continue to alarm the hawks.
The latest trends in international food markets will do nothing to ease fears of higher prices.
Black Sea Blackmail …
The Kremlin said earlier this week that it would pull out of the international agreement that allowed Ukraine to resume its grain exports through the Black Sea.
Russia’s withdrawal from a deal that had kept Ukrainian grain flowing to world markets has sent prices soaring in recent days. A main beneficiary of the surge is Russia itself.
Wheat futures in Chicago have climbed 12% this week so far, rising to the highest level since June 23. Futures tied to corn are up 9.3%.
Rice Prices Rising ...
India’s rice export ban could send decade-high prices spiking even further. India has banned the exports of non-basmati white rice with immediate effect. India is the world’s leading rice exporter, accounting for more than 40% of the global rice trade.
Analysts told CNBC this week’s ban could send already elevated prices shooting even higher, compounding effects from the country’s September ban on shipments of broken rice.
So what next for rates ...
Financial markets reacted positively to the inflation news. There was a sharp drop in swap rates. Two-year swap rate dropped from 5.93 per cent on Monday to 5.46 per cent on Wednesday. Forecasts for peak interest rates dropped from 6% to 5.75%.
There was little reaction along the gilt curve. Ten basis points the average fall over the duration. Three month gilts trade at 5.5% from 5.4%. Six month gilt yields trade at 5.7% from 5.8%. UK two years offer 5.0% down from 5.1%. UK ten year gilt yields are trading at 4.30% from 4.40%. UK 30 year rates are at 4.44% from 4.54%.
Lower mortgage rates are in prospect. Short term rates remain over priced. No real price adjustment, the immediate reaction.
We maintain our base rate peak this year at 5.5% on the basis of two 25 basis point hikes in August and September. We model 4.50% as the long run rate for base rates and ten year gilts in life after Planet ZIRP.*
* Long Term Note : In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%.
Friday Forward Guidance Every Week ...
This is a section from our Friday Forward Guidance for Friday 21st July. Every week we update our scenario forecasts for base rates in the U.S., UK and Europe over a three year period. We also include our expectations for inflation, as an input to the central bank reaction function, in the Saturday Economist updates.
Average pay rose by 7.4 per cent in May, according to labour market data released by the Office for National Statistics today. The month data was down from 7.8 per cent in April. The three month average rate moved higher to 6.9% up from 6.7%.
Doves will note, unemployment increased by 65,000 to 1.370 million. The unemployment rate increased to 4.0%. Employment dropped, redundancies increased and vacancies fell. The monetary medicine appears to be working albeit slowly.
The hawks will focus on the earnings data. Average pay rose by 7.4 per cent. Private sector pay increased by 7.7%. Service sector pay increased by 7.6%. Funds for finance fat cats in the financial sector increased by 9.2%.
Public sector pay was up by 5.8%. Construction pay was restricted to 4%. No wonder vacancies are increasing in retail. The rate of pay gain for retail workers was less than 4%.
Where Are Rates Headed? Bet on Higher for Longer —Here and Everywhere … prices and labour costs are weighing on central bankers despite fears of instability in the U.S. regional banking sector and the prospects of recession in Europe and the U.K.
Andrew Bailey has warned that interest rates will continue to rise. Both the Chancellor and the Governor have urged pay restraint. The Bank of England may raise rates by as much as 50 basis points when the monetary policy committee meets early next month. Real wage cuts for workers, no return to the Gold Standard but the pound has risen sharply since the release of the data trading at $1.2923 as we write.
Capital Economics suggest “Our forecast is for the Bank to raise interest rates by 25 basis points in August … but we can’t rule out another 50 basis points hike. Much will depend on June’s CPI inflation data.”
"In the latest update Bloomberg economists expect the Bank of England will push the UK into recession by the end of the year. A year-long recession will hit Britain in the final three months of the year assuming the Bank of England raises interest rates to 5.75% by November.
JP Morgan said its central forecast was for rates to peak at a lower level of 5.75% by November, but warned rates could go higher, possibly to 7% under “some scenarios”. "The Bank of England could be forced to push interest rates as high as 7 per cent and “raise the odds” of a recession to bring down inflation." said Allan Monks, economist.
Three month gilts trade at 5.4%. Six months gilts trade at 5.8%. For the moment we are adjusting our base rate peak this year to 5.5% on the basis of two 25 basis point hikes in August and September. Bloomberg forecasts rates at 5.75% by the end of the year. JP Morgan thinks rates could hit 7%. Markets are pricing in at least another 125 basis points to reach 6.25%. It all seems a bit of a stretch.
We model 4.50% as the long run rate in life after Planet ZIRP.
In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%. Ten year gilts currently trade at 4.64%. 30 year gilts trade at 4.68.
No return to the era of zero rates. No return to Planet ZIRP. No return to the "Forbidden Planet". Where Are Rates Headed? Bet on Higher for Longer —Here and Everywhere. Follow our weekly updates with our Saturday Economist Friday Forward Guidance.
The UK’s manufacturing sector contracted for the 11th month in a row in June as factories faced lack lustre demand at home and abroad. The S&P Global-CIPS UK manufacturing purchasing managers’ index (PMI) fell to 46.5, from 47.1 in May. A figure below 50 indicates contraction.
Although the reading was revised up from a preliminary “flash” reading of 46.2, it was lowest this year and one of the weakest since the 2008-09 financial crisis. Weaker demand from the United States, mainland China, Europe and Brazil hit new export orders, while foreign demand has now deteriorated for 17 months in a row. This, along with market uncertainty, increased competition and higher costs, has made businesses more cautious.
Rob Dobson, a director at S&P Global Market Intelligence, said: “Manufacturers remain in defence mode, looking to cut back spending on purchasing and employment wherever possible and release capital tied up in stocks.”
Britain’s services sector grew at the slowest pace in three months in June but remained resilient as rising interest rates and economic uncertainty weighed on demand, a closely watched survey showed.
The S&P Global/CIPS UK services purchasing managers’ index (PMI) eased to 53.7 last month, down from 55.2 in May, well above the 50 level that indicates growth.
Companies continued to hire as more people looked for work, with staffing levels rising at the fastest pace since last September. However, this increased costs for businesses as higher salary payments offset falling energy and transport costs.
The survey said business and consumer spending was resilient, despite inflationary pressures. However, higher interest rates were having a particular impact on services related to construction and real estate. Markets expect interest rates to rise above 6 per cent this year.
The slump in housebuilding accelerated last month as higher mortgage rates and the cost of living squeeze weakened demand and dragged the construction sector into contraction.
Activity in residential building reduced at the fastest pace since the first Covid lockdown in June three years ago, the construction purchasing managers’ index from S&P Global and the Chartered Institute of Procurement & Supply (CIPS) showed. Excluding the lockdown fall, housebuilding activity fell at its fastest pace in 14 years.
The downturn resulted in activity in the construction sector shrinking for the first time in five months. UK construction PMI dropped to 48.9 last month from 51.6 in May and housebuilding activity dropped to 39.6 from 42.7 in May. A figure below 50 indicates contraction.
The housing market has been slowing since last autumn after Bank of England interest rates increases to contain inflation. Dr John Glen, chief economist at the CIPS, said: “The sudden reduction in construction sector hiring is one of the red flags facing the UK economy at the moment.”
Matthew Pointon, senior property economist at Capital Economics, said he expected gilt yields and interest rates to be higher for longer. “Not only is that likely to lead to further falls in commercial capital values, but it will also lead to a mild recession later this year,” he said.
Martin Strydom at the Times
PMI by S&P Global
The Saturday Economist
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