Inflation falls as the Bank holds steady on interest rates

There was another sharp fall in Consumer Price Index (CPI) inflation in November, falling by 0.2% on the month, and rising by 3.9% in the 12 months to November, down from 4.6% in October, and 6.7% in September, according to the Office for National Statistics (ONS). The largest downward contributions to the monthly change came from transport, recreation and culture, and food and non-alcoholic beverages.

Of the components of inflation the largest fall has been in goods inflation, dropping from 14.8% in the year to October 2022 to 2.0% in November 2023. The effects of supply chain shortages following the pandemic have passed. Also, positively, there continues to be downward movements in services inflation and core (which excludes volatile energy, food, alcohol and tobacco) inflation which stand at 6.3% and 5.1% respectively in the year to November (Figure 1). However, these remain higher than CPI inflation and markedly higher than the Bank of England’s target of 2% inflation.

Figure 1:

As inflation rose so the Bank of England Monetary Policy Committee (MPC) raised interest rates. However, following on from recent decisions the MPC again voted 6-3 to hold interest rates steady at 5.25% in December. Still, as the Bank Rate has risen from 0.1% in December 2021, with rate increases over 14 consecutive meetings, current monetary policy is restrictive. The decision whether to increase or maintain this rate was finely balanced between the risks of not tightening policy enough when underlying inflationary pressures could prove more persistent and the risks of tightening policy too much given the impact of some of the previous rate rises are still to come through – it is only in 2024, for example, that many mortgage rate holders on fixed rate mortgages will re-mortgage their properties. For some members of the MPC it was too early to conclude that services price inflation and pay growth were on a firmly downward path. These effects were likely to be slow to unwind and, with the labour market still tight, the extent to which wage and price-setting would take account of the downward path of CPI inflation was not clear.

Three members of the MPC continued to judge that there was evidence of more persistent inflationary pressures. Real household incomes had continued to edge up, and forward-looking indicators of output had remained positive. An increase in the Bank Rate was necessary to address the risks of more deeply embedded inflation persistence according to these members.

The MPC continued to judge that monetary policy was likely to need to be restrictive for an extended period of time. Further tightening of monetary policy would be required if there was evidence of more persistent inflationary pressures. The risks to CPI inflation in the medium term remained skewed to the upside including from events in the Middle East, and possible increases in oil prices if the Israel-Hamas war became more widespread.

On the day of the decision sterling rose 1.1% against the dollar to $1.28. Sterling has become more attractive as market expectations are that interest rates will be held higher for longer in the UK than elsewhere. Services price inflation and pay growth remained higher in the UK than other major advanced economies. This may reflect less favourable supply-side developments, as labour market inactivity after the pandemic increased relatively more in the UK, and stronger wage-price effects. Like the Eurozone the UK was hit harder by the energy price upsurge than the US.

The UK economy shows signs of weakness, although London is faring comparatively well

The ONS estimates that UK GDP contracted by 0.1% in the three months to October 2023, compared with the three months to July 2023. It is also now estimated that the economy did not grow in Q2 2023. If the UK economy contracts in Q4 2023 this would mean the UK has entered a technical recession (estimated as two consecutive quarters of contracting output).

Looking at the first month of Q4 2023 monthly GDP (which was published before the re-estimated quarterly GDP data discussed above) is estimated to have fallen by 0.3% in October, following growth of 0.2% in September. Services output was the main contributor to the fall in growth in GDP, falling by 0.2% in October. The UK economy has flatlined through 2022 and 2023 and remains only 1.6% higher than its pre-pandemic level in January 2020. In comparison, GLA Economics estimates that London’s output was 7.7% higher than its pre-pandemic level (2019 Q4) by 2023 Q3 and grew by 0.1% between Q2 and Q3. See the economic indicators section for more information.

Looking more widely at the economy, previously LET has reported that service exports have been growing strongly, and that this should be helpful for London’s business sector. This is despite continued subdued levels of investment nationally.

There are however signs that households are struggling. UK retail sales, while only a part of consumer expenditure, have also been weak, and declining since September 2021 – by October 2023 they were 3.9% below their January 2020 level. The ONS estimates volumes to have fallen by 0.3% in October 2023, after a fall of 1.1% in September.

More positively, inflation-adjusted Mastercard credit card shop spending in London (which broadly corresponds to retail spending without the online element) was around 40% higher than pre-pandemic, according to data from the GLA High Streets Data Service. This is spending by residents, commuters, and visitors.  The benefits of this increase in spending are unlikely to have been felt equally across households in London as London has a disproportionate share of low income households (after housing costs) who have been badly affected by the cost-of-living crisis.

Wages across the UK have also been suffering. Through 2022 and until August 2023 total pay after CPI inflation was falling, before recovering over the last couple of months. In October they remained 4.1% below their level in January 2020 in real terms (Figure 2). This may be worse in London, with ONS employee pay data indicating that pay growth in the capital has been slightly weaker than for the UK.

Figure 2:

Looking forward, this month GLA Economics published its latest forecast for London, and this is summarised in the supplement. We suggest, after output growth of 0.9% this year, weak quarterly momentum in 2023 continues into 2024 before picking up in 2025, giving growth of 1.0% in 2024, and 1.6% in 2025. Jobs growth has been a strong 3.5% in 2023, before decelerating to 0.1% in 2024, and normalising at 1.1% in 2025.

One other development is that the US has rebuffed UK efforts to agree a “foundational trade agreement” as a weakened form of a full-blown trade agreement. This might have covered digital trade, labour protections and agriculture. However, the UK did not want to open its markets to some controversial US agricultural products, and ran against isolationist tendencies in the US. This leaves a large gap in the UK’s scope to make bi-lateral trade agreements after Brexit.

Other central banks hold interest rates steady

Beyond the UK, the US Federal Reserve (the Fed) and the European Central Bank (ECB) both held interest rates steady this month. Like the Bank, the ECB signalled there is still work to do to tame price pressures, even as it cut its inflation forecasts for this year and 2024.

There was a shift, though, in the policy direction of the Fed. It has moved from a position of as much flexibility over monetary policy as possible to one that sees the multi-year campaign to tighten monetary policy as drawing to a close. Fed officials are entertaining sharper cuts to borrowing costs next year to ensure a soft landing for the US economy. Traders in federal funds futures markets assess that the lowering of interest rates might begin from March, and that by the end of 2024 rates might be below 4%. This is well below their current level 22-year high of 5.25-5.5%.

The primary risk for the Fed is if the US jobs market continues to defy expectations. Non-farm payroll employment increased by 199,000 in November – partly because strikes in Hollywood and the car industry ended, and the unemployment rate edged down to 3.7%, reported the US Bureau of Labor Statistics. A more positive sign of labour market cooling, in data from the same bureau, was that job openings, a measure of labour demand, fell to 8.7 million in October, down from 9.4 million in September.

Immigration clampdown is likely to have adverse effects for London

November’s LET editorial reported a sharp rise in net migration after the post-Brexit immigration regime came into effect in 2021. The ONS estimated that numbers rose to 745,000 in the year to December 2022, although these are expected to fall, and the Migration Observatory estimates that net migration might decrease to 300,000 by 2030, roughly similar to pre-Brexit levels.

On 4 December, the Home Secretary, James Cleverly, announced a series of changes to the UK’s immigration policy although these changes were then subsequently modified. This modified package will see the earning threshold for skilled overseas workers increase to £38,700 in spring 2024. The minimum income requirement for family visas will also rise in the spring to £29,000. The government then intends to bring family visas “in line with the new minimum general salary threshold for Skilled Workers, £38,700” via further stepped increases. The Prime Minister, Rishi Sunak, has said the £38,700 threshold should be reached in early 2025. The new immigration policy will also end the 20% going-rate salary discount for shortage occupations.

According to the Home Office, this package, and the previously announced restrictions on student dependants, will reduce immigration by 300,000 in future years compared with 2022. There are concerns about what immigrant workforce reductions may mean for the provision of social care as well as other sectors.

GLA Economics analysis has concluded that these changes are likely to hit sectors important to London’s economy, including Health and social care, Hospitality and Construction. There are over 1,000,000 jobs in these sectors, of which around 47% (at least 500,000) are held by non-UK nationals. London also has a large university sector, reliant on foreign students.

Public spending in London falls while rising nationally

HM Treasury has released country and regional public spending figures on services. After inflation, UK public spending in 2022-23 (at £1,077 billion) was largely unchanged from 2020-21 during the pandemic, recovering from a fall in 2021-22. On a similar basis, after inflation, expenditure in London remained almost at the same level in 2021-22 and 2022-23 at £128 million in 2022-23, and lower than expenditure of £146 million during the pandemic. While the growth in expenditure in London over the pandemic was higher than the UK, the growth in 2022-23 compared with 2019-20 was relatively lower in London (Figure 3). London’s share of public expenditure has returned to pre-pandemic levels at 12%.

Figure 3:

There have been increases in expenditure compared with before the pandemic for both London and the UK across a range of categories. Notable is in Economic affairs – this includes transport, as the government continues to offer higher subsidies to both national rail operators and Transport for London (TfL) because of changed commuter patterns.

It has been reported previously in LET that London historically makes a net contribution to the Exchequer, which provides funds for public spending to other countries and regions of the UK. Although this did not happen during the pandemic in 2020-21, London returned to providing a net contribution in 2021-22.

Hybrid working job postings have become more established

Looking at the evolving labour market a National Bureau of Economic Research working paper was published recently, on Remote work across jobs, companies and space. The academics have developed an algorithm which achieves 99% accuracy in flagging job postings that advertise hybrid or fully remote work. Applied to Lightcast data this shows a sharp rise in online job postings offering hybrid or fully remote working arrangements during the pandemic from under 5% of job postings to over 25% in London during 2022, and around 20% nationally. The proportion has been slipping over 2023, still to over 20% in London by September, and nearer 15% nationally. Birmingham and Manchester have shown a similar trend to London, with the rate of postings for hybrid or remote working jobs being slightly higher in Manchester (Figure 4).

Figure 4:

The researchers have found evidence that hybrid working is more likely to be available for higher paid jobs, and it may well also be that jobs in certain sectors are more amenable to this type of working. Both factors might favour city-based job postings.

GLA Economics will continue to monitor all these issues over the coming months in our analysis and publications, which can be found on our publications page and on the London Datastore.

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