Inflation turning a corner, but households still face pinch points ahead

Consumer Price Index (CPI) inflation eased for a second consecutive month in December, according to the Office for National Statistics’ (ONS) latest release. But at 10.5% year on year, headline CPI price growth remains near the highest level in 40 years. The latest data offers some key positives for the path of inflation ahead, but projections suggest that even as inflation falls, real incomes are likely to trough later this year.

The modest deceleration in headline inflation (from 10.7% in November) was mostly driven by vehicle fuel as falling global oil prices feed through into pump prices. Global prices for Brent crude oil have fluctuated between around $75 to $85 per barrel since late November, some of the lowest steady levels since a year ago. If this continues, vehicle fuel should soon become an outright drag on the headline inflation figure.

As has been the case for several months, the main contribution to inflation came from household energy costs, with bills around 90% above their level a year earlier, even with the Energy Price Guarantee (EPG). The outlook for this area of inflation is clearly downward. Global gas prices have been falling firmly since mid-December, with UK-cleared prices down by around a half. If this trend continues, industry experts Cornwall Insight project that the standard Ofgem price cap could come below the new level of the EPG by July (Figure 1).

Figure 1:

Yet even if the contribution of energy to inflation is set to start easing sharply from some time in the spring or summer, household bills will still be at record levels – and higher than they are now. The average annual bill of around £2,800 that Cornwall Insight project is still 12% above the current estimated bill on the Energy Price Guarantee, and universal energy bill support payments will come to an end in April. Our polling already showed in October that 44% of Londoners would either “definitely” or “probably” struggle to meet their energy bills over the following six months. With tariffs set to rocket another 20% in April, before hopefully easing to levels still above their present rates, this presents a steep challenge to households, especially at the bottom of the income scale. London households on average devote less of their spending to energy than in the wider UK. But data from the Bank of England/NMG household survey showed that 13% of Londoners were already falling behind on energy bills in 2022, compared to 9% across the UK on average.

Real incomes haven’t bottomed out yet

Alongside price data, the ONS released fresh labour market data this month, with payroll employment and pay figures including a regional breakdown. While our Labour Market Update, released alongside the data, includes a full analysis of these figures, one figure stood out in terms of its relevance to the cost of living crisis. Real median wages in London are currently falling 1.5% year on year, in line with the national figure of around -1.4%.

While wages failing to keep pace with inflation might help prevent a longer inflation overshoot as firms hike prices once again to compensate for the higher payroll costs, it is also placing further strain on household finances. The Resolution Foundation’s Living Standards Outlook 2023 included a set of projections for UK real income growth across the distribution – and taking account of different inflation experiences by households with different incomes. The results make for sobering reading, with the bulk of households still to see real incomes trough between April 2023 and March 2024. Almost no-one across the income distribution will see their incomes back to 2019-20 levels within the next three years. And those at the bottom of the income scale are set to see their incomes hover around this year’s trough for some time (Figure 2).

Figure 2:

UK economy unexpectedly grew in November

The UK economy unexpectedly grew in November 2022, against the expectations of most commentators. Data from the ONS showed UK GDP grew by 0.1% in November from October. Despite this monthly growth, UK GDP remains 0.3% below its pre-pandemic level in February 2020 (Figure 3).

Figure 3:

The services sector saw growth of 0.2% in November with output in the consumer facing services growing by 0.4%. However, output in construction was flat in the month and production output fell by 0.2%.

Although monthly GDP grew in November, data for the three months to November 2022 showed it fell by 0.3% compared to the three months to August 2022. In these three months only construction increased by 0.3%, while services fell by 0.1% and production fell by 1.4%. Looking forward a survey of 101 economists by the Financial Times found that most of them expected the current inflationary shock to last longer in the UK than in other countries. They also expected output to lag with the majority expecting it to fall for much of 2023.

Retail sales volumes fall in November

In an indication of the continuing problems faced by retailers as the cost of living crisis bites ONS data published in January showed that the volume of retail sales fell by 1% in December. This followed on from a drop of 0.5% in November. Sales volumes are 1.7% below their February 2020 pre-pandemic levels, although sales values are 13.6% higher indicating the impact of rising prices on sales. Non food store sales fell by an even greater extent in December with them declining by 2.1%. The ONS noted that this continued “feedback from retailers and other wider evidence that consumers are cutting back on spending because of increased prices and affordability concerns”. Looking forward the British Retail Consortium (BRC) expects the first half of the year to be challenging before picking up in the second half of 2023. It forecasts sales to rise by only 2.3% in the first half of the year but this could improve to 4.7% in the second half of the year.

UK businesses face a challenging start to 2023

SMEs are also facing a challenging start to the year, with a survey by the Association of Chartered Certified Accountants and the Corporate Finance Network finding that the numbers planning to expand had fallen from 38% last summer to 17% now. Further only 10% of SMEs in London plan to recruit new staff in 2023, although this was the highest of the surveyed UK regions. Surveyed company bosses in particular raised concerns around energy costs which they expect to remain high with state support being cut back from April. Repaying debts accrued during the pandemic was also a concern for a number of surveyed SMEs.

More widely, a survey for the Bank of England has found that UK firms are cutting back on investment due to rising UK interest rates. Thus, respondents to the Bank’s decision makers panel said that they would reduce investment by 8% compared to a situation where rates had not increased. There was also an increase in wage growth expectations which may place pressure on the Bank’s Monetary Policy Committee to further increase interest rates. More increases in interest rates will further dampen UK business investment which was already low. Thus, analysis by the Financial Times found that business investment was 8.1% below its pre-pandemic level in the third quarter of 2022 and 6.4% below the second quarter of 2016 when the Brexit vote took place.

The impact of Brexit also remains a drag on trading firms with a survey for the British Chambers of Commerce finding that 77% of firms affected by the Brexit deal saying it was not helping them increase their sales. While 56% said they were having difficulties adapting to the new trading rules.

Signs of a spring thaw for the global economy?

A mix of improving surveys, a likely IMF forecast upgrade and political pronouncements at Davos have fostered a sense that the downside risks for the global economic outlook may be easing.

In Europe, the German ZEW gauge of investor sentiment turned positive this month for the first time since the invasion of Ukraine, as improving energy costs and government policy helped ease economic gloom. German GDP growth for 2022 also came in marginally ahead of expectations, with stagnation rather than decline in the final quarter of the year. Professional forecasters are now also projecting that the eurozone is likely to avoid recession, according to a survey run by Consensus Economics. In an interview with the Financial Times, Philip Lane, Chief Economist at the European Central Bank reinforced this even tone on economic prospects, stating that “our current assessment is that if there is a recession, it’s going to be mild and short lived.”

Meanwhile, the International Monetary Fund’s (IMF) deputy managing director, Gita Gopinath, signalled at the World Economic Forum in Davos that the organisation was about to upgrade its forecasts. China’s vice-premier Liu He also sent a bullish message on Chinese growth prospects, claiming “China is back”. While the country is currently suffering a disorderly end to its ‘Zero Covid’ policy, it is likely to see a rebound in the second half of the year.

Yet any optimism remains tempered, and a global rebound may have its drawbacks for UK prospects. The IMF still projects a “tough year” ahead, and the World Bank has only just downgraded its forecasts in its first forecast update since last June. Meanwhile, the International Energy Association predicted that a rebound in Chinese demand would lead to an all-time high demand for global oil, pushing up prices. So, while fears of a deep global recession may now be abating, and key trading partners are set for improving prospects, UK economic policy still faces a tough balancing act responding to competing global pressures.

London’s offices lift off less than European peers

The first month of 2023 has also seen some London-specific data points come out, including numbers from Finnish lift-maker Kone. While this might seem a niche figure, the company’s lift-tracking data can in fact help give us a view on the office recoveries of cities around Europe. The latest figures look like bad news for the capital’s office space. While London seems to have begun 2022 with a stronger recovery in office lift use than most other major European cities, its rebound flattened off this year. And the addition of strike action by rail and other workers in December caused a significant drop back in December – well ahead of seasonal averages. Across the full year, London’s office lift activity rose by the least of any of the 10 major cities with Kone data.

These real-time figures build on previous data from the Royal Institution of Chartered Surveyors showing demand for office space falling in London starting in the second half of 2022. The surveys also show availability rising and new investment falling sharply. With recession looming and long-term office working patterns still unclear, headwinds are growing against major investments in commercial real estate.

While the coming months are likely to prove a dry spell for investment, overall business sentiment in London ticked back into positive territory in December. The London PMI for current business activity rose to 50.2, returning above the neutral 50 mark from 48.2 in November. Yet there were some mixed signals across the components of the PMI, with future activity also rising but new business holding below 50 and employment falling into negative territory for the first time since February 2021.

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