London’s Economy Today editorial – July 2023
Inflation eases, but households still under pressure
For the first time in almost two years, June’s Consumer Price Index (CPI) inflation release offered some good news in that the actual figure was below what forecasters expected. The cost of living crisis is far from over though, and price increases are still extremely rapid, but the data showed clear signs of improvement.
Official UK inflation data from the Office for National Statistics (ONS) showed the CPI up 7.9% year on year in June. This was down from a pace of 8.7% in May, and came below a consensus that inflation would hit 8.2%. According to Trading Economics, inflation had come in at least 0.3 percentage points above the consensus for the previous four months straight. And this was the largest downward surprise since August 2022.
Under the headline, there were widespread signs of slower price momentum. Core inflation (excluding food and fuel) offered the clearest sign of a broad cooldown in prices, dipping to 6.9% in June from 7.1% in May. But the main driver of the deceleration came from falling fuel prices. Drivers are now seeing prices at the pump down nearly 23% from last year’s highs. This sharp drop pulled the wider transport category into deflation for the first time since August 2020, when the pandemic was depressing global fuel costs. Food price inflation also slowed by a full percentage point, but at 17.3% year on year, the pace remains rapid.
Imported costs offer good reasons to expect further deceleration in inflation. Input costs for food producers are falling, which should soon pass into consumer prices. And the Ofgem price cap for energy bills is set to fall 17% in July – the first time bills have fallen since the winter of 2020. Even the collapse of the Black Sea grain deal should not decisively raise food prices in the UK given that energy has likely been the most important factor raising costs.
But some factors will likely keep inflation from falling back to target quickly. Regular pay increased 7.3% in the three months to May, the joint highest pace on record. While this still implies real wages are falling, it will keep business costs growing, probably creating some pass-through to consumer prices. And housing costs are a key concern amid rising mortgage interest rates, which landlords are likely to pass on as higher rents (see below).
A slower-than-expected inflation reading might offer some relief to the Bank of England, and offer a chance to moderate their path of interest rate hikes. The Bank raised rates by a larger-than-expected 0.5% at the end of June, setting the policy interest rate at 5%. Markets had since expected another 0.5% rate raise in the Bank’s August meeting. But since the latest inflation figures, that expectation has moderated to a more normal 0.25% rise. The Bank could also opt to keep rates on hold, but the focus on rapid wage growth in recent communications makes this less likely.
However, one former member of the Bank’s Monetary Policy Committee, which sets interest rates, sounded a cautionary note against more rate increases. Andy Haldane, the Bank’s former Chief Economist, warned vividly that over-tightening to create a wage squeeze could turn into a self-defeating form of monetary austerity. “Past tightening of the monetary elastic is about to propel a brick towards the financially vulnerable. For the UK, that would spell recession… Imagine a doctor, uncertain about the nature and severity of a disease, who has administered a large medicinal dose which has yet to take effect. Prudence would cause them to pause to see how the patient responded before doubling the dosage.”
Mortgage costs continue to rise
Concerns continued to mount in July on the impact of rising interest rates on the housing market. This was seen with the average cost of new two year fixed rate mortgages overtaking the level seen in the wake of last year’s mini Budget according to data from Moneyfacts. Rising mortgage costs has seen some lenders reporting that house prices are falling as was covered in depth in the June edition of LET. With further evidence coming this month from for example Halifax who reported that UK house prices were down by 2.6% in June compared with the same month a year earlier. This was the largest house price drop they have seen since June 2011 although official ONS statistics do still show price rises. And Bank of England analysis has shown that just under 7 million UK households are expected to see a rise in their mortgage costs between the end of 2023 and the end of 2026. With, around a million households expected to see a rise of over £500 a month.
Renters are also experiencing rising costs with data from the ONS showing private rental payments rose 5.1% in the 12 months to June 2023 in the UK. For London this figure stood at 5.3%, which was the highest rate of increase since September 2012. Survey evidence has indicated that rental demand has been rising recently and other surveys of rents have shown higher rises, this is likely in part due to the high cost of getting a mortgage.
Still the latest bank stress test from the Bank of England which was published in their Financial Stability Report in July found that UK banks are resilient to some businesses and households not being able to cover their debts due to rising interest rates. Thus, in a “stress scenario [which] included the unemployment rate increasing to 8.5%, inflation rising to 17%, and house prices falling by 31%” the Bank found that “the UK banking system would continue to be resilient, and be able to support households and businesses”.
UK economy stuck in a rut
GDP contracted in the month of May, as UK economic activity continued to flatline at around its pre-pandemic level.
Production was the main factor behind the drop, falling 0.6%, but Construction also fell (-0.2%) and Services showed no growth. The extra bank holiday for the Coronation likely had an impact by cutting out a working day, but momentum is weak across the board. Despite the hospitality and shopping opportunity of a major public event, Accommodation and Food services fell 0.9% and Wholesale and retail dropped 0.5%.
But more broadly, UK growth momentum is stagnant. For the last year, monthly GDP has fluctuated at the same level as in December 2019 – indeed, never pushing above more than 0.1% (Figure 2).
And the indications are weak for the near-term outlook. Consumer confidence fell back in July, reversing its progress over the previous three months and hitting -30. Looking at the list of concerns, households appear increasingly worried about both inflation and a recession. Strikes from teachers, doctors and rail workers also continued this month, which is likely to weigh on activity. Perhaps reflecting the industrial action, as well as the cost of living crisis hitting the poorest hardest, the share of consumers worried about economic inequality also rose in July.
The cost of living crisis, monetary tightening and a stalled pandemic recovery are the backdrop to the UK’s weak growth. But these factors are not unique to the UK, and other major economy peers are growing stronger. In the first three months of this year, the UK’s pandemic recovery was some 3.6% behind the G7 average, 4.8% behind the wider OECD average, and 5.5% behind the USA. The current stagnation in the UK is a reminder of the chronic long-term challenges faced by its economy, amid more than a decade of flatlining productivity. Improving the output we get from every hour of work would expand our long-term economic potential and support real wages without stoking inflation, helping ease the economic malaise on almost every front.
UK to spend highest share of revenue on debt interest
Fitch, a credit ratings agency, published analysis this month that showed the UK government is on course to spend the highest proportion of its revenue on debt interest payments of any high-income country. They forecast that the UK government will pay 10.4% of its revenue on interest in 2023, the highest ratio of any high-income country and the first time the UK has topped the data set which goes back to 1995. This is being driven by the high proportion of UK debt, around a quarter of all debt, which is indexed linked to inflation, while most other countries have less than 10% of their bonds linked to inflation. The UK debt interest costs to revenue ratio has been rising in recent years according to Fitch and has increased from an average of 6.2% between 2017 and 2021 while the Western European average has been generally stable or declining. However, Fitch expects this ratio to fall in the UK in 2024 as inflation drops and for the US and Italy to overtake the UK on this measure.
IMF upgrades its 2023 forecast but says global recovery is slowing
In July the IMF increased its global growth forecast for 2023, with it now expecting growth of 3.0% this year, an upgrade of 0.2 percentage points (pp) on their April forecast but still slower than the growth of 3.5% seen in 2022. Growth of 3.0% is also forecast for 2024 (unchanged on April).
Most countries also had their forecast for 2023 slightly upgraded but with limited changes made to most forecasts for 2024. Thus the UK is now forecast to grow by 0.4% (an upgrade of 0.7pp on April) and 1.0% in 2024 (no change on the previous forecast). The US is expected to grow by 1.8% this year (a 0.2pp upgrade) and 1.0% next year (a -0.1pp downgrade). For the Eurozone growth of 0.9% is forecast in 2023 (a 0.1pp upgrade) and 1.5% in 2024 (a 0.1pp upgrade).
Commentating on their forecast the IMF said that the global economic outlook “remains weak by historical standards” with “the rise in central bank policy rates to fight inflation [continuing] to weigh on economic activity”. They argue that the priority for most countries “remains achieving sustained disinflation while ensuring financial stability. Therefore, central banks should remain focused on restoring price stability and strengthen financial supervision and risk monitoring”.
Top Londoner earners get highest post-Covid pay growth
The Institute for Fiscal Studies (IFS) published analysis in July looking at UK pay growth since the start of the pandemic. They found that between February 2020 and May 2023 “mean earnings growth among employees living in and around London has outstripped growth in the rest of the country”, with mean earnings for employees living in London increasing by 5.0% in real terms over this time period.
They however observed that “despite high growth in mean earnings, real median earnings have risen by only 1.7% since the pandemic began, to £2,700 a month before tax. That is, top earners in London have pulled away whilst middle earners have seen little real pay growth, leading to an increase in earnings inequality within London”. This higher growth in mean than median earnings in London was not however generally replicated in other regions who likely saw a fall in inequality at the local level. They observed that this was caused by pay growth over this period “being concentrated in business services sectors, which tend to be highly paid and located in and around London”.
GLA Economics will publish a detailed examination of regional wages in the coming months.
London’s economy showing the strain
The risks for London look increasingly skewed to the downside. With mortgage rates increasing, and the likelihood this passes on to rents, London’s housing cost situation is troubling. Asking rents in London are already rising 12.5% year on year according to HomeLet. This will test households’ financial resilience, and already GLA-commissioned polling by YouGov showed a high of 23% of Londoners saying they are “financially struggling”. London’s consumer confidence fell faster than the national average in July, but was still less pessimistic at -14.
And while this month saw London receive some positive indications on future investment, many question marks remain about its long-term potential. A proposed expansion of capacity at Gatwick and the Chancellor’s Mansion House speech ambition to make the City a ‘capital for capital’ offered hope for the future.
But London’s labour market inactivity rose in the latest data, and on the business side, office vacancies continue to rise across the UK. The office market also shows how future challenges will not be spread evenly across the capital. HSBC’s move from Canary Wharf to the City may point to how different business areas will face different levels of stress. And the same data showing shorter office tenancies and rising vacancy rates across the UK also show resilient demand for quality space – the market appears to be segmenting.
While the capital has recovered its pre-pandemic output level ahead of the rest of the country, how it recovers from the current stresses is still unclear.
 All figures, unless otherwise stated, are from YouGov Plc. Total sample size was 1227 adults. Fieldwork was undertaken between 23rd to 29th June 2023. The survey was carried out online. The figures have been weighted and are representative of all London adults (aged 18+). Financially struggling is the combined responses for “I am having to go without my basic needs and/or rely on debt to pay for my basic needs” and “I’m struggling to make ends meet”