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London’s Economy Today editorial June 2023

Inflation remains stubbornly high in the UK

Data published by the Office for National Statistics (ONS) this month showed that annual Consumer Price Index (CPI) inflation stood at 8.7% in May unchanged from April (Figure 1). This rate was unexpected by most economists with a poll by Reuters showing that most expected a lower inflation rate in May. Core annual CPI inflation which excludes energy, food, alcohol and tobacco rose in May to 7.1% up from 6.8% in April.

Figure 1:

The monthly CPI inflation rate in May stood at 0.7%, the same as in May 2022. Increasing prices for air travel, recreational and cultural goods and services, and second-hand cars were the largest drivers of inflation, whereas falling motor fuel was the largest downward contribution to inflation.

Food and non-alcoholic beverages price rises did ease a touch in May but remained very high. They increased at 18.4% in the year to May 2023, down from 19.1% in April and from their 45-year high of 19.2% in March.

Annual growth in private sector earnings increased to 7.6% in the three months to April, and while lower than inflation making workers on average worse off, it was 0.5 percentage points above the Bank of England’s Monetary Policy Committee’s (MPC) expectation in May. Still, the direct source of the rising CPI inflation, annual producer price inflation (PPI) for output has fallen very sharply in recent months as supply chain logistics ease, and so the MPC expects core goods CPI inflation to decline, (Figure 1). The MPC also expects CPI inflation to fall significantly further during the year, in the main reflecting developments in energy prices.

The Bank makes a large interest rate rise as inflation fails to fall

In an attempt to tackle inflation the Bank of England announced its thirteenth consecutive interest rate rise, pushing it to 5%, a more than expected increase of 0.5%. The Bank’s MPC said, “There has been significant upside news in recent data that indicates more persistence in the inflation process, against the background of a tight labour market and continued resilience in demand.” At the time of May’s MPC meeting, the market-implied path for the Bank interest rate averaged just over 4% over the next three years. Stronger than expected economic conditions, and persistently high inflation, have led to yields on government borrowing, or gilts, rising materially, particularly for shorter maturities – they suggest a path for the Bank interest rate that averages around 5½%.

The MPC recognises that the second-round effects in domestic price and wage developments generated by external cost shocks are likely to take longer to unwind than they did to emerge. As a sense of the challenges facing the MPC, UK inflation in May is higher than in other major economies – for the EU it is 7.1%, and the US, 2.7%.

The effect of interest rates on housing costs has yet to be fully felt, and will impact on London most

Higher interest rates feed through into higher lending costs for businesses and households, and so over time into fewer funds for other activities. The Resolution Foundation (RF) has conducted an analysis of the impact on households, both so far, and what there may be to come. Annual mortgage repayments are on track nationally to be £15.8 billion a year higher by 2026 compared with December 2021, when the Bank started raising interest rates. This estimate is up from £12 billion in May, reflecting how sharply expectations of mortgage lending rates have risen. By the end of June 4.2 million (56% of mortgage holding) households in Britain will have seen their mortgage rate change, and payments increase by £6.3 billion. The remaining 3.3 million have yet to see their fixed rate deals expire, and three-fifths (£9.5 billion) of the projected increase in repayments is yet to come. By the end of 2026, British households are set to end up with annual mortgage bills that are £2,000 higher on average than in December 2021. In contrast, when repayments surged in 1989 after the Bank increased interest rates to nearly 15%, the increase in repayments was only about £1,200 in today’s money for the typical mortgagor.

This gives mortgagors an incentive to pay off their loans. The Bank reports that borrowers repaid £1.4 billion more on their mortgages than banks lent out in April. Higher mortgage repayments may also be making house purchases less attractive with both the Halifax and Nationwide reporting year-on-year falls in house prices. Although the ONS figures reported with the LET indicators, which are based on completed sale prices, are still showing prices rising, if at a slowing rate, on an annual basis for London and the UK.

Further, there will be important distributional impacts. The pain of rising mortgage repayments is less widespread than in the past. In 1989, almost 40% of households nationally owned a home with a mortgage. By last year, through more older people owning outright, and fewer young people owning at all, the corresponding figure was below 30%, estimates the RF. London is seeing the highest absolute increase in mortgage payments at £520 per month, followed by the South East at £390, estimates the Institute for Fiscal Studies (IFS) – these are the areas where house prices are higher. This raises concerns about affordability, despite the comparative affluence on average of these regions, because the ratio of house prices to earnings is also higher than for other regions. The IFS reports that the increase in mortgage payments corresponds to a 12% fall in disposable income for mortgagors in London, and a 9.4% fall in the South East, compared with 6-7% in Britain outside the East of England and the South West. (The reported studies in this section are using different methodologies, so estimates are not strictly comparable.)

A bright spot is that the number of repossessions remains low, affecting 1,250 properties nationally in the first three months of the year. There are reasons to believe repossessions will remain restrained, particularly compared with the 1990s, thanks to: regulatory reforms to require lenders to support struggling borrowers; increased levels of equity held by homeowners; and, the widespread use of fixed rate mortgage deals.  Additionally, UK banks have agreed to introduce a 12-month minimum period before repossessing the homes of borrowers who cannot keep up with mortgage payments.  This is similar to the assistance introduced by banks during the pandemic.

There may also be consequential impacts on renters. Rising interest rates are putting pressure on landlords, pushing some to consider selling up, according to the Royal Institution of Chartered Surveyors (RICS). In turn, this could further squeeze the availability of rental properties and raise costs for tenants. Rental costs have been rising both in London, and beyond, although they are now rising faster in the capital as the London market picks up from the fall in demand during the pandemic, Figure 2. As these figures are for all rentals, many of which will be subject to existing rental agreements, that pre-date recent rent increases, the cost of new rentals is rising faster. The GLA has published research this month on these trends.  The IFS notes that historically renters have had higher housing costs than mortgagors – with this being 24% higher pre-pandemic.

Rising interest rates and high inflation are also having a negative impact on some heavily indebted firms. This has been seen with the issues faced by Thames Water which has £14billion of debt. The company is seeking extra funding to finance this debt and the government has discussed the possibility of a temporary nationalisation of the company if necessary.

Figure 2:

Cost of living crisis heavily impacting low income Londoners

Further evidence of the hardships to Londoners caused by the cost of living crisis came to light this month. A new survey by the Joseph Rowntree Foundation found that nearly 80% of Londoners on low incomes (defined as households in the bottom 40% category of equivalised income across the UK) were skipping meals or going without essentials. While 84% of low income renters in the capital were going without essentials. This compares to 75% for the UK. The survey also found that 26% of low-income renters were in arrears in the capital compared to 16% in the UK. 84% of low-income households with children were going without essentials, with this rising to around 90% for lone parent households. And 27% of all low-income households in London are in energy arrears, compared to 16% at the UK level.

Other data also shows the continuing price pressures caused by the cost of living crisis. Kantar found that supermarket prices rises stood at 16.5% on the year in the 4 weeks to 11 June. Although this was down from the 17.2% seen in the previous 4 weeks.  This mirrors the high official inflation estimates for food and non-alcoholic beverages reported above.  This will affect low income households disproportionately, as they spend a larger share of their income on these items.

UK government debt now more than 100% of GDP

ONS data published this month showed that public sector net debt excluding public sector banks exceeded 100% of GDP in May 2023 with it standing at 100.1% of UK GDP. The last time debt as a percent of GDP exceeded 100% was March 1961.

Still at least data shows that the UK economy continued to grow into the second quarter of 2023 with ONS data showing that GDP grew by 0.2% in April, after falling by 0.3% in the previous month. The service sector grew by 0.3% in the month after falling by 0.3% in the previous month. Output in consumer facing services grew by 1% in April after falling by 0.8% the previous month. However, output in the production and construction sectors both fell in April after seeing growth in the previous month.

Eurozone inflation falls but it has entered a recession

Data published this month gave a mixed picture for the Eurozone. Thus, data shows that inflation in the Eurozone fell back again in May 2023 to 6.1%. This was down from the 7.0% seen in April and a high of 10.6% in October 2022. For the EU as a whole inflation stood at 7.1% in May down from 8.1% in April. Despite this positive news other indicators were less optimistic with GDP data showing the Zone had entered a technical recession. The data thus showed that the economy contracted by 0.1% in Q1 2023 with this following a contraction of also 0.1% in Q4 2022. Household spending in the Eurozone is also declining with it falling by 0.3% in the first three months of the year having fallen by 1.0% in the final three months of last year.

London’s culture sector and creative industries contribute to the success of the London and UK economies

GLA Economics has published an assessment of the contributions of the cultural and creative industries sectors, and whether they have been supported through the levelling up agenda. London’s creative industries paid £13 billion in taxes in 2019/20, around 8% of taxes paid in London, a significant component of London’s net fiscal contribution to the Exchequer, see below. It is the capital’s third largest sector, after finance and real estate. The sector supports regions outside of London through trade and supply chains. There is 24p of production generated elsewhere in the UK for every pound consumed or invested in London.

Despite London’s need to level up, it is being ignored. 4% of the Government’s £23 billion of levelling up funding is for London, despite 12% of England’s most deprived neighbourhoods being in the capital. In 2023/24 there has been an 18% uplift in funding for the arts through Arts Council England National Partnership Organisations – there were no additional funds for London. Despite their own cutbacks local authorities, especially in London, have been topping up arts funding withdrawn by central government – this is suggestive of insufficient central government funding. The lack of provision of funds for London is damaging for London and the UK.

Overseas tourism to London recovers to near pre-pandemic levels

New data shows that international tourism is approaching near pre-pandemic levels. The ONS has published data on international visitors up to 2022 Q4. Quarter-on-quarter over 2022 there has been a steady recovery compared with trends in 2019. By 2022 Q4 visits and spend were around 90% of their level in 2019 Q4, and nights had more than recovered to reach 106%.

Narrower, but more recent, data on traffic at Heathrow up to May 2023 suggests that recovery has continued this year, Figure 3. Indeed, in May passenger numbers were at the level of May 2019. GLA Economics research suggests that the recovery has been led by North Americans visiting friends and relatives, rather than going on holiday. Business trips have been the slowest to recover. In contrast, Heathrow cargo movements remain almost 20% lower. Notably, as this month’s London’s Economic Outlook reports, UK goods exports remain depressed compared with pre-pandemic levels.

Figure 3:

Once again, London makes a net contribution to the Exchequer

London made a positive (often large) net contributions to the Exchequer between 2009/10 and up to the start of the pandemic. A surplus of £4,500 per person in 2019/20 switched to a deficit of £800 per person in 2020/21. Even in 2020/21, London – out of all the UK countries and regions – made the smallest call per head on the public purse. In 2021/22, London returned to making a net contribution to the Exchequer, and again the largest of the countries and regions of the UK, at £4,300 per person, Figure 4. These contributions can be disbursed to the other countries and regions of the UK, and so support the development of the nation.

Figure 4:

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