Britain’s economy seems to be turning a corner – but don’t get your hopes up just yet

 Don‘t get carried away by overly optimistic economic data – the numbers are still patchy

Source - Daily Telegraph 22/01/23

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Just as the days start to get ever so slightly longer, is it possible to glimpse the beginnings of a brightening of the economic scene?

Let us not be parochial. The economic travails that we have been passing through here in the UK have been largely global in nature. Accordingly, you could reasonably expect the recovery, when it comes, to have a large global element too.

As it happens, the economic data continues to be decidedly soft in America, where a recession looks on the cards. Yet, over recent weeks, European economic data releases have tended to surprise on the optimistic side.

It has long seemed that France was well positioned to avoid a recession but in the last week the German Chancellor, Herr Scholtz, expressed confidence that Germany would also avoid a recession this year. Given the importance of manufacturing to the German economy and the damage that sky-high energy prices have done to manufacturing, that would be quite something.

I suppose this result should not be surprising because the root cause of recent economic difficulties in Germany and elsewhere, namely energy prices, have failed to fulfill the forecasts of the doom mongers. Even better, prices have fallen back substantially. International gas prices are now back down to where they were before the Ukraine invasion, although not back to 2019 levels.

In the wider world, China is undergoing a major resurgence following the abandonment of the zero covid policy. The downside, however, is that, if sustained, this could put upward pressure on international commodity prices – including energy. Nevertheless, China’s economic recovery will be good for international economic activity.

On balance, therefore, it is not surprising that recent data in the UK have mainly turned out on the stronger side of expectations. Mind you, this doesn’t include last Friday’s retail sales data for December, which turned out to be surprisingly soft.

Perhaps the most significant recent data release, however, was November’s GDP, which showed a small rise of 0.1 per cent. This was not a great deal to write home about and the numbers are in any case highly unreliable. But it now seems likely that Q4 as a whole will show a small rise in GDP and this means that, contrary to many earlier forecasts, we will not have fallen into recession in 2022.

It still looks plausible that we will experience two consecutive quarters of contraction (the widely recognised definition of a recession) in the first half of this year. But that is not a done deal.

Last week’s labour market data was instructive. It showed employment growing by 27,000 in the three months to November, confirming the continued tightness of the labour market. More importantly, the growth of average earnings rose from 6.2 per cent to 6.4 per cent, which will not please the Bank of England.

Admittedly, as expected, the CPI inflation data showed another small fall from 10.7 per cent to 10.5 per cent. Moreover, there is every reason to expect that inflation will fall sharply in the coming months. The Prime Minister’s pledge that inflation will halve by the end of the year is pretty much an empty promise. This development is all but baked in.

But core inflation, that is inflation shorn of all the distorting influences, is still at 6.3 per cent. This will surely go down badly with the Bank. 

An increase in interest rates, probably of 0.5 per cent, is likely at the coming meeting of the Monetary Policy Committee next week.

Just because the strain on households from surging inflation seems to be past its peak, this does not mean that the pressure is off. Indeed, while inflation is ahead of pay rises then real pay is still falling.

It is just that it is falling at a slower rate than before. That doesn’t butter any parsnips. It will be well into the second half of the year before real pay starts to rise.

Moreover, the pressure on mortgage-burdened households is still growing. Indeed, even if Bank Rate rises no further than the current 3.5 per cent, the average mortgage rate paid will continue to increase for some time as month after month people come off previously fixed mortgage deals at rates much lower than today’s. A further rise in Bank Rate will simply intensify this pressure.

Meanwhile, though, there has recently been some good news on the public finances. It is true that the latest monthly figures (for November) showed public borrowing at £22bn, above expectations and well above the same month last year. The figures for December, due out tomorrow, may also look bad. 

But these figures are being heavily influenced by the payments under the Government’s energy support measures. Looking further out, because of dropping international energy prices, by July the energy price guarantee may fall into disuse. The saving to the Treasury could be some £10-20bn.

On top of this, there are savings from lower yields on government debt and a profit registered on the emergency buying of gilts at the time of the brief Truss administration. There would also be an improvement in tax receipts relative to expectations if the economy turned out to be less weak than anticipated. The net result is that by the time of the Budget in March, borrowing in 2023/24 may be set to be some £40bn lower than anticipated in November.

This opens up the interesting possibility of the Chancellor rescinding some of the planned tax rises – or increasing public spending, perhaps by conceding increases in public sector pay. Alternatively, of course, he could just allow borrowing to be lower, perhaps hoping to reduce taxes a bit in March 2024, the last budget before the General Election.

So things are a bit better than seemed likely just a short while ago. Still, it wouldn’t do to become too optimistic. As Friday’s weak retail sales emphasised, the economic data is still patchy. You should know only too well that what the data gives, it can easily take away.

Roger Bootle is chairman of Capital Economics