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20 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

Changes in market pricing more important than borrowing data

• Lower debt interest payments mean that public sector net borrowing is now running slightly below last year's level. But if the recent performance continues, borrowing in 2024-2025 as a whole will be more than £3bn above the Office for Budget Responsibility's (OBR) forecast.
• The bigger risk to the Chancellor's fiscal plans is this week's movements in financial market pricing. If the changes are sustained, the EY ITEM Club calculates they would wipe out more than half of the already-slim headroom the Government has left against its fiscal rules.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “Public sector net borrowing was £11.2bn in November, down £3.4bn on a year earlier, as lower Retail Price Index (RPI) inflation reduced the level of debt interest payments. The OBR is yet to publish a month-by-month profile for its borrowing forecast, so it's difficult to judge progress at this stage. However, if the recent performance is extrapolated over the remaining five months of the fiscal year, borrowing will come in at around £131bn, a little above the OBR's Budget forecast.

“This week, the Chancellor announced that the OBR will publish its next set of economic and fiscal forecasts on March 26. Though the Chancellor adopted less restrictive fiscal rules at the Autumn Budget, she still opted to leave a small margin for error of just £10bn. And while there was nothing in today's data to suggest the OBR will take a more pessimistic view on the medium-term outlook for the public finances, this week's movements in market pricing pose a material risk to the fiscal position. At market close on December 19, gilt yields and market expectations for Bank Rate were around 30bps higher than the assumptions that the OBR used in October's Budget forecasts. If sustained, the EY ITEM Club calculates this would wipe more than £5bn off the £10bn headroom that the Chancellor has left.

“Reeves has said there will be no policy changes alongside the forecast update. But even if the OBR continues to judge that policy complies with the fiscal rules at that point, it's likely to be a problem deferred, not resolved. Navigating the spending review without increasing the size of the spending envelope will be challenging, and there will be other obstacles to negotiate, such as the annual decision over whether to return to indexing fuel duty.”

20 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

Retail sales edged up in November after successive falls

• Retail sales rose for the first time in three months in November. But given the significant degree of seasonality in the retail data, and this year's later Black Friday, it’s not possible to draw firm conclusions on the strength of pre-Christmas demand until the December data is available.
• The outlook for retail in 2025 is heavily dependent on the mood of consumers. Spending power has recovered strongly in 2024, but consumers have adopted a cautious approach. Real income gains are likely to be much weaker in 2025, but with signs that confidence is firming, the EY ITEM Club is optimistic that consumers will be more willing to spend.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “Retail sales rose by 0.2% month-on-month in November, following two successive falls. On a sectoral basis, there were modest increases in each of the three main sectors – food, non-food, and non-store – which were partly offset by a sharp fall in fuel sales.

“There's a pronounced seasonal pattern to the retail data, with around 21% of total annual sales coming in November and December. This creates significant challenges for the Office for National Statistics (ONS) in seasonally adjusting the data. Those challenges are compounded by the growing importance of Black Friday and Cyber Monday discounting, and the fact these events don't always fall in the same reporting period each year. This year, both dates will be in the December reporting period, although given that many promotions ran for a week or more, a significant proportion of the sales will still have occurred in November. With Black Friday falling later this year, it’s not possible to draw firm conclusions on the current health of the sector’s performance until the December data is available.

“2024 has been a better year for retailers, with sales on track to grow by around 1% after large falls in 2022 and 2023 respectively. However, the scale of the pickup has been underwhelming given the strength of the recovery in spending power, with the EY ITEM Club estimating that real incomes rose by more than 3% in 2024. Prospects for income growth in 2025 are softer, given that inflation is likely to be higher and earnings growth weaker. But given the significant caution of consumers in 2024, and recent evidence that confidence has begun to firm, the EY ITEM Club sees scope for spending growth to run ahead of income gains in 2025, driven by stronger demand for credit and lower levels of saving.”

19 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

Differing views starting to emerge on the Monetary Policy Committee

• The Bank of England’s decision to keep Bank Rate unchanged at 4.75% was unsurprising. However, there was more division than expected amongst Monetary Policy Committee (MPC) members, with three favouring a cut in Bank Rate. 
• There was no clear commitment on how the Bank of England would act when it meets again in February. But the minutes of the meeting did suggest that all camps on the Committee favour further rate cuts, albeit at differing paces. While the timing and extent of future rate cuts will be determined by incoming data in early 2025, for now the EY ITEM Club continues to expect gradual interest rate cuts over the first half of next year.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “Coming out of November’s meeting, the clear message from the majority of the MPC was that it would lower interest rates gradually. Given the incoming data has continued to show some continued stickiness in inflationary pressures, today’s decision to keep Bank Rate unchanged at 4.75% does not comes as a surprise. The bigger surprise was the extent to which the Committee was split, with three of the nine members voting in favour of a 25bps cut in Bank Rate. That provides a notable contrast to September’s meeting when Bank Rate was left unchanged by a more unified vote of 8-1 in favour. 

“Since the November MPC meeting, the growth-inflation trade-off has worsened, which appears to have prompted the split on the Committee. The majority of MPC members continue to favour a gradual approach to reducing Bank Rate to ward off sticky inflation. This would allow time to see how the changes to employers’ National Insurance Contributions (NICs), the National Living Wage and trade policy play out in the labour market and across wages and prices. For the minority of the Committee who favoured a rate cut, they had greater and more immediate concerns around weakening growth data.

“The Bank of England provided no clear view on how it would act at its February meeting, instead saying it will observe how the data develops over the start of 2025 before deciding on its next move. Before today’s meeting, the consensus among the MPC was that some economic slack would likely need to develop to sustainably bring inflation back to target.

“Remarks from MPC members in recent weeks suggested that this could be consistent with the Bank of England sustaining the ‘cut hold’ tempo of interest rate reductions it has established through 2025. With the December minutes suggesting that both camps on the MPC still want to reduce interest rates, albeit at a differing pace, and no indication that the consensus around the economic outlook has shifted, the EY ITEM Club continues to expect further but gradual interest rate cuts in the first half of 2025.”

18 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

Sticky inflation points to gradual rate cuts in 2025

• UK Consumer Price Index (CPI) inflation picked up again in November, as base effects for core goods and petrol prices pushed up the annual rate. With the drag from falling energy prices now fading, and several upward pressures coming into play, the EY ITEM Club expects inflation to remain above the 2% inflation target in 2025. 
• Today's data continues to point to a slow normalisation of inflationary pressures. With a hold in Bank Rate tomorrow almost assured, the stickiness still present in the inflation data is more informative of how the Monetary Policy Committee (MPC) is likely to proceed at the start of next year. The EY ITEM Club continues to expect the MPC to cut Bank Rate gradually.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “CPI inflation picked up further above the Bank of England's 2% target, rising to 2.6% in November, up from 2.3% in October. The rise was largely down to a base effect from a weak core goods reading in November 2023 dropping out of the calculation, and a smaller drag from the petrol category, with a modest rise in pump prices in November this year contrasting with a large fall in 2023. Looking past some of these more transient price moves, services inflation, which is particularly sticky, held firm at 5% in November.

“Much of the easy progress on inflation has now been made. The drag from falling energy prices is receding and is likely to disappear altogether by the spring. Similarly, weak core goods readings in late 2023 as supply chains normalised have weighed on core and headline inflation over the past year. But these effects are waning, and core goods inflation is on the rise, with a stronger dollar following the US presidential election outcome adding to the upward pressures. Recent fiscal policy changes will also have an impact, such as businesses passing on some of the cost of higher National Insurance Contributions (NICs). Therefore, while services inflation should gradually slow on the back of easing domestic inflationary pressures, the EY ITEM Club still expects CPI inflation to remain above the 2% target in 2025.

“Even before today's inflation data, there appeared to be little chance of a cut at December’s MPC meeting. Looking further forward, the continued stickiness in services inflation and the increase in core goods price inflation will likely lead the MPC to maintain a gradual pace of Bank Rate cuts in 2025.”

17 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

Sticky pay growth to keep Bank of England cutting gradually

• December's labour market data was a mixed bag. On the quantities side, there were still signs of a gradual loosening in conditions. Nonetheless, even looking past base effects, there were signs that pay pressures remain sticky.
• The chances of a rate cut at Thursday's Monetary Policy Committee (MPC) meeting have always looked slim, and that remains the case after this release. The data also reinforces the likelihood that the MPC will continue to adjust Bank Rate gradually in early 2025.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “Wage growth picked up in the three months to October. In part, this reflected base effects caused by a very weak October 2023 reading dropping out of the calculation. But underlying earnings growth also picked up, with private sector regular pay growth reaching 5.6% on a three-month-on-three-month annualised basis. Though it remains weaker than in H1, underlying pay growth is far above 3%-3.5% that the MPC considers to be consistent with inflation returning to the 2% target on a sustained basis. 

“The unemployment rate remained flat at 4.3% in the three months to October. However, the ongoing issues with the Labour Force Survey (LFS) means that the data provides an unreliable steer on labour market conditions. Looking at the wider sweep of indicators, it appears that the labour market eased a little further, but remains tight. Payrolled employees fell by 35,000 in November, while vacancies edged down a little further.

“The message from the majority of the MPC has been that it will reduce Bank Rate gradually unless there's strong evidence that wage and price pressures are easing more quickly than anticipated. The chance of a Bank Rate cut at the Bank of England meeting later this week has always looked very low, and that remains the case after today's data. The consensus on the MPC is that it's likely some economic slack will need to emerge to bring inflation back to target sustainably, so the gradual loosening in labour market conditions is good news in that respect. However, sticky pay growth is likely to keep the MPC cautious around the pace of rate cuts.”

16 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

December PMI points to a marginal increase in activity

• The UK flash composite Purchasing Managers’ Index (PMI) held steady in December, continuing to point to only a slight increase in activity. Recent PMI readings have shown a weak mapping into official estimates of economic growth. Nonetheless, the EY ITEM Club continues to expect weaker growth in Q4 2024 than in the first half of the year.
• The EY ITEM Club does not think that today's PMI will lead the Bank of England to shift from its current ‘cut hold’ tempo. While today's PMI painted a picture of a softening labour market, signs of inflationary pressures persisted. The EY ITEM Club continues to expect the Bank of England to keep Bank Rate unchanged at 4.75% at its meeting later this week.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “December's S&P Global flash survey saw the composite PMI remain in expansionary territory, recording 50.5, unchanged from November. Below the surface, there were diverging trends. On the one hand, the dominant services sector saw a modest rebound after November's 13-month low. On the other hand, the manufacturing sector posted the second consecutive month of reduced output. New work declined in December, with survey respondents reporting weak European demand, thereby limiting new sales of goods.

“The composite PMI is a relatively poor leading indicator of GDP growth, particularly given recent volatility in sectors not covered by the S&P Global surveys. The survey results also tend to be heavily affected by sentiment, and the recent weakening in the PMIs may have been exaggerated by responses from businesses to the increase in employers' National Insurance Contributions (NICs) announced in the Budget. However, given the PMI survey readings across the final quarter of 2024 and October's soft GDP reading, the EY ITEM Club retains its long-held view that growth will be weaker in Q4 2024 than it was in H1.

“Recent activity data has been a little softer than the Monetary Policy Committee (MPC) expected at its November meeting. But while December's PMI survey showed a further fall in employment levels, there were still some signs of inflationary pressure that the Bank of England will need to be wary of. Both input and output price balances accelerated, reaching levels not seen since the first half of this year. The EY ITEM Club continues to expect the Bank of England to keep Bank Rate unchanged at 4.75% at its meeting later this week.”

13 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

UK GDP falls again in October

• UK GDP saw a -0.1% contraction in October, a second consecutive monthly fall. The decline was fairly broad, with consumer-facing services, manufacturing and construction all retreating. However, the Office for National Statistics (ONS) acknowledges that the timing of the Autumn Budget may have introduced some additional noise into this month's data.
• The EY ITEM Club expects GDP growth to be decent but fairly limited in 2025. Further real income growth and less consumer caution are likely to support household spending. However, the lagged impact of interest rate rises and restrictive fiscal policy will likely weigh on growth.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “GDP fell by -0.1% month-on-month in October, below the consensus forecast of +0.1% growth.  For the second consecutive month, the dominant services sector was flat, masking a particularly weak reading in consumer-facing services, which fell by 0.6%. The manufacturing and construction sectors both contracted on the month, falling by 0.6% and 0.4%, respectively.

“A slow start to the final quarter of 2024 suggests that growth in Q4 will likely remain muted. Growth in Q3 slowed to 0.1%. However, the EY ITEM Club thinks the recent loss of growth momentum may be exaggerated by some noise in the data. Indeed, the ONS noted that survey respondents had provided mixed feedback on the impact of the October Budget, but its notable that businesses had seen some demand delayed until after the Budget.

“Looking to the new year, the EY ITEM Club expects solid but fairly limited growth. Higher real incomes and less consumer caution should support household spending, and there are good reasons to believe global growth will continue at a decent pace. But set against that, past interest rate rises will weigh on disposable incomes as some households continue to refinance mortgages at higher interest rates. The recent Budget loosened the purse strings. Nonetheless, fiscal policy is still set to tighten substantially, and further tax rises may be needed for the government to meet its fiscal targets.”

12 Dec 2024 | EY ITEM Club comments | Media contact: James White - Senior Executive, Media Relations, Ernst & Young LLP

Bank of England expected to maintain gradual pace of cuts

• The EY ITEM Club expects the Bank of England to keep Bank Rate on hold at 4.75% at December’s Monetary Policy Committee (MPC) meeting by a vote of 8-1 in favour.
• This is likely to just be a skip in the cutting cycle, and while it will stop short of committing to a February cut, the EY ITEM Club expects the Bank of England will return to lowering Bank Rate in the new year.
• With MPC members pointing to the upcoming change in National Insurance Contributions (NICs) as a key source of uncertainty, the EY ITEM Club doesn’t expect any update on where interest rates may head through next year at the December meeting.

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “The message from the majority of the MPC at its November meeting was loud and clear: it intends to reduce Bank Rate ‘gradually’. With incoming data so far giving them no reason to chart a new course, the EY ITEM Club expects the Bank of England to stick to its ‘cut hold’ tempo and keep Bank Rate unchanged at 4.75% when it meets next week by a vote of 8-1 in favour.

“Since November’s decision to reduce Bank Rate to 4.75%, pay and inflation data have evolved as the MPC excepted. While activity has been a little weaker than the MPC anticipated, the EY ITEM Club doesn’t think it has been soft enough to sway a majority of members to vote for a consecutive cut in Bank Rate. Indeed, most MPC members’ remarks since the November meeting have emphasised the consensus on the Committee that some economic slack will be required to bring inflation sustainably back to target.”

Following the September playbook

“Without updated projections or a press conference, next week’s focus will be on the MPC’s written guidance. Barring large upside data surprises between now and the December meeting, it seems likely that the majority of the MPC will indicate that they’ve seen welcome progress on inflation persistence. Nonetheless, the EY ITEM Club expects the Committee to emphasise that it remains vigilant of inflation risks and so interest rates will continue to be adjusted “gradually”. 

“Given MPC members’ recent comments that they expect multiple interest rate cuts in 2025, December’s written guidance will likely take a page out of the September playbook and indicate a full assessment of the economic outlook in February. While this clearly stops short of a commitment to cut Bank Rate in February, the EY ITEM Club would view a February cut as likely provided the economic data develops as the MPC expects. The EY ITEM Club will also be keeping an eye out for any update of the Bank of England’s Agents’ survey of pay settlements for 2025, as this will be an important input into the Committee’s thinking over the coming months.

Uncertainty to persist

“The EY ITEM Club does not expect the MPC to give a detailed update on where interest rates will head through 2025. Indeed, in recent weeks, some MPC members have cited the upcoming increase in employers’ NICs as a key source of uncertainty around the outlook. The Bank of England thinks this uncertainty will likely persist until at least the Spring, so unless there is a sharp weakening in demand in the first couple of months of next year, the EY ITEM Club doesn’t think the MPC will feel the need to deviate from the current “cut hold” tempo over the next few meetings.”