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28 June 2024 | EY ITEM Club comments:

National accounts point to a slightly stronger start to 2024

• The UK national accounts reported a slightly stronger rebound at the start of 2024 than earlier estimates had shown. According to the income breakdown, real household income continued to grow at a solid pace, with an increase in the saving ratio in Q1 suggesting consumers remain cautious.
• Rising consumer confidence suggests this picture could soon change. The EY ITEM Club expects sustained real income gains will increasingly translate into stronger consumer spending growth. 

Peter Arnold, EY UK Chief Economist, said: “After a weak end to 2023, the scale of the rebound in activity at the start of this year was upgraded in Q1's national accounts. GDP growth in Q1 was revised up to 0.7% quarter-on-quarter from the previous estimate of 0.6%. Revisions to the expenditure components saw support from consumption and the net trade increase, though this was partly offset by more downbeat assessments of business investment and government consumption.

“The income breakdown indicated that Q1's 0.4% rise in consumer spending was supported by continued strong growth in real household disposable income, which increased 0.7% for the second consecutive quarter. This meant that the household saving ratio rose to 11.1% in Q1 from an already-high 10.2% in Q4 2023.

“Looking ahead, the EY ITEM Club expects GDP to grow at a decent pace in Q2. The composite Purchasing Managers’ Index (PMI) averaged the same level in Q2 as Q1. However, the earlier-than-usual Easter appeared to boost consumer activity in March at the expense of April, while strike action in the healthcare sector in June will likely drag on output this month. Therefore, the EY ITEM Club thinks quarter-on-quarter GDP growth will probably come in a bit softer than Q1's strong rise.

“Further ahead, the EY ITEM Club expects low inflation and persistently strong pay growth to mean real household incomes continue to grow strongly. Provided rising consumer confidence results in households gradually moving away from the cautious sentiment exhibited over the last year, the EY ITEM Club thinks there is a prospect of a decent consumer-led recovery.”

12 June 2024 | EY ITEM Club comments:

GDP on track for solid growth in Q2

• UK GDP was flat in April, as lower output in the manufacturing, construction, and consumer-facing services sectors was offset by broad strength elsewhere in the services sector. Some of the drags on activity in April were driven by one-off factors, which the EY ITEM Club expects will unwind. Looking through this volatility, the EY ITEM Club still thinks GDP is likely to grow at a decent pace in Q2.
• Looking further ahead, rising real incomes and consumer confidence suggest the economic recovery should become more firmly entrenched as the rest of the year progresses. Still, tighter fiscal policy and the lagged passthrough of past interest rate increases will likely mean the UK’s exit from its long period of stagnation will be steady rather than spectacular. 

Peter Arnold, EY UK Chief Economist, said: “GDP was unchanged in April, as the economy consolidated the strong gain made in March. The sector breakdown showed that lower output in the consumer-facing services sector provided the largest drag on activity in April, driven by a significant fall in retail sales and an earlier-than-usual Easter. Elsewhere, manufacturing and construction activity both fell. But this was offset by stronger output elsewhere in the services sector.

“Monthly GDP data can be noisy and the focus placed upon individual outturns should therefore be measured. Indeed, after three strong month-on-month gains, it was always likely that there would be some payback in April, and a flat outturn beat the EY ITEM Club’s expectations. Looking through this volatility, the EY ITEM Club expects GDP to grow at a decent pace in Q2. The drag on some sectors from an early Easter should unwind in May. Moreover, early business survey data has signalled that private sector activity growth remained robust across the first two months of the quarter. However, planned strikes in the healthcare sector at the end of June will likely weigh on activity. On balance, the EY ITEM Club expects quarter-on-quarter GDP growth to be slower in Q2 than in Q1.

“Looking further ahead, the EY ITEM Club thinks rising real household incomes and consumer confidence will be the key drivers of stronger economic growth over the rest of this year and into 2025. However, tighter fiscal policy and the lagged passthrough of past interest rate rises are likely to mean that the UK economy’s exit from its long period of stagnation will be steady rather than spectacular.”

11 June 2024 | EY ITEM Club comments:

Pay growth continues to cool despite national living wage rise

• UK private sector regular pay growth continued to cool in April, despite a large increase in the national living wage that month. At the same time, labour market conditions continued to loosen, albeit to a lesser extent than around the turn of the year.
• April’s large overshoot for services inflation likely took a June interest rate cut off the table. But with pay growth slowing in line with the Bank of England’s expectations and labour market conditions loosening, the EY ITEM Club sees today’s release as being consistent with the Monetary Policy Committee (MPC) cutting rates later in the summer. 

Peter Arnold, EY UK Chief Economist, said: “April's pay data had been eagerly awaited, as it would show the effect of the near-10% increase in the national living wage on whole economy wage growth. In the event, the Bank of England's favoured measure – private sector regular pay growth – cooled to 5.8% in the three months to April, from 5.9% in March. The relatively benign outcome was partly due to large base effects, but the EY ITEM Club also thinks that the impact of the National Living Wage rise was smoothed over the early months of the year and that this likely explains some of the strength in previous months. It is difficult to benchmark the outturn against the Bank of England's expectations, as it only provides quarterly forecasts for this series. But factoring in additional large base effects coming into play in the next couple of months, the April data leaves pay growth on track to meet the Bank of England's Q2 projection.

“On the quantities side, labour market conditions still appear to be loosening, albeit perhaps not as much as previously. A 12,000 fall in vacancies on three months earlier was a much smaller decline than those recorded over the past couple of years, while the decline in HMRC's count of pay-rolled employees in May was also more modest than of late. Workforce jobs bucked the loosening trend, with another large gain in Q1, but this series appears to be an outlier.

“April's large overshoot for services inflation has likely taken a June rate cut off the table. However, with pay growth slowing in line with expectations and labour market conditions loosening, the EY ITEM Club doesn't see anything in today's release that would prevent the MPC from cutting rates later in the summer.”

07 June 2024 | EY ITEM Club comments:

Halifax shows house prices remain broadly flat

• House prices were broadly flat in May, extending the period of relative stability that we’ve seen since the turn of the year. The stabilisation in market conditions reflects the large fall in mortgage rates since last summer, with transactions and prices having decisively passed their trough.
• But the recent rise in mortgage rates is likely to prevent any meaningful pickup in transactions and prices in the short-term. 
• Looking further ahead, the recovery in prices is likely to be slow and steady, given that poor affordability continues to significantly limit the pool of potential buyers and mortgage rates are likely to fall back slowly. 

Peter Arnold, EY UK Chief Economist, said: “The Halifax measure of house prices fell by 0.1% month-on-month in May, after being flat in April. This continued the period of relative stability in house prices observed since the start of this year.

“While 2023 was a challenging year for the housing market, data for the first half of 2024 has suggested that the market has passed the bottom. The substantial fall in mortgage rates since last summer, combined with strong growth in nominal wages, has reduced the scale of the mortgage affordability problem. This has helped to entice some buyers back to the market, leading to a recovery in transactions and putting a floor under prices.

“Over the past couple of months, mortgage rates have edged up again in response to rising swap rates, as financial markets anticipate a slower pace of Bank of England interest rate cuts. This is likely to prevent any meaningful pickup in transactions and prices in the near-term. But so far, the increases have been small and mortgage rates remain well below last summer’s peaks. The EY ITEM Club does not expect to see a renewed downturn in the housing market.

“Further out, the EY ITEM Club expects a slow and steady recovery in house prices. After the Global Financial Crisis, prices were broadly flat for three years before a recovery took hold. Though mortgage affordability is much better than it was last summer, it remains stretched relative to historical norms, and the EY ITEM Club expects only a slow fall in mortgage rates over the next couple of years. Furthermore, it’s not just the affordability of mortgage payments that is limiting the pool of potential buyers. The relatively small fall in house prices over the past couple of years means that both loan-to-income and loan-to-value ratios remain high, preventing many people from being able to access mortgage finance. Tight supply, resulting from very low levels of housebuilding, will provide some offset to subdued demand. But the EY ITEM Club expects a very slow pickup in prices over the next few years.”

06 June 2024 | EY ITEM Club comments:

Construction recovery gathered pace in May

• A two-year high for the construction Purchasing Managers’ Index (PMI) in May suggests the sector is well on the road to recovery. The EY ITEM Club expects to see a solid rebound in construction output in Q2, after Q1 was significantly affected by unusually wet weather.
• The fact that the recent upturn was broad-based across the sub-sectors and built on improving new orders suggests it should have some durability. The belated housing upturn is a lagged response to increasing evidence that housing transactions and prices have passed the bottom. The EY ITEM Club expects this recovery to continue, albeit at a modest pace. 

Peter Arnold, EY UK Chief Economist, said: “The construction Purchasing Managers’ Index (PMI) rose to 54.7 in May from 53.0 in April, reaching its highest level in two years. All the underlying detail of the S&P Global survey was encouraging. Rising activity was driven by stronger growth in new business, while supply-chain conditions continued to improve, and input cost inflation cooled further.

“The construction PMI has been a relatively good leading indicator of the official measure of construction output over the past couple of years. The official series underwhelmed in Q1, largely because of the disruption caused by a prolonged period of wet weather. However, the strength of the recovery in the PMI in April and May suggests that Q2 is likely to see a robust recovery in construction output. This should help to mitigate the impact on GDP of April’s poor retail performance and the planned healthcare sector strikes at the end of this month.

“The strength of the new orders balance suggests the recent construction upturn should have some durability, and the broad-based nature of May’s strength further supports this view. It was the first time since May 2022 that all three sub-sectors – commercial, civil engineering, and housing – reported rising activity. Experience suggests that housebuilding reacts to movements in housing transactions and prices with a lag, so the return to growth of the residential sector is a response to increasing evidence that prices and demand have passed the bottom. The EY ITEM Club expects this recovery to become more firmly entrenched over the coming months, although the pace of the upturn is likely to remain modest.”

05 June 2024 | EY ITEM Club comments:

Weaker services PMI points to less robust activity growth in Q2

• May's final UK services Purchasing Managers’ Index (PMI) signalled a more modest pace of activity growth than in recent months. In combination with April's fall in retail sales and planned healthcare sector strikes in late June, May's lower PMI readings are consistent with the EY ITEM Club’s forecast for slower GDP growth in Q2, following Q1's strong outturn.
• The survey also pointed to lower input cost inflation, as upward pressure from the introduction of the higher national living wage in April unwound in May. Together with evidence of a further slowdown in output prices, this supports the EY ITEM Club’s view that the Office for National Statistics’ (ONS) measure of services inflation will steadily cool through the summer.

Peter Arnold, EY UK Chief Economist, said: “May's final S&P Global survey reported a slower pace of services activity growth than in recent months, with the Purchasing Managers’ Index (PMI) falling to 52.9, from 55.0 in April. Respondents linked the smaller upturn to a softer rise in demand, particularly from overseas customers. But with May's earlier manufacturing survey having reported an increase in production, the fall in the composite PMI was smaller, to 53.0 from 54.1 in April.

“Though still above the 50 'no-change' mark, May's weaker composite PMI reading is consistent with the EY ITEM Club’s view that the UK is set to see a slower pace of quarter-on-quarter GDP growth in Q2. Some of the consumer strength at the end of Q1 may have reflected the earlier-than-normal Easter, so this should have unwound at the start of Q2. Indeed, April's fall in retail sales was consistent with that idea. Additionally, four days of planned junior doctor strike action at the end of June – a factor that won't be captured in business surveys – should weigh on output in the health sector this month. As a result, the EY ITEM Club thinks quarter-on-quarter GDP growth will slow, after Q1's 0.6% increase.

“On the inflation front, May's services survey reported that input costs rose at their slowest pace for three years, after the large national living wage increase had caused a significant rise in labour costs in April. Together with evidence of a further slowdown in prices charged inflation, this is consistent with the idea that services inflation will continue to cool through the summer.”

24 May 2024 | EY ITEM Club comments:

Significant fall in retail sales points to softer GDP growth in Q2

• A surprisingly substantial fall in UK retail sales in April added to the evidence that GDP growth is likely to cool a little in Q2, after Q1's very strong gain. Retail sales data is always volatile, but recent outturns have been exceptionally choppy. The EY ITEM Club expects April's fall to be reversed in May, mirroring the experience of December and January.
• The EY ITEM Club remains cautiously optimistic about the consumer outlook for H2 2024. Wages are growing strongly in real terms, following the significant fall in inflation. And strengthening confidence suggests real income gains should translate into solid spending growth, in contrast to last year.

Peter Arnold, EY UK Chief Economist, said: “Retail sales fell by 2.3% month-on-month in April, following a decline of 0.2% in March (revised down from flat). There were large month-on-month falls in sales in the food, non-food, and fuel categories, with the Office for National Statistics (ONS) blaming poor weather for reducing footfall in stores. Even by the standards of the retail sales data, which is an exceptionally volatile series, recent outturns have been particularly choppy. The early Easter has probably added to the complications this time around. But the EY ITEM Club thinks May should see a strong rebound, mirroring the experience of December and January.

“However, taking a broader sweep, it's clear that the retail sector is still struggling to generate much momentum. And coming on the back of yesterday's softer composite Purchasing Managers’ Index (PMI), it suggests that the UK is likely to see a weaker outturn for GDP growth in Q2, after Q1's very strong performance.

“Still, the EY ITEM Club remains cautiously optimistic about the consumer outlook for H2 2024. Though inflation is proving stickier than previously hoped, it has fallen significantly over the past year and most consumers are enjoying strong real wage gains. That said, the strength of real income growth is being dampened by tighter fiscal policy and, for borrowers refinancing fixed-rate mortgages this year, by the lagged impact of tighter monetary policy. But today's GfK release suggests that consumer confidence is continuing to gradually strengthen, particularly around prospects for personal finances and the economy over the next 12 months. Therefore, in contrast to the past year, the EY ITEM Club thinks there's a good chance that real income gains will translate into solid growth in consumer spending.”

23 May 2024 | EY ITEM Club comments:

Composite PMI falls, but recovery still running at a solid pace

• Though the UK composite Purchasing Managers’ Index (PMI) dropped back in May, it continued to signal a solid pace of activity growth. The UK remains on track to see another decent outturn for GDP growth in Q2, with the recovery becoming more firmly entrenched.
• Much softer cost and price pressures in the services sector provided some pushback to the narrative from yesterday's inflation data. But in terms of the June monetary policy decision, it's likely to be a case of too little too late.

Peter Arnold, EY UK Chief Economist, said: “May's flash S&P Global survey reported a fall in the composite Purchasing Managers’ Index (PMI) to 52.8, from 54.1 in April, taking the balance back to the level seen in March. A fall in the services PMI (to 52.9 from 55.0) was the cause, with growth in new orders cooling. On the flip side, the manufacturing PMI rebounded back into positive territory again (51.3 in May after 49.1 in April).

“The PMIs are often volatile from month-to-month, while the strength of last month's balance did look like an outlier compared with other indicators, so the EY ITEM Club does not see May's softer outturn as being problematic. Indeed, it is consistent with GDP continuing to grow at a solid pace in Q2, and the recovery becoming more firmly entrenched.

“The other interesting development in May's flash survey was the weakness in the costs and prices balances. Input cost inflation was the weakest in seven months, while output prices rose at their slowest pace since February 2021, with the service sector being the source of weakness in both sectors. Following on the back of yesterday's large upside surprise for services inflation, these results offer some cause to hope that the official data will cool in the months ahead. But the chances of a June rate cut look very low after yesterday's data, and softer survey data is unlikely to do much to change that.”

22 May 2024 | EY ITEM Club comments:

Inflation overshoot complicates matters for the Bank of England

• Though UK Consumer Price Index (CPI) inflation fell significantly in April, the decline was 0.2ppts less than the Bank of England had forecast. The fact that services inflation was responsible for the overshoot presents a challenge for the Monetary Policy Committee (MPC) and reduces the probability of a June rate cut.
• Inflation should still drop back to the 2% target over the coming months, as large base effects in the food and core categories continue to emerge. But with the scale of the once-a-year rises in index-linked and regulated prices being higher than anticipated, higher inflation in these categories now appears baked in for another year.

Peter Arnold, EY UK Chief Economist, said: “Consumer Price Index (CPI) inflation slowed to 2.3% in April, down from 3.2% in March. The fall was slightly smaller than the EY ITEM Club expected and 0.2ppts less than the Bank of England had forecast. About half of the decline came from the energy category, with the Ofgem price cap having been cut by nearly 12%. Other downward pressures came from the food and core categories. But the fall in core inflation was disappointingly small. Indeed, the month-on-month change in services prices was slightly smaller than last year's substantial increase, when high inflation the previous year had driven very large once-a-year price rises for many index-linked contracts and regulated prices. As expected, some categories, such as telecoms, had much smaller increases this April. But others, such as water bills, rose significantly again.

“The stickiness of services inflation presents a challenging complication for the Bank of England. The outturn for services inflation was 0.4ppts higher than the Bank of England forecast in May's Monetary Policy Report. Given the importance attached to this series as a measure of inflation persistence, the scale of the overshoot will likely make it much harder for the Monetary Policy Committee (MPC) to cut in June. Furthermore, the fact that some of the overshoot reflected higher increases for goods and services where prices change once-a-year means that higher inflation is now likely baked into these categories for another year. 

“Still, recent movements in wholesale gas futures prices mean Ofgem's energy price cap is on track to fall by another 6-7% in July. And strong base effects in the food and core categories will continue to emerge. Therefore, inflation should still drop back to the Bank of England’s 2% target over the coming months.”

22 May 2024 | EY ITEM Club comments:

A challenging start to the new fiscal year

• The new fiscal year got off to a disappointing start for the UK’s public finances, with borrowing coming in above the Office for Budget Responsibility's (OBR) forecast. The effect on debt servicing costs of higher Bank Rate and gilt yields than the OBR assumed in its Budget forecast mean that this underperformance is likely to continue for the rest of the financial year.
• It's unlikely that OBR forecast revisions would offer the government scope for another tax-cutting fiscal event before the next general election. However, it is possible that the Chancellor could still create room for tax cuts by asking the OBR to assume even greater spending restraint.

Peter Arnold, EY UK Chief Economist, said: “Public sector net borrowing (excluding public sector banks) came in at £20.5bn in April, £1.5bn higher than a year ago and £1.2bn above the Office for Budget Responsibility's (OBR) forecast. The overshoot against the OBR's forecast reflected both softer growth in tax revenues and higher spending.

“The EY ITEM Club thinks this underperformance will continue through the rest of the financial year, given that gilt yields and Bank Rate are set to be higher than the assumptions used in the OBR's March forecast, implying higher-than-expected debt servicing costs. Some of this impact looks likely to endure to the end of the OBR's five-year forecast horizon, cutting the already-slim headroom against the government's main fiscal rule. The annual roll forward of the forecast horizon would be supportive of the fiscal arithmetic, but equally there's always the risk that at some point the OBR will revisit its optimistic growth forecasts. Therefore, the scope for another tax-cutting fiscal event before the election looks limited, unless the Chancellor opts to make further changes and asks the OBR to assume even greater spending restraint.

“Fiscal policy is due to be tightened significantly over the next five years through both higher tax revenues, via the ongoing freeze of most allowances and thresholds, and very tight spending plans. Given Labour’s vow to maintain the existing debt rule, it’s unlikely a potential change of government would yield a markedly different approach to fiscal policy. Still, there may be an incentive for whoever forms the next government to front-load the fiscal tightening and get the bulk of it out of the way early in the term, well before they need to seek re-election.”

14 May 2024 | EY ITEM Club comments:

Pay data keeps the Bank of England on track to cut interest rates

• Private sector regular pay growth for March came in slightly lower than the Bank of England's forecast, clearing the first hurdle for a rate cut. But next month's release will likely present a more significant obstacle given it will factor in the effect of April's near-10% rise in the national living wage, while underlying pay pressures remain firm.
• Though the EY ITEM Club puts little weight on the Labour Force Survey (LFS) estimates given the ongoing problems with small samples, other indicators also suggest labour market conditions are continuing to loosen. This should further drag on pay growth over the coming months.

Peter Arnold, EY UK Chief Economist, said: “The headline finding from today's labour market release was that private sector regular pay growth – the Bank of England's favoured measure – edged down to 5.9% in the three months to March. The minutes of last week's Monetary Policy Committee (MPC) meeting made clear that outturns for this variable and services inflation would be key determinants of the timing of the first rate cut. The Monetary Policy Report included a Bank of England staff projection that pay growth would be 6% in the three months to March, so on the face of it, today's outturn effectively clears the first hurdle for a rate cut.

“However, next month's data – which will include the impact of April's near-10% rise in the national living wage – is likely to be more important. Timelier HMRC data showed a rise in pay growth in April. And with the main measure of pay growth running above 5% on a three-month-on-three-month annualised basis in March, a sizeable minority of the MPC may see today's data as evidence that there's still work to do before rates can be cut. 

“Conversely, another factor that will be supportive of rate cuts is the continued loosening in labour market conditions. The ongoing volatility caused by low response rates means the EY ITEM Club places little store on the LFS data, which showed the unemployment rate edging up to 4.3%. However, a range of other data suggests conditions are continuing to loosen. Most notably, vacancies continued to edge down, while HMRC's count of employees on payrolls showed a large month-on-month fall in April. Furthermore, loosening labour market conditions should add to the downward pressures on pay growth over the coming months.”

10 May 2024 | EY ITEM Club comments:

Strong March delivers a big upside surprise for GDP in Q1

• A big upside surprise for UK GDP growth in Q1 adds to the evidence that the economy is on the road to recovery after two years of stagnation. Early business survey data for Q2 also suggests the momentum is being maintained.
• The first cut of the expenditure data for Q1 showed a surprisingly small contribution from consumer spending. But the EY ITEM Club expects the consumer outlook to strengthen as we move through the year, via a combination of solid real income growth and some dis-saving. 

With the lagged effect of tighter monetary policy still emerging and fiscal policy becoming progressively tighter, the EY ITEM Club expects the economic recovery to be steady rather than spectacular.

Peter Arnold, EY UK Chief Economist, said: “GDP comfortably exceeded expectations in March, growing 0.4% month-on-month. March's expansion was relatively broad-based, but there were particularly large contributions from consumer-facing services and health. The health sector saw the drag from industrial action fade away, with no nationwide industrial action in March. The consumer strength may partly reflect the earlier-than-normal Easter, suggesting there could be some payback in April. But conversely, there's scope for a rebound in construction output, since unusually wet weather hampered activity in the sector in both February and March.

“With February's growth also revised up (to 0.2%, from 0.1%), this meant that GDP rose by 0.6% quarter-on-quarter in Q1. The Q1 gain more than offset the small falls in output seen in H2 2023. The first cut of the expenditure data for Q1 showed strong contributions from investment and net trade, though the latter was again affected by flows of non-monetary gold. Consumer spending edged up, but the scale of the rebound was underwhelming, particularly given the larger pickup in distribution activity reported in the output data.

“Early business survey data for Q2 has been positive, with the composite Purchasing Managers’ Index (PMI) reaching an 11-month high. Though consumers had a relatively slow start to the year, the EY ITEM Club expects them to lead the recovery, with lower inflation driving solid real income growth and the savings ratio likely to drop back from its recently high level. Therefore, the EY ITEM Club expects Q1 to mark the beginning of a sustained recovery in economic growth after two years of stagnation. However, with the lagged effect of tighter monetary policy still emerging and fiscal policy becoming progressively tighter, the recovery is likely to be steady rather than spectacular.”