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

Retail sales rebounded in July but data may remain noisy

• Retail sales rebounded in July after a poor June, driven by an upturn in stronger spending in department stores. The retail sales series is notoriously volatile and recent outturns have been exceptionally so. But looking through the noise, the EY ITEM Club sees signs of a gradual improvement in sales over the past year.
• The consumer outlook remains relatively upbeat. Tighter fiscal policy and the lagged effect of past interest rate rises will continue to weigh on spending power. However, sustained real wage gains should boost real household income growth and, provided consumer confidence continues to rise, the EY ITEM Club thinks retail sales will strengthen further in H2 2024 and 2025.

Peter Arnold, EY UK Chief Economist, said: “Retail sales volumes rose 0.5% month-on-month in July, following June's 0.9% fall (revised from -1.2%). Higher sales in July were largely driven by a rebound in non-food retailing. The Office for National Statistics (ONS) attributed this to summer discounts and sporting events. But the first of those arguments looks difficult to justify, given that prices rose on a seasonally adjusted basis in July. A more plausible explanation is that the data has been noisy over the past year, and July's rebound merely continues this pattern.

“With July's modest retail rebound coming alongside some solid business survey data, the EY ITEM Club thinks there's a good chance that month-on-month GDP growth resumed in July, after output was unchanged in June. 

“Given the exceptional volatility over the past year, it's hard to identify underlying trends. Still, the EY ITEM Club thinks there has been a gradual increase in consumer demand. Meanwhile, the consumer outlook looks reasonably positive, so the EY ITEM Club expects the retail sector's fortunes to improve in H2 2024 and 2025. Real incomes have grown strongly over the past year, which has put household finances on a firmer footing. Tighter fiscal policy will continue to weigh on spending power, as will the effect of past interest rises on debt service payments for some mortgage holders. However, real wage increases will continue to support spending power and, provided consumers adopt a less cautious attitude to spending and credit demand, the EY ITEM Club expects retail sales to continue strengthening.”

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

Flat June completes another strong quarter for GDP

• Though UK GDP was flat in June, this was a slightly better outturn than the EY ITEM Club had expected, given the drags from the health and retail sectors. GDP rose by 0.6% quarter-on-quarter in Q2, a second successive strong outturn following two years of economic flatlining.
• The EY ITEM Club expects GDP to continue to grow at a solid pace in H2 2024 and 2025, despite the likelihood that the economy will struggle to sustain recent above-trend growth rates. The consumer outlook is reasonably positive but drags from the lagged impact of past interest rate rises and tighter fiscal policy will mean activity growth is steady rather than spectacular.

Peter Arnold, EY UK Chief Economist, said: “GDP was flat in June, after having grown by 0.4% month-on-month in May. June's softer outturn was largely due to three factors. First, retail sales fell significantly, continuing a run of very volatile outturns for the sector. Second, four days of industrial action in the healthcare sector meant that many operations and hospital appointments were cancelled, which dragged on health output. And third, some parts of the services sector had enjoyed a rise in output over the previous couple of months but then saw some payback in June.

“June's outturn left GDP up 0.6% quarter-on-quarter in Q2, following growth of 0.7% in Q1. The first cut of the expenditure data showed that government consumption was the key driver of GDP growth in Q2. Meanwhile, there was another somewhat underwhelming quarter-on-quarter increase in consumer spending (0.2%). Household income data won’t be published until the next release on September 30, but the EY ITEM Club expects real incomes to have grown at a faster rate than the tepid increase in spending, implying a further rise in the household saving ratio.

“The prospect of rebounds in health and retail output in July means that Q3 should get off to a reasonable start. Beyond that, the EY ITEM Club expects the economy to continue growing at a decent pace, though it will struggle to sustain the above-trend rates seen in H1 2024. Continued solid real income growth and a less cautious attitude from consumers should underpin firmer growth in household spending. However, with the lagged effect of past interest rate rises continuing to emerge, and the government expected to tighten fiscal policy, the EY ITEM Club predicts that GDP growth will be steady rather than spectacular in H2 2024 and 2025.”

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

Inflation edged up in July due to energy-related base effects

• UK Consumer Price Index (CPI) inflation edged up in July, as base effects in the energy category more than offset a slowdown in services inflation. With further base effects still to come, the EY ITEM Club expects headline inflation to rise gradually over the rest of H2 2024.
• Services inflation undershot the Bank of England's new staff forecast. However, the more dovish majority on the Monetary Policy Committee (MPC) are now placing less emphasis on this measure, and have signalled they will take a cautious approach to loosening policy. Therefore, the EY ITEM Club still thinks back-to-back rate cuts are relatively unlikely.

Peter Arnold, EY UK Chief Economist, said: “CPI inflation rose to 2.2% in July, from 2% in June. A smaller drag from the energy category added almost 0.5ppts to the headline rate in July, with last month's 7% cut in the Ofgem price cap less than half of the fall seen in July 2023. But this upward pressure was offset to a certain extent by lower services inflation, which partly reflected the unwinding of June's unusual rise in hotel prices.

“The outturn for services inflation in July was 0.4ppts below the Bank of England's new staff projection of 5.6%. However, the EY ITEM Club is sceptical that this will shift the dial on the outlook for interest rates. Minutes of recent MPC meetings have indicated that the dovish majority feel they now have a better understanding of the inflation generation process and are placing less weight on backward-looking measures such as services inflation. Having overlooked recent overshoots for services inflation, the EY ITEM Club would expect the MPC to treat undershoots in the same way and maintain the gradual pace of loosening signalled at the August meeting. The EY ITEM Club expects the MPC will vote to keep Bank Rate at 5% in September, before delivering another 25bps cut in November.

“The EY ITEM Club expects CPI inflation will gradually drift upwards throughout the rest of H2 2024. Services inflation should continue to cool as businesses pass on the gains from lower energy costs to their consumers. However, this is likely to be more than offset by the fading drag from the energy category.”

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

Pay data offers something for doves and hawks alike

• A steady slowdown in UK pay growth, partly due to base effects, will likely reinforce existing perspectives within the Monetary Policy Committee (MPC). The doves will view it as evidence that the inflation shock is dissipating, suggesting that policy can be gradually loosened. Hawks will argue that pay growth is still too high for inflation to remain at 2% over the medium-term.
• The loosening in labour market conditions seen in early-2024 seems to have tailed off. But with vacancies still falling and HMRC's count of payrolled employees only edging up, the labour market appears to be broadly stable, rather than tightening again.

Peter Arnold, EY UK Chief Economist, said: “The main measures of pay growth continued to cool in the three months to June, though base effects caused by large increases last summer played a major role. The fall in whole economy total pay growth was particularly large, declining to just 4.5% in the three months to June from 5.7% in May, driven in part by the one-off bonuses awarded to National Health Service (NHS) and civil service workers last June. Headline (three-month average of the annual rate) private sector regular pay growth fell to a 25-month low of 5.2% in June. 

“The EY ITEM Club expects that different camps within the MPC will likely see this as vindication of their recent votes. The doves will interpret slower wage growth as evidence that the inflation shock is dissipating, suggesting that policy can be gradually loosened. But the hawks will likely maintain that the rate of pay growth is still too high to keep inflation at 2% over the medium-term.

“Other data also presents a mixed picture. HMRC's timelier measure of pay growth rebounded in July, after a very soft reading in June. The Labour Force Survey (LFS) showed a surprise fall in unemployment to 4.2% in Q2, following an exceptionally low single-month reading for June. But with Office for National Statistics (ONS) methodological improvements yet to be incorporated, the EY ITEM Club is sceptical of LFS data as a reliable indicator and expects June's reading may prove to be more noise than signal. Vacancies continued to fall, but HMRC's count of payrolled employees rose again in July. While labour market conditions are no longer loosening in the way they were in early 2024, there's little evidence that they are tightening again either.

“The weakening in pay growth is unlikely to be sufficiently significant to convince enough doves to vote for back-to-back rate cuts. Therefore, the EY ITEM Club still expects the MPC will opt for a 25bps Bank Rate cut in November.”

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

Halifax reports surprise increase in house prices in July

• The EY ITEM Club is approaching July’s rise in house prices on the Halifax measure with a degree of caution. This data can be prone to volatility, particularly in the quieter months of summer. And today’s data only took prices back to the level they were in February.
• Though mortgage affordability is better than last summer, it remains very stretched, which is limiting the pool of potential buyers. The EY ITEM Club expects to see a period of relative stability for activity and prices until this valuation gap closes.

Peter Arnold, EY UK Chief Economist, said: “The Halifax measure of house prices rose by 0.8% month-on-month in July, after prices were flat in the previous three months. But the lenders’ series are prone to volatility, particularly in the summer when activity tends to be lower, so the EY ITEM Club is approaching today’s data with a degree of caution.

“Indeed, July’s increase only took prices back to where they were in February. Stepping back and looking at the bigger picture, the market has been fairly flat so far this year in terms of both prices and transactions, and the EY ITEM Club thinks these conditions are likely to persist.

“Mortgage rates remain well below the levels seen in both late-2022 and last summer. This, combined with strong growth in nominal wages, has reduced the scale of the mortgage affordability challenge, which has helped to entice some buyers back to the market.

“But while mortgage affordability is much better than it was last summer, it remains stretched relative to historical norms. And though financial market pricing has moved a little in response to last week’s interest rate cut from the Bank of England, the adjustment implies only a modest fall in quoted interest rates for fixed rate mortgages, indicating that mortgage affordability will likely remain stretched. Other affordability metrics, such as loan-to-income and loan-to-value ratios, also remain high. This is preventing many people from being able to access mortgage finance and limiting the pool of potential buyers. 

“The EY ITEM Club thinks the most likely scenario is that this period of relative stability in activity and prices continues in the near-term, at least until the valuation gap closes. This would be consistent with the post-Global Financial Crisis experience, where prices were broadly flat for three years before a recovery took hold.”

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

Construction recovery back on track after June blip

• The construction Purchasing Managers’ Index (PMI) rose to its highest level in more than two years in July due to stronger activity in all three sub sectors. The EY ITEM Club expects to see a firm rebound in the official construction output series in Q3, after unusually wet weather had disrupted the first half of 2024.
• Housebuilding activity recovered after a temporary setback in June and the EY ITEM Club expects this to continue. Housing transactions and prices appear to have passed the bottom and businesses should feel more confident about building. The government’s focus on housebuilding should also help, though some have suggested the sector may need to enhance its current capacity to support a substantial step up in activity. 

Peter Arnold, EY UK Chief Economist, said: “The construction PMI rose to 55.3 in July from 52.2 in June, reaching its highest level since May 2022. As with the manufacturing and services surveys, the 2024 General Election appears to have injected some month-to-month volatility into the construction survey results, with a soft June followed by a stronger July as uncertainty cleared. The detail of July’s survey was also positive, with new orders growing at the strongest pace in more than two years, and hiring and purchasing activity also increasing. After a challenging couple of years, the construction sector appears to be in the early stages of a strong recovery.

“Unlike its manufacturing and services counterparts, the construction PMI has been a relatively good leading indicator of the official measure of construction output over the past couple of years, although that relationship has faltered somewhat of late. The disruption caused by a prolonged period of poor weather is probably a factor in the recent weakness of the official output series. But given that has been less of an issue in recent weeks, the EY ITEM Club expects to see construction output grow strongly in Q3.

“The sub-sector breakdown showed activity increasing in all three sectors in July, after housebuilding had endured a blip in June. The EY ITEM Club expects the recovery in housebuilding activity to continue. House prices and transactions appear to have passed the bottom, so businesses should feel more confident about building. The new government’s focus on housebuilding also promises to be positive for the sector. However, some have suggested that in order to meet national housebuilding targets, the sector will need to take steps to enhance its capacity, particularly when it comes to securing staff with the necessary skills.”