Economic Highlights

The UK economy has turned out to be more resilient than expected in recent months. Not only did May’s GDP report show growth of 0.5% month-on-month (against expectations of being flat), but there were also upward revisions to March and April’s figures. Manufacturing posted its biggest monthly gain since November 2020, and travel-related services, perhaps unsurprisingly, grew 11%. Even so, with inflation still outstripping wage growth, it is difficult to see consumption accelerating further, especially when people return from summer holidays that they booked months ago and with the prospect of another big rise in energy bills to come in the autumn. Investec Economics forecasts that the UK economy will indeed tip into a mild technical recession around the end of the year. When it arrives, June’s data will be clouded by the effects of the long Jubilee weekend bank holiday, which will only add to the Bank of England’s soul-searching about how aggressively to tighten monetary policy.

It was a bumper week for US economic data, with the headliner being the 9.1% year-on-year headline consumer price inflation print, the highest seen since 1981. Within the details, services inflation accelerated from 5.2% to 5.5%, while goods inflation subsided slightly from 8.5% to 7.2%. The latter print is consistent with some reduction in supply chain disruption and possibly also some clearing out of excess inventory. The Federal Reserve’s “Trimmed Mean” reading, which excludes the extremes of price changes (and claims to be a better measure of core inflation), also rose from 6.53% to 6.93%. Later in the week, there was a mixed set of further data on the economy. The New York Empire State Manufacturing survey jumped back into positive territory, but the outlook readings were less optimistic. Retail sales in June (+1% month-on-month) also beat expectations, although much of this was due to higher nominal prices, and so not in real terms. Industrial production in June missed forecasts, but there was a small and welcome bounce in the University of Michigan Consumer Sentiment Survey, probably helped by some easing in gasoline prices and mortgage rates, both of which are highly correlated with short-term sentiment. Perhaps the best news for the Fed was that surveyed inflation expectations also retreated. The one-year ahead reading fell from 5.3% to 5.2% (vs 5.3% expected), while the 5-10 year measure dropped from 3.1% to 2.8% (3% expected). These are relatively small sample surveys (a few hundred people), but seem to have an outsized influence on the Fed’s decision-makers. All in, though, expectations remain that the Fed will crack on with its rate rising policy at the end of the month, definitely to the tune of 0.75%, while the chance of a 1% rise now looks to have reduced.

The latest ZEW investor sentiment survey did not read well for Europe’s economic outlook. German sentiment slumped in July to the lowest level since 2011, with both current conditions and expectations readings coming in below estimates. The wider Eurozone readings were equally dismal, with the expectations index falling to -51.1 from -28.0. At the same time, Euro area inflation expectations continued to rise, having fallen back in previous months. Another signal of Europe’s malaise is the trade balance, long considered one of the region’s pillars of support. With demand from China weak and with domestic disruption from sharply higher energy prices, the Eurozone posted another trade deficit in May. More tellingly, even Germany experienced its first trade deficit since 1991. Along with the interest rate differential and worries about Italian politics (again), this heaps further pressure on the euro, which traded below parity with the US dollar for the first time in two decades.

China’s economy expanded by just 0.4% year-on-year in Q2, below consensus estimates of a 1.0% rise. On a quarter-on-quarter basis, the fall was 2.6%. Even so, the underlying weakness was not necessarily a big surprise given the country’s relentless zero-Covid policy, which saw many big cities under lockdown for considerable periods of time. There was some solace in June’s retail sales data, where growth of 3.1% year-on-year beat flat expectations, but these numbers will continue to be volatile as Covid case numbers ebb and flow. Whether the Communist Party adheres to its stated goal of 5.5% GDP growth for the year remains to be seen. Still, the experience so far suggests that it will be a tall order, at least without applying some aggressive stimulus to the economy, of which there have been only limited signs so far.