Economic Highlights

The MPC maintained its various policy settings at August’s meeting, as widely expected. Most visibly it kept the Bank rate at 0.10%. The targeted stock of gilt purchases was left unchanged at £875bn and that for corporate bonds at £20bn.The vote on the Bank rate was unanimous at 8-0 (awaiting the new member to join). The growth forecast for 2021 was unchanged at 7.25%, but raised by 0.25% to 6% for 2022. Unsurprisingly inflation was the biggest source of revisions, with the Bank now seeing inflation rising to 4.0% over Q4 this year and Q1 next. However, although inflation is still forecast to be marginally above the 2.0% target in Q3 2023, it subsequently falls and stands at 1.9% at the end of the third year of the forecast horizon. The key collective message from the committee is very Fed-like in the sense that the current rise in inflation is believed to be transitory. The most interesting area of discussion was the Bank’s conclusions on the sequencing of measures, once the appropriate point to tighten monetary conditions is reached. The committee now intends to consider not replacing maturing gilts in its portfolio once the Bank rate reaches 0.5%. It would then be open to outright gilt sales when at a 1% policy rate. Previously the Bank rate threshold for a reduction of the balance sheet was 1.5%. However, neither we nor the market expect to see these levels hit soon, with the first rate rise of just 0.15% to 0.25% no earlier than Q2 2022.

The US labour market report was unquestionably strong, with payrolls rising by 943k in July (f/c 858k). There were upward revisions to previous data too. Jobs gains were largely concentrated in the service sector, especially leisure and hospitality (+380k). There were also large gains in local government education (+221k) and private education (+40k), possibly the result of seasonal distortions that will reverse once the school year begins again, as there were fewer layoffs during the summer than in typical years. The unemployment rate declined markedly, dropping by 0.5% to 5.4%, but still clearly above the pre-pandemic level of 3.5%. Average hourly earnings rose by 0.4% on the month and 4.0% y/y. The report offers reassurance to the Fed that further progress towards its employment goals is being made, which should pave the way for tapering in the coming months. But it is not clear that progress is so rapid that starting to taper before the end of the year will be necessary.

Although consumer price pressures are lower in Europe than elsewhere, the pipeline looks more ominous, with Producer Prices rising 10.2% y/y. It remains to be seen what power companies have to pass these on to consumers, or whether margins will be hit. Meanwhile there were signs of deceleration in overall economic growth, with the Composite PMI settling at 60.2 vs 60.6, although this remains a pretty strong underlying number. Retail Sales growth dipped to 1.5% m/m in June from 4.6% in May, with the year-on-year figure falling from +9% to +5%. Still healthy too, but more evidence of “peak growth”.

Both CPI and PPI data for July was stronger  than expected at 1% & 9% y-o-y respectively. The divergence between the CPI and PPI indices indicate that the downstream impact of high material costs seem not to be passing through to the wider economy. On the CPI front, service sector items increased by 1.6%, however a fall of 3.7% y-o-y in food prices capped the headline inflation print.