UK wage growth slowing, but from high rates
- Today’s UK labour market report described a situation where activity in the UK labour market continues apace (payrolls and LFS employment robust, unemployment remaining low), but there are some signs that pay growth may be easing.
- We’ve seen this in the surveys too, such as the REC, which has reported slower pay growth, even if it does remain above normal for now.
- Nonetheless, pay growth over recent months has still been strong enough, in our view, to justify another 25bp hike by the Bank of England at its March meeting, though of course we’ll have had another labour market report by then (and two CPI prints).
EUR, GBP and market thoughts
- After a series of hot US data prints, it would be surprising if the USD wasn’t stronger. But looking ahead we expect the factors that drove EUR/USD to 1.10 to kick back in (euro area terms of trade up, growth bouncing, China reopening).
- However, our previous target of 1.11 in February for EUR/USD looks less feasible as investors wait to see whether February provides payback for US data bounces (i.e. softer US CPI) or continued strength for the data. EUR’s climb to 1.11 could now be a March story.
- Meanwhile, weak UK CPI data highlight how the UK may be quicker to slow down than others, raising our confidence of EUR/GBP trading into a range of 0.90-0.92 in Q2. Naturally, risk sentiment taking a hit from Russia’s spring offensive is real, but Russia’s oil production cut has so far potentially been offset by higher US, Europe and African oil production increases.
China’s reopening: Implications for Europe
- With China reopening we take a look at how this might affect the European growth, inflation and policy outlook.
- China’s increased importance in the global economy over recent decades has been felt by some countries more than others – in Europe, Germany, for example, could stand to benefit by more to the extent that its share of GDP exported to China has risen among the fastest and to higher levels than most countries.
- But with Germany being a large global producer of manufactured goods and consequently importer of commodities, this may mean more resilient price pressures in Europe if China’s reopening leads to significantly higher global commodity prices. This in turn could hamper growth.
UK inflation: the long road back to target
- Today’s inflation data send the right signals to the Bank of England, with services inflation falling significantly in January. This brought down core and headline CPI inflation by more than economists expected.
- Core inflation is still too high for the Bank of England so, in our view, there is likely to be another 25bp hike at its March meeting. However, today’s inflation numbers (and yesterday’s underlying wage data) give us more confidence that this will be the last hike in this cycle, bringing Bank Rate to a terminal level of 4.25%.
- Headline UK CPI inflation slowed in January to 10.1% from 10.5% in December. This was lower than economists’ expectations for a 10.3% rise, with the biggest surprise coming from core inflation, which fell to 5.8% from 6.3% (consensus and Nomura: 6.2%).
The inflation risks in H2 2023 are bigger in Europe
- A potential wedge is opening up between inflation risks for the US and euro area later this year – one in which euro area inflation may remain hotter than in the US.
- However, in the near-term, every leading indicator of inflation that we track points to big disinflationary pressures in coming months (a variety of lead-lag relationships, surveys, shipping costs, energy prices, etc).
- But China’s reopening and strong US labour market data have markets wondering whether a second round of inflationary pressures is building in H2 2023 and beyond.
Cautiously optimistic on UK price data
- In the euro area, it goes without saying that survey measures overstated the negative growth outlook during H2 2022. The question now, however, is whether they are overstating the near-term positive growth outlook.
- With the ECB’s aggressive monetary policy tightening, and financial conditions reaching levels not seen since the 2012 sovereign default crisis, and with the lags involved, we still expect a recession, albeit expect it to be short (three quarters) and mild (GDP to fall by only 0.7% peak-to-trough).
- In the UK, inflation data softened, supporting our forecast that the Bank of England only hikes once more in the current cycle. However, the labour market report looked strong with payrolls and wage growth up and exceeding expectations.