Deck the halls with higher expectations

Last week must have felt like Christmas had come in July for those people who want the Bank of England to start raising interest rates this year. Both the most recent runs of inflation and unemployment data came out very strong, particularly the former; from a macroeconomic point of view this was a healthy dose of justification wrapped in a bow of consensus beating. We still have our doubts though.

The inflation picture was a real surprise. The June annual rate of inflation is now rising at 1.9%, much higher than the 1.6% consensus. This was fastest rate since January with clothing, food and transport contributing well. What is more of a surprise is the rally in core prices to 2% given the move higher in sterling in the past few months; it is currently only around 0.3% from a fresh 5 year trade weighted high.

Once again we are seeing a divergence in the data from the ONS and other surveys; last week’s poor industrial output numbers jarred against recent PMI sentiment surveys and likewise, today’s inflation number tells a different story to the British Retail Consortium that has, earlier in the day, warned of very low inflation this month.

Why are we not getting carried away? The rises were largely seen in the more volatile components of the basket such as clothing, which also benefited from the typical summer sales starting a little later this year than normal. Durable goods prices only rose by a marginal 0.2% and we can easily see the overall headline number resuming a lower trend next month following this rather elevated reading.

Likewise we remain encouraged with the declines in the headline unemployment rate and the overall jobless claims number which lost around 36,000 people in the month of June. Employment overall has now reached a record of 73.1% – the highest since 2005 with a strong expansion in full-time work. Previous moves lower in the unemployment rate have been largely as a result of increases in the number of self-employed registrants. A continuation of this trend is a very encouraging sign for the longer-term prosperity of workers.

Unfortunately, at the moment our preferred measure of prosperity continues to slip in the UK. Earnings growth slipped to 0.3% in June, down from 0.7% and leading the differential between price and wage increases back above the 1.5% mark for the first time since Q4 of last year. Following a brief period of real wage growth at the beginning of the year we are squarely back in negative territory.

We are forecasting that wages will increase in the UK, as slack in the labour market dissipates, but there is almost no chance that the Bank of England’s real wage growth target of 2.5% by year end is met. In this case, we are in agreement with the more dovish members of the Bank of England’s Monetary Policy Committee that despite overall feelings of strength within the UK economy, wage growth is far too fragile for a rate increase this year and we would be looking for it to be closer to 2% in nominal terms before considering it.

As such we anticipate a unanimous vote for policy to have been kept on hold this month.