15 February 2023: Private sector pay an issue

While the wave of industrial action that is blighting the outlook for the public sector shows little sign of abating, the Bank of England is likely to be concerned by the inflationary nature of pay deals in the private sector.

The January employment report was published yesterday and while the jobless rate remains close to a historic low at 3.9%, it is the average earnings figure that will contribute to another hike at the next rate setting meeting.

Average earnings not including bonuses rose by 6.7% in the three months to December, and another 12.9k workers left the claimant count. The previously published claimant count figure was revised from -19.7k to -3.2k.

In the Budget due next month, Chancellor Jeremy Hunt is expected to do away with the cap on Bankers bonuses that was an EU initiative made law in 2014.

Another possible change in taxation that is expected in the Budget is a reduction in VAT. It is unlikely that it will be an across the board cut, fuel and public transport are two areas apparently being looked at.

The dumping of hundreds of laws that arrived on the UK’s statute books courtesy of Brussels are expected to be repealed in the coming weeks, but in a surprise move, the Confederation of Small Businesses commented recently that it doesn’t expect any major simplification of trade, particularly in the area of import and export.

While deregulation remains a major initiative for the Government, the lack of foreign workers is driving down productivity in two sectors in particular, agriculture and hospitality.

A lack of foreign workers continues to drive a shortage of candidates, which leads to an increase in wages being demanded.

The January employment report will be released today, with headline inflation still in double figures despite the Bank of England having hiked interest rates at ten consecutive meetings.

The effect of multiple increases was never expected to have a radical effect on inflation until rates reached a restrictive phase, which they are likely to be close to reaching. Lower energy costs will bring the headline down, but food inflation reached another high of 13.3% in January, which held back the fall in the headline.

Sterling rallied to a high of 1.2262 yesterday, but fell back to close at 1.2177 in the wake of the U.S. inflation report. It remains hemmed in by technical support and resistance at 1.2260 and 1.2080.

The January inflation report that was published yesterday threw up more questions than it answered, particularly around the actions of the Central Bank.

For some considerable time, members of the FOMC have commented that they are data driven when voting for rises in interest rates, but appear to be looking at each month’s figures in isolation.

The fall in headline inflation in January was just 0.1% from 6.5% to 6.4%, and could be almost totally be explained by lower energy costs. The core fell by the same amount from 5.7% to 5.6%.

Questions are being raised whether the Fed, which is still predicting an average core inflation rate of 5% for 2023, is more than a little concerned about the effect of interest rate hikes that has seen the fed funds rate move from close to zero to almost 5% since last Spring.

Short-term interest rates have moved into restrictive territory following the latest increase, but while that is probably dampening down demand, the effect on both new jobs and average incomes has so far been negligible.

Every month, there are those commentators who believe this will be the month when employment cools but in January despite a series of extraordinary factors the economy still produced more than 500k new jobs and average hourly earnings were barely changed.

The minutes of the latest FOMC meeting will be released next Wednesday, and they will make interesting reading as they are pored over to find the reason why a majority of members voted to taper of the hike from fifty to twenty-five basis points.

Data for retail sales will be released later today. Following a fall of 1.1% in December, the data is expected to bounce back and see an increase of close to 2%.

Yesterday, the dollar reacted badly to the inflation report, since there is a degree of confusion over the continuation of the Fed’s moderation of its rate hikes.

The dollar index fell to a low of 102.54, but recovered to close at 103.25.

It is impossible to imagine monetary policy having the same effect on every member of the Eurozone. For that reason, the level of growth, or contraction, seen by each economy is likely to vary significantly.

This is one of the factors that makes the job of Christine Lagarde and her colleagues at the ECB extremely difficult.

There is a theory that given the lack of any form of fiscal union, comparisons of the twenty-one economies that now make up the Eurozone is both futile and pointless.

Several economists are now looking at growth through the lens of individual sectors. Since for example construction has similar drivers in Germany as it does, say, France or Spain, they bear more resemblance than the economies of those countries.

This is particularly true since fiscal policy can provide support to the economy, while state aid of specific industries is specifically precluded.

Construction in the Eurozone is without question in recession. Output across the entire sector has been falling for four straight months, while there has been a significant upswing in investor confidence.

The contraction in construction has been far more severe than that of the entire economy and paints a more obvious picture of the situation on the ground.

There are several technical avenues that are open to Brussels to massage the numbers to show that the economy, while stagnating, didn’t fall into recession.

The Governor of the Irish Central Bank, Gabriel Makhlouf, suggested in an interview yesterday that the ECB could push interest rates to 3.5% and hold them there for the rest of the year.

In a speech centred mostly on his concerns that cryptocurrencies are worthless assets, and little more than an elaborate Ponzi scheme, Makhlouf said he sees sufficient support for further rate increases as long as the Central bank demonstrates to Eurozone members that is has a clear exit strategy that is driven by the data and considers trends particularly in the place of the fall in inflation.

He also said that the ECB should consider using a representative basket to calculate the inflation rate, rather than each inflation rate individually.

The euro drifted yesterday, driven by the market’s reaction to the U.S. inflation report. It rose to a high of 1.0804 but was unable to achieve any follow through and fell back to close at 1.0738.

Have a great day!