Equities have had a tough time of late. And fears of higher interest rates are the main reason. The markets are pricing in a 90% chance that the European Central Bank and the US Federal Reserve will hike rates by 25 bps in their upcoming meetings. It’s a 90% chance for the Bank of England (BoE) too but that’s for a 50-bps move. No wonder that the FTSE 100 has failed to be live up to its defensive reputation during the latest sell off.
Central banks keep telling us that their policy decisions are data dependent and the focus this week is on US consumer inflation which is out on Wednesday. But that’s a lagging indicator and I’m much more interested in data that gives us clue about the future, so I’ll be watching the National Federation of Independent Businesses (NFIB) survey – which is out on Tuesday 6am Eastern Standard Time. This is a good guide to small businesses which tend to be underrepresented in much of the data but account for the overwhelming bulk of employment. The NFIB also reports on plans to raise wages, and these are falling too. They are a reliable guide to the Federal Reserve’s preferred measure of wage inflation, the employment cost index. This measure is quarterly, but the next number is due at the end of July.
If the new numbers from the NFIB show a further decline, the Federal Reserve may still go ahead and hike but could indicate that they will pause further tightening. The markets will then take comfort.
Much more uncertainty surrounds the BoE. In contrast to the position in Europe and the US, core inflation has picked up in the UK. Wage inflation has also shown signs of acceleration. All very worrying and I’ll be honest – I did not expect the increase in inflation– and there are reasons why the data might get worse before it gets better.
Some of the increase in wage inflation reflect April’s 10% rise in the minimum wage. As this has risen relative to other wages in recent years, it affects more and more people. The BoE has told us that it focuses on wage inflation over three months annualised and that will exaggerate the impact. At a more fundamental level, UK consumers are gaining confidence and still have a pile of unspent savings left over from covid. Despite the cost-of-living crisis and the surge in mortgage rates the outlook for consumer spending has improved markedly in recent months. Many firms, unable to hire workers appear to have decided to put their prices up instead.
It could be a long hot summer in the UK. But further out, things should get better. First, labour supply is increasing. Some of this reflects the rise in non-UK born workers. Immigration is on the up as firms learn the new rules and how to fill in the forms post-Brexit. The salary threshold was increased by only 2% this year, a cut relative to other wages. But it’s not just new migrants here. Many of the non-UK born workers had been here for many years but went home after Brexit or during covid. Most of UK born workers who left the labour force due to covid have now returned. The only exception is long term sick which will take time to reverse.
The UK labour market is easing slowly but surely. There are some other positives for inflation. The impact of last year’s sterling weakness is probably adding around 2% to current inflation. Given the lags this is likely to disappear over the balance of the year and should be a favourable factor in 2024. Some branded products can now be bought online from Europe at lower prices than are available in the UK and food prices will fall as contracts are re-set. Headline inflation should continue to fall with household energy bills down 17% this month and likely to fall further in in October.
I think the BoE will hike rates by 50 bps in their meeting on 3 August. They need to restore their credibility after several miss steps and this may make them more hawkish. The markets will be watching vote closely, especially given the new member’s debut.
So, what does all this mean? I do think we are close to the peak in US rates and I expect significant declines in the year ahead. There’s a lot more uncertainty in the UK. I expect rates to fall in 2024 too but they are headed higher first, possibly a lot higher first.
