13 September 2023: Pay rises at record rate despite higher unemployment

There has been a remarkable turnaround in the fortunes of the country in the past three months. The country was headed for a damaging recession as a “doom loop” of negative economic developments looked likely to engulf it.

Then the IMF produced a report in which it predicted that the UK would not fall into recession this year and the ONS updated its data on the country’s post-Pandemic performance and suddenly confidence is beginning to flow again.

Yesterday’s employment report for August showed that wages have finally caught up with prices and both should now begin to increase in unison.

Average wages rose by 8% annually which is likely to be the highest of the three measures which determines the level of the increase in the state pension and other benefits from next April.

The “Triple Lock” under which benefits increase each year by the highest of average wages, inflation and 2.5%, was introduced in 2010 by the coalition government as a method of ensuring that the state pension “kept up” with overall wage growth.

It has become a divisive pledge with successive Prime Ministers looking at ways to reduce what has become a significant burden on the economy. It meant that pensions rose by 10.1% in April this year and look set to increase by 8.5% next April.

The Conservative Party has so far failed to commit to the policy after the next General Election, while the opposition Labour Party has also so far avoided the subject.

The data released yesterday increased the odds of another increase in the base rate of interest at the next MPC meeting which will take place a week from tomorrow.

According to the ONS, the economy exceeded its pre-Pandemic level by the end of 2021 and is now 1.5% above that level by the end of the second quarter of this year. That compares favourably with several Eurozone economies and dwarfs the German rate of just 0.2%.

It is unlikely that this cascade of positive energy is yet sufficient to change the country’s mind about the need for a change of Government in the election, but it has the potential to make a closer contest than had previously been expected.

Today’s data may inject a further dose of reality into proceedings with monthly GDP figures for July expected to show that the economy shrunk by 0.2% in July following a 0.5% increase in June.

The pound remains in a narrow range and fell to a low of 1.2459 yesterday and closed at 1.2490 as the dollar reasserted itself.

The FOMC meeting which takes place a week from today is now almost certain to agree to a further pause in the target for fed funds which currently stands at 5.25% to 5.50%.

Today sees the release of the August inflation data which is expected to show that headline price increases rose by 0.6% in the month leading to a year-on-year rise of 3.6% from 3.3% in July.

The notion of a fall to below 3% was scotched by the rise in the price of a barrel of oil which has risen over the past month and is now standing at $91.62. This has led to a surge in the forecourt price of gasoline, although the effect has been muted by falling demand following the end of the vacation season.

Overall, inflation remains in a downwards trajectory while the “alchemy” of a soft landing is becoming increasingly likely. With inflation reacting well to a fed funds rate that has not yet reached the stage when it is restricting demand, and the employment market cooling but still creating more than 150k new jobs a month, a soft landing is becoming several economists’s base case.

There is still expected to be further interest rate increases before the end of the year depending on the pace at which inflation falls. The hope is still that the headline rate reaches 2% by year-end, although FOMC members are avoiding making that a target that the market can use as a “stick to beat it with.”

It is interesting that a soft landing may be achieved by a Republican Fed Chairman, who is not even a trained economist who has used his lawyers’ skills to set a path for monetary policy and has had both the gumption and tenacity to see it through.

Jerome Powell has had a rough ride over the past two years dealing with the outcome of the Pandemic and inflation that rose to historic highs. He has gained the grudging respect of Congress who approved his second term in office by a large majority.

There are still nagging doubts of a recession further down the road but with a more data dependent path being plotted for interest rates, there is a growing confidence that the Fed will see its challenges through to the end.

The dollar index resumed its upwards trajectory yesterday reaching a high of 104.92 but fell back a little to close just three pips higher at 104.57.

This has been the busiest for the market in a considerable time as data releases by several G7 members have driven the market to continuously re-evaluate its view of the various monetary policy decisions that will be taken over the next week or so.

The first of those decisions will be made tomorrow as the Governing Council of the ECB will meet with a hawkish rate increase, a dovish increase, or a pause still possible.

A hawkish hike will entail Christine Lagarde announcing a further increase in interest rates to 4% and either making no mention of a pause or using the time-honoured cliché of being data dependent. A dovish increase would mean that rates still rise, but Lagarde commented that a pause will take place following the next meeting and using the parlous state of several member’s economies as justification.

A pause will mean just that immediately, although if that happens, she will reserve the right for a further hike or two to be agreed further down the line.

Data released yesterday showed that Spain has both the highest rate of growth and the lowest rate of inflation in the Eurozone. The jury remains out whether this is by judicious use of its social welfare programmes, or the increase in tourist numbers that have finally reached pre-pandemic numbers.

The estimate for full year 2023 GDP has been increased from 1.9% to 2.2% while inflation is expected to fall to 5.6% this year and 2.9% in 2024.

2024 GDP is likely to see a moderate slowdown and has been revised from 2% to 1.9%.

The overall growth estimate for the Eurozone in 2024 has been revised down yet again, as inflation continues to take a toll on people’s willingness to spend.

While a recession is not the official expectation, it is becoming more likely. Officially, the economy is now expected to grow by just 1.3% next year, which is revised down from 1.8% previously.

A pause in rate increases tomorrow may see the date revised again but for now the euro continues to suffer. Yesterday it fell to a low of 1.0705 but recovered to close at 1.0754.

Have a great day!