June 26, 2023
A Sticky Wicket- Flexport Weekly Economic Report
The latest UK inflation numbers not only prompted a sharp rate hike from the Bank of England, they also threaten an inflation and policy divergence between major economies.
The Weekly Economic Report will be on hiatus July 3rd due to the U.S. July 4th Federal Holiday. The next Weekly Economic Report will be released on Tuesday July 10.
In Focus - Mounting Concern
The UK Office for National Statistics released troubling May inflation numbers this past week. The broadest measure (CPIH), which includes owner-occupied housing, was up by 7.9% over a year earlier, a slight increase from the 7.8% figure reported for April. More problematic was the Core CPIH number, which excludes energy, food, alcohol, and tobacco. It increased to 6.5%, the highest annual rate since October 1991.
In short order, the Bank of England raised its policy rate by 0.5 percentage points to 5.0%, a larger increase than many market participants had been expecting. The Bank is obligated to push for a 2% inflation target (the dashed line on the graph).
The climbing inflation rates reported in May are important for at least two reasons – what they mean for the UK’s economy and how they compare to inflation trends in other major economies. We take each in turn.
The chart shows the broad CPIH in red and the Core CPIH in navy. UK inflation began to rise above its target in the fall of 2021. CPIH peaked in October 2022 at 9.6% and, while remaining high, seemed to be subsiding after that. We shouldn’t make too much of a potentially-brief upturn this month. We saw a bigger jump in February of this year, only to have further decreases ensue.
It is the increase across the last two months in the Core CPIH measure that is more worrisome. In January, it was at 5.3%, then 5.7% in March. While headline numbers can be buffeted by volatile components, the whole idea of a core series is to exclude those.
Even if the numbers turn down before too long, the persistence of high inflation poses serious risks to the UK economy. First, as with all economies, there is a worry that inflationary expectations will adjust accordingly. Second, for the UK in particular, prolonged high inflation rates bring high policy rates and raise housing costs, since UK mortgage rates are commonly fixed for only 2 to 5 years.
Turning from the domestic effects to the international, this latest report seems to mark a divergence in the inflation experiences of the U.S., the UK, and the Euro Area. Whereas UK core inflation has risen this year, Euro Area core inflation has held fairly steady, with the May figure at 5.3%, the same as it was in January. U.S. Core CPI in May was 5.3%, down from 5.5% in January.
In each of these economies, core inflation is above target, but the US and Euro Area look steady while the UK is climbing. This is likely to provoke different monetary responses – as evidenced by the U.S. Fed’s decision to hold off on hiking rates at its last meeting. Such a divergence in rates is likely to affect trade, most prominently by driving exchange rate shifts. A relatively higher interest rate from the Bank of England would be expected to drive up the value of the pound, although in the few days since the latest hike the pound has held steady against the dollar.
The broader concern is that a sharp, simultaneous slow down across major economies can be harder to reverse. And the latest UK inflation numbers will only increase the scope of the problem.
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Japan’s headline and core inflation, which excludes fresh food but not energy, both rose at the same annualized rate of 3.2% in May. Core-core inflation, which does strip out both energy and fresh food, was 4.3%, a rise of 0.2% percentage points from April... While lower than in most advanced economies (see this week’s essay above), the core-core inflation figure is the highest it has been in Japan since June 1981. The Bank of Japan’s next monetary policy meeting is scheduled for July 15 - 16.
The flash Euro area PMI for June was 50.3, barely above the 50.0 level and the weakest result since January. Any reading below 50.0 indicates a contraction. Manufacturing output fell for the third consecutive month, hitting a 37-month low of 43.6 on an increasingly sharp decline for ‘new goods orders’ in recent months. That sub-component of the index is at the lowest level since last October.
The flash estimate for Euro area consumer confidence in June was -16.1, up 1.3 points from May. It was the highest it has been since February 2022 but still well-below its long-term average. The final figure will be released on June 29th.
The latest World Trade Monitor, which covers trade up through April, showed global merchandise trade falling 1.4% month-on-month after a 1.9% month-on-month increase in March. Increases in imports across the advanced economies, including a 2.7% rise in Japan and a 2.3% rise in the Euro area, were offset by significant declines in developing world exports, led down by a 6.4% decline in Chinese exports. World trade momentum, an average of the current three-month period over the previous period, rose 0.6 percentage points to -1.0%.
The latest estimate of global trade in intermediate goods, a measure of supply chain activity, showed a 10% year-on-year drop in the last quarter of 2022. The declines were across almost all regions and supply chains. The shift appears driven by geopolitical tensions, commodity shortages, high energy prices and “weak or fluctuating” industrial and consumer demand (see recent Flexport research on the subject of the supply chain recovery here).
Chairman Powell defended the Fed’s recent decision to pause monetary policy in his semi-annual testimony to the House Committee on Financial Services, citing “uncertain lags” in the effects of interest rate moves and “potential headwinds” to the economy from monetary tightening. He added further justification for the decision, saying that while speed was important earlier in the process, “it’s not very important now.”
During Indian Prime Minister Narendra Modi’s visit to Washington last week the two sides agreed to ‘terminate’ six ongoing disputes at the WTO. India will drop tariffs – mainly on agricultural products – it put in place in retaliation to the section 232 measures the US took on aluminum and steel from India during the Trump administration. USTR Tai said in a statement that the “integrity” of those measures will be maintained but without further explanation.
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