June 27, 2022
Front Runner, Slow Progress - Flexport Weekly Economic Report
The Bank of England has been at the forefront of tightening monetary policy with the first rate rise made in December. So far inflation and the housing market have yet to respond, though consumer spending is falling. More tightening may be ahead - the last time CPI was at 9.1%, base rates were 10x their current level.
In Focus - Bank of England Moved First, Has Further to Go
In recent research we flagged that the U.K. has been at the forefront of the consumer-led economic slowdown. A surge in inflation, which has left harmonized CPI at 9.1% in May, led the Bank of England to start to raise interest rates in December 2021, well ahead of more recent moves by the European Central Bank and the U.S. Federal Reserve.
Has this early rising had a significant impact on the economy?
The short answer is: not yet. First, bear in mind that Bank of England Base Rates are still only 1.25%. The last time inflation reached 9.1% (in December 1990) the Minimum Band 1 Dealing Rate (the base rate of its time) peaked at nearly 15%!
One peculiarity of the U.K. economy is the prevalence of variable rate mortgages (around one-quarter of all mortgages), which move up and down in-line with Bank of England base interest rates, and fixed rate mortgages with a typical life of under five years (much of the remainder) of which 20% need refinancing each year.
The average mortgage rate in the U.K. is now around 4.9%, so each 25 basis point increase in base rates will add 5% in pound sterling terms to spending on housing costs. This will likely mean that higher interest rates will be a drag on consumer spending for an extended period.
Higher rates will start to add to inflation too. As shown above the owner-occupier housing cost inflation rose by 3.1% in May, up from 2.2% at the start of the year and the fastest rate of increase since April 2009. Rental incomes, which can lag owner-occupier figures in reflecting the cost of landlord’s expenses, have increased at a similar rate.
The housing market has started to slow, perhaps indicating one sign of the impact of rising rates, though not yet significantly. The average number of homes changing hands in the three months to May 31st was 20% lower than a year earlier but still 11% higher than in 2019.
Reduced home transactions will cut into demand for durables such as furniture and nondurables like building supplies which in turn will drag on trade activity. As noted below consumer spending on such products have already started to decline.
The real crunch for the economy may come, however, if house prices start to fall. That could have a marked impact on people’s wealth and, in turn, on their willingness to spend rather than save. So far, prices have stayed robust, rising every month since November at an average rate of 1% and are now 12% higher than a year ago. The Bank of England has said that it expects inflation to begin to fall in 2023, while reiterating its 2% inflation rate target.
This all shows that the transmission of monetary policy tightening into the real world economy can take several quarters, complicating the job of central banks as they attempt to calm raging inflation.
The next edition of the Weekly Economic Report will be out on July 5 as we take a breather for the U.S. Independence Day holiday.
Latest Flexport Metrics & Research
The Flexport Ocean Timeliness Indicator for Transpacific Eastbound routes fell by one day to 97 days while the first stage of the shipping process has declined to the lowest since June 2021. Flexport’s Air Timeliness Indicator meanwhile remained unchanged at just over 11 days.
Flexport research reports in the past week include a review of whether sanctions imposed against Russia have had an impact on global trade. We find that Russian imports have collapsed, largely due to lower aerospace and autos shipments. Exports by contrast remain robust as commodity flows realign on a global basis.
The University of Michigan’s survey of U.S. Consumer Sentiment hit its lowest level on record in June. The part of the survey that seemed to give markets hope, however, was the long-term inflation expectations measure, which receded from a preliminary 3.3% to a final 3.1%.
- While inflation expectations are very important, there are reasons for caution in interpreting this number, including survey respondents indicating the highest uncertainty about long-run inflation since 1991, plus some curious details about how people respond.
As further evidence of the breadth of global inflation concerns, the Canadian inflation rate rose to an annual 7.7% in May, the highest since 1983.
Existing U.S. home sales declined for the fourth straight month in May, though the median price set a new record and was up 14.8% from a year before. New home sales in May reversed a four-month decline and 10.7% above the revised April rate.
The U.S. current account deficit increased from 3.7% of GDP in Q4 of 2021 to 4.8% of GDP in Q1 of 2022. That is the highest level since Q3'08. The current account deficit is the broadest measure of the balance of U.S. international transactions, including goods, services, and income.
The average U.K. consumer continues to have a tough time. U.K. headline consumer price inflation climbed 9.1% higher vs. a year earlier, up from 9.0% a month earlier and the fastest rate since the measure was created in 1998. Producer price inflation rose by 22.0% from 20.8% a month earlier, with energy costs being a major contributor to both.
- Elevated inflation, the prospect of strikes and worries about the state of the economy led the GfK measure of U.K. consumer confidence to -41 from -40 a month earlier, the lowest since the series began in the 1970s.
- A CBI survey of U.K. retailers shows an increasing number of firms see their inventories as being too high (a net 12%), while a net one-quarter see retail sales in July as being “poor for the time of year”.
- U.K. retail sales fell by 0.5% on a weekly, real (inflation adjusted) basis in May compared to April, leaving the total 4.7% below May 2021. Sales of household goods did worst and are now 20.4% below the year earlier level while clothing did best with an 8.3% improvement. Online sales are down by 9.6%.
Policies & Regulations
The European Parliament has finally passed the legislation needed to implement the Carbon Border Adjustment Mechanism. The coverage of CBAM has been widened to include certain chemicals and plastics. Further changes may be needed after consultation with member states, as detailed in our two-part research on the topic.
- At the same time the EP has voted to include maritime freight in the CO2 emissions permit trading system.
- There is pending legislation to introduce a CBAM in the United States, but it has yet to draw sufficient support in the U.S. Senate.
The U.K. has launched free trade talks with the Gulf Cooperation Council, following the post-Brexit launch of discussions with Canada, India and Mexico. The U.K. will reportedly look for improved access to food markets as well as financial services liberalization.
The Biden administration appears to still be considering the future of Section 301 duties on imports from China. On the one hand there’s the imperative of reducing inflationary pressures while on the other the administration is keen to retain “a significant piece of leverage”.
- The U.S. is also reportedly open to discussing the future of tariffs on imports of Canadian softwood lumber, which arguably have added to building supply cost inflation.
Supply Chain Update
Strikes are a spreading problem for logistics networks, as flagged in recent research. A one-day strike at the port of Antwerp came at the same time as a one-day stoppage at three German ports. Rail strikes are also taking place in the U.K. and Canada. The former has proven more disruptive than the latter.
A new survey by the European Union Chamber of Commerce in China has indicated that 23% of firms plan to move current or budgeted investments away from China. That was up from 11% in the prior survey.
Flooding in Guangdong, China has reportedly resulted in government-mandated closures of businesses for safety purposes with manufacturers and rail operators both affected
A group of four solar power project developers have decided to form a “U.S. Solar Buyer Consortium” to support manufacturing of panels in the U.S., with $6B of spending planned. That follows policy moves by the Biden administration to support domestic manufacturing.
Commodity markets continue to face disruption from the conflict in Ukraine. Indian coal buyers for example have increased their purchases of Russia products, reforming global trade flows.
- Russian exports of oil face fewer blockages with more vessels being certified by the Indian Register of Shipping after registration elsewhere for SovComFlot vessels was withdrawn.
- Food supplies remain under pressure. Ukraine’s harvest conditions this year are expected to be down by 54% for corn and 40% for sunflowers in 2022 due to conflict damage to fields, infrastructure and staff availability.
Chart of the Week - Go-go Gasoline!
Supply chains have been beset by higher fuel costs in the wake of the conflict in Ukraine, which has disrupted global crude oil markets. The impact on both goods and personal transport has led the Biden administration to propose a gasoline tax holiday and to push to bring more refineries online to meet demand.
Another step may be to limit U.S. international trade in petroleum products. The chart above, based on U.S. Energy Information Administration data, shows that U.S. production of refined oil products - which includes gasoline, diesel and a variety of petrochemicals - has risen by 6% year-to-date as of June 10 to reach a record.
Yet, at the same time, net exports of refined oil products have risen by 92% having reached a record high in April. Net exports were equivalent to 49% of production in the past four weeks versus 37% on average in 2020.
Disclaimer: The contents of this report are made available for informational purposes only and should not be relied upon for any legal, business, or financial decisions. Flexport does not guarantee, represent, or warrant any of the contents of this report because they are based on our current beliefs, expectations, and assumptions, about which there can be no assurance due to various anticipated and unanticipated events that may occur. This report has been prepared to the best of our knowledge and research; however, the information presented herein may not reflect the most current regulatory or industry developments. Neither Flexport nor its advisors or affiliates shall be liable for any losses that arise in any way due to the reliance on the contents contained in this report.