The inflation data from the UK over the past week has hinted that the Bank of England’s rate raising cycle may not yet be over. Wage inflation of 8% and core CPI inflation of 6.9% suggest that the target of 2% remains distant, despite falling producer prices.
It is unlikely that the wage price cycle will disappear until unemployment reaches levels that put downward pressure on wages – this will not happen without a recession.
But there are some recessionary forces already in train. The main hit on disposable incomes from mortgage rate rises is yet to be felt, with Cebr modelling suggesting these effects will intensify across 2024 and 2025. The pressure on public finances means that public spending will have to be constrained, despite next year being an election year, while stealth taxes are still rising. And the impact of monetary policy is well known to operate with long and variable lags.
Data emerging worldwide in the past weeks also indicate a further reason for caution. Looking at the two main exporters of manufactured goods, Chinese exports in July fell by 14.5% year on year, while German exports for the same month also disappointed, falling 1.9% on the same basis. Meanwhile the ratio of US inventories to sales has reached 1.4, its highest level since Covid while the cost of holding inventory has risen with interest rates. The US manufacturing PMI is 46.4 while that in the EU is 42.3 – both well below the equilibrium benchmark of 50. PMIs (as their full name Purchasing Managers’ Indices imply) are especially good indicators when an inventory cycle is taking place.
For most of the past 50 years economists have been expecting that modern stock control measures should mean that the ratio of inventories to sales should fall. But globalisation, which has lengthened supply chains, has in fact caused them to rise. A significant proportion of total inventories are floating around the world in ships which can take many months from being loaded in China to reaching warehouses in the West. These inventories do not appear in any country’s own figures.
The composite world shipping rate has fallen from a peak of $10,377 per container in September 2021 to $1,791 last week indicating lacklustre demand. Meanwhile Danish shipping giant Maersk have predicted falls in container volumes this year ‘prompted by stunted economic growth and a reduction in inventories by customers’.
The balance of evidence is that there will be a medium sized world inventory cycle, probably more muted than that which took place in 2009. Inventories will be run down while supply will be met from the shelves rather than from new production.
This will subdue manufacturing output in most countries, especially the big manufacturers like China (which has recently seen growth forecast revised down) and Germany. There will be a knock-on impact on other economies.
Will this be enough to prevent further rate rises in the UK? Unfortunately, the Bank of England’s recent forecasting track record will have discouraged it from relying on predictions too heavily, which means that it is likely to have to follow the curve, reacting to historic data which tends to be subject to lags. This means that it would be surprising if there is not at least one further rate rise in the UK, and possibly another one after that bringing the bank rate to a peak of 5.75%.
Looking further forward, the Fed may let the Bank of England off the hook. Whereas in the UK, because we started so late, we are still in the early phases of the inflation reduction cycle, in the US they are further ahead. If manufacturing goes into recession, as we expect, this will bring down inflation both for finished goods and raw materials. This will create leeway for the Fed to cut rates sooner than many expect. And in turn it will limit the scale of UK rate rises.
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