Occasionally you get a week where the news is sufficiently unexpected to revise one’s appreciation of events.
The past week has been such. The new news included: a rapid upsurge in Covid cases in the UK, especially from the Omicron variant against a background of increasing travel and other restrictions around the world; a tightening of monetary policy by the Federal Reserve Bank that pushed market expectations for base interest rates in Q4 2022 up by 75 basis points; a surprise jump in the UK inflation rate to 5.1% on the CPI measure and to 7.1% on the RPI measure; unexpected UK labour market data that combined data on employment and unemployment showing a tightening and data on earnings suggesting lower wage inflation than had been expected; and a 15 basis point rise in UK base rates that seems to have taken most observers and certainly the financial markets by surprise, judging by the immediate jump in the sterling exchange rate.
First the pandemic. In this week’s Clash of the Titans forecasting debate, where I competed with Linda Yueh and Dilip Shah, Dilip made a persuasive case that given the limited effectiveness of the vaccines, even when triple dosed, against the Omicron variant of Covid, although the variant is much less virulent than most of its predecessors, we should expect infections to reach such a rate that there will be pressure on the NHS at some time in the coming week and that therefore it would be sensible to expect further lockdown measures. We now therefore expect these, though because the government is sensitive about Christmas parties, they will probably do all they can to prevent these from being cancelled. So it is likely that these further measures will be mainly about work and probably socialising after Christmas.
Second, inflation. The markets have focussed on the price inflation figures which were certainly higher than expected. What is not quite clear from them is how much the statistics have fully factored in the rise in the cost of eating and drinking in pubs, restaurants and clubs. Anecdotal evidence suggests double digit inflation in these areas. But the most interesting item of information here was the fall in the wage inflation figure to 4.3%, which looked surprising given what is happening to the tightening of the labour market and the rise in the cost of living. If it is a true reflection of the underlying trend, it may be that the follow through in inflation as higher wages feed through to prices will be less aggressive than I had previously expected. But it’s hard to believe that people will let their living standards be squeezed significantly when labour markets are tight.
Finally interest rates. The moves by both the Fed and the Bank of England Monetary Policy Committee took the markets slightly by surprise. The apparently tougher line from the Fed will encourage Central Banks around the world to respond. Indeed the Norwegian Central Bank also raised their bank rate by 25 basis points on Thursday though the Swiss and the ECB only hinted at tightening at their meetings on the same day. If authorities around the world continue to raise rates it will mean inflation peaks at a lower level than had been expected.
Taking all this together, we should probably be revising down our forecasts for 2022 even before we have made some of them. But the good news is that lower than expected wage inflation and earlier than expected action on interest rates means that the chances of needing a recession to stop rising prices have fallen a bit.
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