Newsroom

16 August 2024 | EY ITEM Club comments:

Retail sales rebounded in July but data may remain noisy

• Retail sales rebounded in July after a poor June, driven by an upturn in stronger spending in department stores. The retail sales series is notoriously volatile and recent outturns have been exceptionally so. But looking through the noise, the EY ITEM Club sees signs of a gradual improvement in sales over the past year.
• The consumer outlook remains relatively upbeat. Tighter fiscal policy and the lagged effect of past interest rate rises will continue to weigh on spending power. However, sustained real wage gains should boost real household income growth and, provided consumer confidence continues to rise, the EY ITEM Club thinks retail sales will strengthen further in H2 2024 and 2025.

Peter Arnold, EY UK Chief Economist, said: “Retail sales volumes rose 0.5% month-on-month in July, following June's 0.9% fall (revised from -1.2%). Higher sales in July were largely driven by a rebound in non-food retailing. The Office for National Statistics (ONS) attributed this to summer discounts and sporting events. But the first of those arguments looks difficult to justify, given that prices rose on a seasonally adjusted basis in July. A more plausible explanation is that the data has been noisy over the past year, and July's rebound merely continues this pattern.

“With July's modest retail rebound coming alongside some solid business survey data, the EY ITEM Club thinks there's a good chance that month-on-month GDP growth resumed in July, after output was unchanged in June. 

“Given the exceptional volatility over the past year, it's hard to identify underlying trends. Still, the EY ITEM Club thinks there has been a gradual increase in consumer demand. Meanwhile, the consumer outlook looks reasonably positive, so the EY ITEM Club expects the retail sector's fortunes to improve in H2 2024 and 2025. Real incomes have grown strongly over the past year, which has put household finances on a firmer footing. Tighter fiscal policy will continue to weigh on spending power, as will the effect of past interest rises on debt service payments for some mortgage holders. However, real wage increases will continue to support spending power and, provided consumers adopt a less cautious attitude to spending and credit demand, the EY ITEM Club expects retail sales to continue strengthening.”

15 August 2024 | EY ITEM Club comments:

Flat June completes another strong quarter for GDP

• Though UK GDP was flat in June, this was a slightly better outturn than the EY ITEM Club had expected, given the drags from the health and retail sectors. GDP rose by 0.6% quarter-on-quarter in Q2, a second successive strong outturn following two years of economic flatlining.
• The EY ITEM Club expects GDP to continue to grow at a solid pace in H2 2024 and 2025, despite the likelihood that the economy will struggle to sustain recent above-trend growth rates. The consumer outlook is reasonably positive but drags from the lagged impact of past interest rate rises and tighter fiscal policy will mean activity growth is steady rather than spectacular.

Peter Arnold, EY UK Chief Economist, said: “GDP was flat in June, after having grown by 0.4% month-on-month in May. June's softer outturn was largely due to three factors. First, retail sales fell significantly, continuing a run of very volatile outturns for the sector. Second, four days of industrial action in the healthcare sector meant that many operations and hospital appointments were cancelled, which dragged on health output. And third, some parts of the services sector had enjoyed a rise in output over the previous couple of months but then saw some payback in June.

“June's outturn left GDP up 0.6% quarter-on-quarter in Q2, following growth of 0.7% in Q1. The first cut of the expenditure data showed that government consumption was the key driver of GDP growth in Q2. Meanwhile, there was another somewhat underwhelming quarter-on-quarter increase in consumer spending (0.2%). Household income data won’t be published until the next release on September 30, but the EY ITEM Club expects real incomes to have grown at a faster rate than the tepid increase in spending, implying a further rise in the household saving ratio.

“The prospect of rebounds in health and retail output in July means that Q3 should get off to a reasonable start. Beyond that, the EY ITEM Club expects the economy to continue growing at a decent pace, though it will struggle to sustain the above-trend rates seen in H1 2024. Continued solid real income growth and a less cautious attitude from consumers should underpin firmer growth in household spending. However, with the lagged effect of past interest rate rises continuing to emerge, and the government expected to tighten fiscal policy, the EY ITEM Club predicts that GDP growth will be steady rather than spectacular in H2 2024 and 2025.”

14 August 2024 | EY ITEM Club comments:

Inflation edged up in July due to energy-related base effects

• UK Consumer Price Index (CPI) inflation edged up in July, as base effects in the energy category more than offset a slowdown in services inflation. With further base effects still to come, the EY ITEM Club expects headline inflation to rise gradually over the rest of H2 2024.
• Services inflation undershot the Bank of England's new staff forecast. However, the more dovish majority on the Monetary Policy Committee (MPC) are now placing less emphasis on this measure, and have signalled they will take a cautious approach to loosening policy. Therefore, the EY ITEM Club still thinks back-to-back rate cuts are relatively unlikely.

Peter Arnold, EY UK Chief Economist, said: “CPI inflation rose to 2.2% in July, from 2% in June. A smaller drag from the energy category added almost 0.5ppts to the headline rate in July, with last month's 7% cut in the Ofgem price cap less than half of the fall seen in July 2023. But this upward pressure was offset to a certain extent by lower services inflation, which partly reflected the unwinding of June's unusual rise in hotel prices.

“The outturn for services inflation in July was 0.4ppts below the Bank of England's new staff projection of 5.6%. However, the EY ITEM Club is sceptical that this will shift the dial on the outlook for interest rates. Minutes of recent MPC meetings have indicated that the dovish majority feel they now have a better understanding of the inflation generation process and are placing less weight on backward-looking measures such as services inflation. Having overlooked recent overshoots for services inflation, the EY ITEM Club would expect the MPC to treat undershoots in the same way and maintain the gradual pace of loosening signalled at the August meeting. The EY ITEM Club expects the MPC will vote to keep Bank Rate at 5% in September, before delivering another 25bps cut in November.

“The EY ITEM Club expects CPI inflation will gradually drift upwards throughout the rest of H2 2024. Services inflation should continue to cool as businesses pass on the gains from lower energy costs to their consumers. However, this is likely to be more than offset by the fading drag from the energy category.”

13 August 2024 | EY ITEM Club comments:

Pay data offers something for doves and hawks alike

• A steady slowdown in UK pay growth, partly due to base effects, will likely reinforce existing perspectives within the Monetary Policy Committee (MPC). The doves will view it as evidence that the inflation shock is dissipating, suggesting that policy can be gradually loosened. Hawks will argue that pay growth is still too high for inflation to remain at 2% over the medium-term.
• The loosening in labour market conditions seen in early-2024 seems to have tailed off. But with vacancies still falling and HMRC's count of payrolled employees only edging up, the labour market appears to be broadly stable, rather than tightening again.

Peter Arnold, EY UK Chief Economist, said: “The main measures of pay growth continued to cool in the three months to June, though base effects caused by large increases last summer played a major role. The fall in whole economy total pay growth was particularly large, declining to just 4.5% in the three months to June from 5.7% in May, driven in part by the one-off bonuses awarded to National Health Service (NHS) and civil service workers last June. Headline (three-month average of the annual rate) private sector regular pay growth fell to a 25-month low of 5.2% in June. 

“The EY ITEM Club expects that different camps within the MPC will likely see this as vindication of their recent votes. The doves will interpret slower wage growth as evidence that the inflation shock is dissipating, suggesting that policy can be gradually loosened. But the hawks will likely maintain that the rate of pay growth is still too high to keep inflation at 2% over the medium-term.

“Other data also presents a mixed picture. HMRC's timelier measure of pay growth rebounded in July, after a very soft reading in June. The Labour Force Survey (LFS) showed a surprise fall in unemployment to 4.2% in Q2, following an exceptionally low single-month reading for June. But with Office for National Statistics (ONS) methodological improvements yet to be incorporated, the EY ITEM Club is sceptical of LFS data as a reliable indicator and expects June's reading may prove to be more noise than signal. Vacancies continued to fall, but HMRC's count of payrolled employees rose again in July. While labour market conditions are no longer loosening in the way they were in early 2024, there's little evidence that they are tightening again either.

“The weakening in pay growth is unlikely to be sufficiently significant to convince enough doves to vote for back-to-back rate cuts. Therefore, the EY ITEM Club still expects the MPC will opt for a 25bps Bank Rate cut in November.”

07 August 2024 | EY ITEM Club comments:

Halifax reports surprise increase in house prices in July

• The EY ITEM Club is approaching July’s rise in house prices on the Halifax measure with a degree of caution. This data can be prone to volatility, particularly in the quieter months of summer. And today’s data only took prices back to the level they were in February.
• Though mortgage affordability is better than last summer, it remains very stretched, which is limiting the pool of potential buyers. The EY ITEM Club expects to see a period of relative stability for activity and prices until this valuation gap closes.

Peter Arnold, EY UK Chief Economist, said: “The Halifax measure of house prices rose by 0.8% month-on-month in July, after prices were flat in the previous three months. But the lenders’ series are prone to volatility, particularly in the summer when activity tends to be lower, so the EY ITEM Club is approaching today’s data with a degree of caution.

“Indeed, July’s increase only took prices back to where they were in February. Stepping back and looking at the bigger picture, the market has been fairly flat so far this year in terms of both prices and transactions, and the EY ITEM Club thinks these conditions are likely to persist.

“Mortgage rates remain well below the levels seen in both late-2022 and last summer. This, combined with strong growth in nominal wages, has reduced the scale of the mortgage affordability challenge, which has helped to entice some buyers back to the market.

“But while mortgage affordability is much better than it was last summer, it remains stretched relative to historical norms. And though financial market pricing has moved a little in response to last week’s interest rate cut from the Bank of England, the adjustment implies only a modest fall in quoted interest rates for fixed rate mortgages, indicating that mortgage affordability will likely remain stretched. Other affordability metrics, such as loan-to-income and loan-to-value ratios, also remain high. This is preventing many people from being able to access mortgage finance and limiting the pool of potential buyers. 

“The EY ITEM Club thinks the most likely scenario is that this period of relative stability in activity and prices continues in the near-term, at least until the valuation gap closes. This would be consistent with the post-Global Financial Crisis experience, where prices were broadly flat for three years before a recovery took hold.”

06 August 2024 | EY ITEM Club comments:

Construction recovery back on track after June blip

• The construction Purchasing Managers’ Index (PMI) rose to its highest level in more than two years in July due to stronger activity in all three sub sectors. The EY ITEM Club expects to see a firm rebound in the official construction output series in Q3, after unusually wet weather had disrupted the first half of 2024.
• Housebuilding activity recovered after a temporary setback in June and the EY ITEM Club expects this to continue. Housing transactions and prices appear to have passed the bottom and businesses should feel more confident about building. The government’s focus on housebuilding should also help, though some have suggested the sector may need to enhance its current capacity to support a substantial step up in activity. 

Peter Arnold, EY UK Chief Economist, said: “The construction PMI rose to 55.3 in July from 52.2 in June, reaching its highest level since May 2022. As with the manufacturing and services surveys, the 2024 General Election appears to have injected some month-to-month volatility into the construction survey results, with a soft June followed by a stronger July as uncertainty cleared. The detail of July’s survey was also positive, with new orders growing at the strongest pace in more than two years, and hiring and purchasing activity also increasing. After a challenging couple of years, the construction sector appears to be in the early stages of a strong recovery.

“Unlike its manufacturing and services counterparts, the construction PMI has been a relatively good leading indicator of the official measure of construction output over the past couple of years, although that relationship has faltered somewhat of late. The disruption caused by a prolonged period of poor weather is probably a factor in the recent weakness of the official output series. But given that has been less of an issue in recent weeks, the EY ITEM Club expects to see construction output grow strongly in Q3.

“The sub-sector breakdown showed activity increasing in all three sectors in July, after housebuilding had endured a blip in June. The EY ITEM Club expects the recovery in housebuilding activity to continue. House prices and transactions appear to have passed the bottom, so businesses should feel more confident about building. The new government’s focus on housebuilding also promises to be positive for the sector. However, some have suggested that in order to meet national housebuilding targets, the sector will need to take steps to enhance its capacity, particularly when it comes to securing staff with the necessary skills.”   

05 August 2024 | EY ITEM Club comments:

Services activity growth improves as inflation continues to cool

• July's final UK services Purchasing Managers’ Index (PMI) reported a slightly stronger pace of activity growth, along with improvements in new orders, employment, and business optimism. This supports the EY ITEM Club’s view that the economy will continue to grow at a solid pace in Q3.
• The survey also pointed to a further slowdown in the growth of costs and prices. However, the Monetary Policy Committee (MPC) has indicated it will take a cautious approach to loosening policy and a marked softening in the official series for services inflation would probably be required for a rate cut to be considered in September. 

Peter Arnold, EY UK Chief Economist, said: “July's final S&P Global survey pointed to a slightly faster pace of services activity growth than in June, with the PMI edging up to 52.5 from 52.1. Respondents linked the upturn to stronger rises in new orders in both domestic and external markets. And with demand ramping up, services firms also increased hiring. Given July's earlier manufacturing survey reported a robust improvement in production, the composite PMI rose to 52.8 from 52.3 in June.

“The sustained run of composite PMI readings above the 50 'no-change' mark since the end of last year suggests the upturn in private sector activity is becoming more firmly entrenched. The composite PMI has been a somewhat unclear leading indicator of GDP in recent years, which is partly due to industrial action in the public sector – a factor not captured in business surveys. But given there were fewer days lost to major public sector strike action in July, and there are no major strikes currently planned in August, the composite PMI should become more consistent with the Office for National Statistics' (ONS) official measure of output. Therefore, the details of today's survey bolster the EY ITEM Club’s view that the economy continued to grow at a solid pace at the start of Q3.

“The services survey reported a further softening in cost and price inflation, albeit both remain well above historic norms. As with the output data, the read across from the survey results to official outturns for services inflation has been inconsistent. And with August's minutes indicating that the MPC will take a cautious approach to loosening policy, it's likely to take a more marked softening in the official series for rates to be cut again at the September meeting.”

01 August 2024 | EY ITEM Club comments:

MPC kicks off the rate cutting cycle

• The Monetary Policy Committee (MPC) voted narrowly to cut Bank Rate by 25bps to 5% in August. However, the MPC appears divided on the outlook for underlying inflationary pressures, suggesting future decisions will be similarly close.
• The MPC’s new forecast shows inflation well below 2% in two and three years’ time. This signals that the majority of the MPC thinks these are the early stages of a cutting cycle and that market pricing is too high.
• But given this month’s decision was such a close call for some of those who voted to cut, the EY ITEM Club doesn’t expect a repeat in September. The EY ITEM Club expects the next cut to come in November, leaving Bank Rate at 4.75% at the end of 2024.

Peter Arnold, EY UK Chief Economist, said: “August’s MPC meeting saw the committee vote 5-4 to cut Bank Rate by 25bps to 5%. The minutes of the June meeting had made clear that the MPC was heading in that direction, and the only real question was whether the recent upside surprise for services inflation would delay the first cut. In the event, the MPC dismissed that as relatively unimportant. Indeed, the fact that headline inflation has now been at 2% for successive months was probably an important influence on those who did vote to cut.

“The justification for cutting rates was a view that inflation is likely to fall back over the next few years, as the influence of recent second round effects fades. The MPC’s new projections show Consumer Price Index (CPI) inflation falling to 1.7% in two years’ time and 1.5% after three years. 

“But, as the minutes make clear, this is far from a unanimous view, with the more hawkish members remaining concerned about the strength of underlying domestic inflationary pressures. This suggests that future decisions are likely to be equally close. Doubt around the composition of the Committee – with one member now leaving and a replacement still to be announced – will add to the sense of uncertainty, with a good chance that there will only be eight members voting at September’s meeting.

“With some of those who voted to cut suggesting that it was a tight decision, the EY ITEM Club thinks it is unlikely that these members would vote for immediate successive cuts. Therefore, the EY ITEM Club expects the MPC to vote to hold rates in September, before cutting again by 25bps in November, which would leave Bank Rate at 4.75% at the end of the year.”

01 August 2024 | EY ITEM Club comments:

Manufacturing PMI rose to a two-year high in July

• The UK manufacturing Purchasing Managers’ Index (PMI) increased in July, following another rise in new orders. The EY ITEM Club thinks the sector’s recovery will likely persist, with solid real household income growth set to support domestic demand for consumer goods. But tighter fiscal policy and subdued external demand means any recovery is likely to be steady rather than spectacular.
• The survey also suggested that output price inflation rose again in July, as manufacturers reflected the impact of more expensive ocean freight rates in higher selling price inflation. But despite being flagged regularly by the S&P Global survey, these pressures haven't been reflected in the official measure of core goods inflation so far.

Peter Arnold, EY UK Chief Economist, said: “July's final S&P Global manufacturing survey pointed to a stronger rise in activity, with the PMI having increased to 52.1 from 50.9 in June. The higher PMI was largely driven by an improvement in hiring and another rise in new orders from domestic customers. Meanwhile, demand in key export markets continued to struggle, albeit to a lesser degree than in recent months.

“The survey reported another strong month of output growth, after an extended period of weakness. But there has been significant divergence between the S&P Global manufacturing survey and the Office for National Statistics' (ONS) measure of manufacturing output in recent years, so the implications of today's survey results for official manufacturing output are probably limited. Still, the EY ITEM Club thinks the recent upturn in manufacturing performance is likely to persist. Solid growth in real household incomes points to a sustained improvement in the order books for producers of consumer goods. However, subdued global demand, together with tighter fiscal policy, is likely to temper the pace of growth and this recovery is set to be more steady than spectacular.

“Survey respondents reported that input costs rose at a faster pace than in June, owing in part to more expensive ocean freight rates amid ongoing geopolitical disruption. Manufacturers reflected the greater cost burden in higher selling price inflation in an attempt to protect their margins. But, as with output, the relationship between the survey results and the official measure of core goods inflation has recently been somewhat inconsistent.”

01 August 2024 | EY ITEM Club comments:

Nationwide reports modest rise in house prices in July, but market remains relatively subdued

• Though July’s Nationwide data showed a modest uptick in house prices, the bigger picture is of a market that has been relatively flat so far in 2024.
• The fall in mortgage rates since last summer has stabilised the market, but poor affordability continues to limit the pool of potential buyers. The EY ITEM Club expects to see the period of relative stability for activity and prices continue until this valuation gap closes.

Peter Arnold, EY UK Chief Economist, said: “The Nationwide measure of house prices rose by 0.3% month-on-month in July, after a 0.2% increase in June. But prices had fallen in the spring, and the lenders’ house price measures can be volatile, particularly in a low transaction market. Taking a broader view, the EY ITEM Club still characterises the market as having been generally flat so far in 2024.

“Though mortgage rates have edged up since the early months of this year, they remain well below the levels seen in both late-2022 and last summer. This, combined with strong growth in nominal wages, has reduced the scale of the mortgage affordability challenge, which has helped to entice some buyers back to the market.

“But while mortgage affordability is much better than it was last summer, it remains very stretched relative to historical norms. And given that financial market pricing already builds in the expectation that the Bank of England will steadily cut interest rates, the EY ITEM Club expects mortgage rates to remain broadly stable in the near-term. Other affordability metrics, such as loan-to-income and loan-to-value ratios, also remain high. This is preventing many people from being able to access mortgage finance and limiting the pool of potential buyers.

“The EY ITEM Club thinks that the most likely scenario is that this period of relative stability in activity and prices continues in the near-term, at least until the valuation gap closes. This would be consistent with the post-Global Financial Crisis experience, where prices were broadly flat for three years before a recovery took hold.”

29 July 2024 | EY ITEM Club comments:

Elevated mortgage rates continued to weigh on approvals in June

• UK mortgage approvals fell marginally in June, with the upward momentum in mortgage demand seen earlier this year tapering off in recent months. Although mortgage rates have edged down, the EY ITEM Club does not expect them to fall much further. Therefore, any recovery in demand will likely be modest.
• Net unsecured lending declined in June due to a rise in repayments. With household incomes growing strongly in real terms and consumer confidence on the rise, the EY ITEM Club thinks households will adopt a less cautious approach towards taking on credit. This is a key factor in the EY ITEM Club’s more optimistic consumer outlook for this year and 2025.

Peter Arnold, EY UK Chief Economist, said: “Mortgage approvals fell fractionally to 59,976 in June, from 60,134 in May. Mortgage demand has remained broadly stable since February, with the impact of a gradual uptick in quoted mortgage rates largely offset by recovering household finances and confidence. Net secured lending increased to £2.7bn from £1.3bn in May, as the unwinding of May's sharp increase in repayments outweighed a softening in gross lending.

“With swap rates having drifted down in July, and some lenders lowering mortgage rates in response, approvals may edge up modestly in the coming months. But with market pricing already factoring in a gradual loosening of monetary policy over the coming year, the EY ITEM Club doesn't expect mortgage rates to fall much further. And with affordability still very stretched, the chances of a strong recovery in activity look low. The EY ITEM Club also expects net mortgage lending to level off over the next few months as the lagged effects of the recent stabilisation in approvals feed through to gross lending.

“Net unsecured lending fell to £1.2bn in June from £1.5bn in May. But encouragingly, gross lending was broadly flat, with the decline in net lending reflecting a fall in repayments, which can be very volatile from month-to-month. As real incomes and consumer confidence continue to improve, the EY ITEM Club expects households to gradually adopt a less cautious attitude towards taking on credit. This expectation is a key factor behind the EY ITEM Club’s forecast of consumer-led growth in 2024 and 2025.”

19 July 2024 | EY ITEM Club comments:

Borrowing overshoot likely to continue through 2024-2025

• Public sector net borrowing was just over £3bn above the Office for Budget Responsibility's (OBR) forecast across the first three months of fiscal year 2024-2025. The EY ITEM Club thinks higher debt servicing costs means there's a good chance this underperformance will persist for the rest of the year.
• Further ahead, the outlook for the public finances depends on how the new government approaches fiscal policy.

Peter Arnold, EY UK Chief Economist, said: “Public sector net borrowing (excluding public sector banks) came in at £14.5bn in June, £3.2bn lower than a year ago but £2.9bn above the OBR’s forecast. This meant that the first three months of the fiscal year saw borrowing of £49.8bn, £3.2bn higher than the OBR anticipated. Receipts are running slightly behind expectations, while spending has been higher.

“The public finances data tends to be prone to revision, so the picture for the start of fiscal year 2024-2025 could look different in a few months' time. But as things stand, the EY ITEM Club thinks this underperformance is likely to persist. The OBR's assumptions for gilt yields and Bank Rate look too low, and this suggests debt servicing costs will prove to be higher than they expect. This is likely to mitigate the reduction in borrowing caused by a significant tightening in fiscal policy.

“Looking further ahead, the EY ITEM Club awaits the new Chancellor’s first budget with interest. Maintaining the net debt rule will mean that, in the absence of forecast revisions from the OBR, the new government will face a similar need to consolidate to their predecessors. It looks likely that the freeze on most tax allowances will be maintained for at least the next three fiscal years. However, it may prove challenging to turn existing spending totals into department-by-department plans, both in terms of current and capital spending.”