Economic Update - August 2022

The Young Fabian’s Economy & Finance Network report on the economy for August 2022, as inflation continues to dominate the global agenda.

At the same time as the Conservative Party soap-drama has reached its final stage, the state of the economy has remained dire. 

There have been more rail strikes over pay and conditions, strikes by barristers, and now the threat of strikes by nurses and other public sector workers. These have prompted a wider debate about conditions and pay in the public sector. Conservative leadership hopefuls, Rishi Sunak and Liz Truss have both suggested weakening the right of essential workers to strike, reducing their bargaining power. However, recent statistics released by the ONS show a stark gap between public and private sector pay – growth in average total pay (including bonuses) was 6.2%. This figure, which is less than the increase in prices, represents an overall fall in real wages. However, the headline figure obscures a divide. Average total pay growth for the private sector was 7.2% in March to May 2022, and for the public sector it was 1.5%. The growth in the private sector also lagged inflation, to be clear, so private sector workers will also see their purchasing power fall. However, the decline for public sector workers is so much greater that the Government will surely face problems in recruitment and retention in coming months.

Inflation remains the major economic issue facing the nation. As previously mentioned, it greatly outstrips wage increases, ever-tightening the cost-of-living crisis. Consumer Price Inflation - which measures the rate of change of an index mirroring a representative basket of consumer goods – rose again from 7.9% to 8.2%. The increase was slightly slower relative to last month’s and was again driven predominantly by price increases in fuel, food, and housing costs. As a result, the impact is likely to continue to hit the poorest – whose spending is concentrated on such essentials – the most.

Producer Price Inflation on outputs, which shows price increases by producers (E.g. UK manufacturers), grew from 15.8% to 16.5%, slowing very slightly in growth from the previous month. PPI often predicts future changes in consumer prices because it can indicate price hikes that are yet to feed through to consumers. As a result, the outlook for inflation is not good.

However, real terms pay cuts across the board – especially in the public sector – suggest that we are yet to enter a ‘wage-price spiral’ in which the cost of labour causes more inflation. Consequently, Government fears that public sector pay settlements may prompt an inflationary cycle are probably overstated at this stage. 

In response to these sky-high levels of inflation, the Bank of England has again sanctioned an interest rate rise. Hiking interest rates - the cost of borrowing - discourages current spending in favour of investment and saving. This slows the economy and reduces inflationary pressure. Such a large interest rate rise is uncommon - indeed, the Bank of England last raised rates by half a percentage point in 1995, before the Bank of England was independent - and reflects the damage inflation can cause. Monetary policy changes like this are not generally considered to be effective in dealing with inflation when it originates in internationally-determined price shocks. The move, therefore, signals further fears from the Bank of England that this inflation may becoming embedded in the UK economy. This rate raise, especially if followed by more, may tip the economy into recession, a high price to pay in exchange for controlling inflation. Nevertheless, the Bank of England is required to do this, because an inflationary spiral would be so costly. The short term outlook for inflation is thus improved, but output and employment may suffer instead.

In a welcome bout of good news, retrospective monthly Gross Domestic Product – a measure of the value of all goods and services produced in the UK – estimates by the ONS for May found higher growth than had been predicted. Having received the data to begin to measure monthly GDP, the ONS has found that the economy was less stagnant than economists expected. Monthly GDP grew 0.5%, whilst 12-month growth was 3.5%, both of which exceed anticipations. The growth was largely attributable to a spike in tourism and rail travel, so may presage stronger growth through the summer months.

However, deep-seated structural problems are still present and are worsening. Despite relatively low economic growth and the grip of the cost-of-living crisis, UK house prices continue to climb. So far this year, the average price of a house has increased by 6.8%, around double the speed of other prices. House price growth varies greatly between the different regions of the UK, with London lagging and Northern Ireland leading the way. Since London has, by some way, the highest house prices in the UK, this may represent a rebalancing of house prices somewhat. At an annualised rate of 7.1%, house prices are likely to be exceeded by overall inflation, meaning the real price of housing in London may fall slightly this year. Such a change reflects a systemic shift in the housing market that occurred as a result of the Pandemic. Similarly, the rate of price increase is higher for houses than flats, as people seek to move to facilitate lifestyle changes and working from home. 

Last month’s Economic Update painted a bleak picture, which this month’s has not been able to match. The economy is still in a dire state, the cost-of-living crisis remains a serious threat to people up and down the country, and the Government is doing little to solve it, but a few green economic shoots have now emerged. Growth forecasts, whilst bad, are not quite as pessimistic as they were just a couple of months ago. Inflation, whilst still growing, appears at last to be slowing. Now is certainly not a time to celebrate, but it should at least not be a cause for despair either.

This post was authored by Matthew Oulton, Vice Chair of the Young Fabian Economy and Finance Network.

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