The economy contracted by 0.6% in September and by 0.2% in Q3, with a 0.5% quarterly decline in household expenditure and a drop in business investment dragging on growth. Neither did a weaker manufacturing sector or a flat services sector help. In short, several areas of the economy are being buffeted. 

Forward-looking indicators are suggestive of a further downturn. While the UK Composite PMI remained unchanged at 48.3 in November – well below 50 – the forward-looking new orders measure fell to its lowest level since December. The Office for Budget Responsibility is forecasting a 7% drop in real disposable incomes over the next two years. This will reverse eight years of gains, with recovery to pre-Covid levels not expected before 2028.

A marginal improvement in consumer confidence helped shore up spending in November. CHAPS card data rose by 3% over the month, although this was partly due to higher prices. UK flight uptake was 84% of its equivalent pre-Covid level at the end of November, only slightly down from its mid-October peak. Meanwhile, restaurant reservations, while still healthy, have fallen since summer. 

The Chancellor’s Autumn statement delivered a path for fiscal consolidation. Most of the spending cuts and tax rises are pencilled in for after the next general election (no later than January 2025), but the withdrawal of energy-price support next year will cut right into disposable income. While many will dip into their savings, people will remain cautious and rein in spending on non-essentials. But for now, savings continue to build and appetite for unsecured lending is muted. 

November UK composite PMI consistent with a quarter-on-quarter contraction in GDP of 0.2% in Q4

Core Price Inflation (CPI) soared to a 41-year high of 11.1% in October, up from 10.1% in September. Energy costs were a big driver despite the government’s Energy Price Guarantee, as were food prices. However, core CPI, which strips out volatile items and gives a sense of underlying price pressures, held steady at 6.5%.

Food and motor fuel CPI are set to fall in the coming months, a year after some major price increases. Goods inflation is also likely to ease due to lower shipping and commodity prices. Services inflation, however, is likely to prove stickier as service prices change less frequently than those of goods.

Despite renewed upwards pressure on inflation when average household energy bills rise from £2,500 to £3,000, inflation should gradually retreat over 2023. 

Unemployment is likely to rise next year as firms face a double-whammy of higher taxes and weaker demand. That should take the pressure off domestically generated inflation. In theory, this should limit the pace of tightening – but that’s uncertain. There’s plenty of scope for inflation surprises next year. 

Energy prices to soar but household grants to fall (GBP Billions)

Unemployment rose from 3.5% in August to 3.6% in September due to a slowdown in hiring activity. Although the labour market is no longer tightening, there is still scope for weakness in business confidence to hit job growth. 

And yet while redundancies have been ticking up since May, they remain at historic lows. The timelier number of payrolled employees measure is still rising, and the number of vacancies, albeit down, is still high.

Pay growth is still best described as high compared with the past decade, but low compared with inflation. Growth in weekly pay (excluding bonuses) rose from 5.5% year-on-year in August to 5.7% in September. Similarly, expected wage growth over the next year was up from 5.5% in September to 5.8% in October. However, if slack in the labour market does increase, it should limit future wage growth. A slowdown in hiring will also lead to less churn in the job market, easing the pressure on businesses to pay more to retain staff.

Labour demand is easing, as reflected in a slowdown in recruitment

On 3 November the Bank of England hiked its policy rate by 75bps to 3%, the highest level since 2008. Market expectations for the policy rate are now stable at 4.50%, well below the 6.25% being priced in a few months ago.

The key question is how much more tightening is still to come. Rate hikes aren’t over, with two Monetary Policy Committee members raising concerns about the second-order effect of the energy price shock and declining labour market participation among older people leading to persistent inflationary pressures. It’s too early to declare victory over inflation. 

Calibrating interest rates is a tricky task as the effects of hikes come with a lag. Escalating debt repayments by households and firms point to weaker activity down the line. And while finances are being squeezed overall, many people with mortgages are making ad-hoc repayments. In fact, UK households collectively increased their cash reserves in October despite the cost-of-living crisis.

That’s perhaps just as well. Expenses are set to rise, and the effective rate on new mortgages looks set to soar to between 5.5% and 6.0% early next year. With a recession in the making, the Bank of England will have to limit its pace of hiking.

Market expectations for the policy rate stable at 4.50%

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