By Bas van Geffen, Senior Macro Strategist at Rabobank
As inflation continues to bite, households are increasingly reassessing what to spend their money on.
According to a YouGov poll, Britons are more likely to spend less on new clothes than they are to cut their gym memberships and TV subscriptions.
“Workouts win out”, as Bloomberg headlined this morning. However, isn’t this just demonstrating the fallacy of gyms? People sign up as a New Year’s resolution, only to be stuck with a membership for the remainder of the year.
Consumers’ spending cuts were clearly visible in UK’s Q3 GDP. The economy shrank 0.2% q/q. Although that is better than the expected decline, the GDP data gives a deceivingly positive picture. The more recent monthly GDP indicator shows a 0.6% m/m decline for September, pointing to a sharper decline in the underlying pace. And, as our UK strategist notes, the drop in GDP is predominantly driven by a fall in private consumption (0.5%). In fact, the output in consumer-facing services is now 10% lower than it was prior to the pandemic. On top of that, business investment fell by 0.5% q/q. So the two key components of domestic demand are weakening.
On the other hand, there have been increases in government spending, particularly for public administration and defence, and government investment.
If we look at external trade: export volumes increased by 8.0% q/q, though much of this was driven by an increase in non-monetary gold.
Import volumes fell by 3.2% in the latest quarter, driven by falls in chemicals, manufactures and other goods. So net trade adds to GDP, but for completely wrong reasons.
Whereas inflation is still a major headache for consumers, US CPI was a reason for markets to rally yesterday. Inflation euphoria struck traders as the US CPI print for October came in at ‘just’ 7.7%. That is a solid drop compared to September’s 8.2%. Moreover, the rate of core inflation decelerated to 6.3% y/y from the prior month’s 6.6%. Did anyone say ‘pivot’? Markets certainly seemed to think so – at least in terms of the implied expectations for the Fed’s next rate hike. Odds of a 75bp hike vanished from Fed funds futures, long-dated yields dropped, and equities rallied.
This renewed ‘pivot’-optimism was not contained to the US. European fixed income and equities rallied alongside their US counterparts, despite quite hawkish comments from Isabel Schnabel.
The ECB executive board member presented a slide deck with the ominous title “Persistence of inflation in the euro area”, in which she noted that “the risk of inflation persistence has risen further” and that “only a deep recession with a sharp rise in unemployment would dampen inflation, but this is unlikely now.”
Ms. Schnabel concluded that the ECB cannot afford to pause and that their policy will have to move into restrictive territory. Is this the central bank fearing the start of a wage-price spiral?
Wage demands are increasing as households feel inflation squeeze their disposable incomes. And, thanks to a relatively tight labour market, some bargaining power seems to have shifted from employers to employees. Earlier this week, Bloomberg reported on the latest trend this earnings season: large European firms warning for increased wage pressures next year – and the risk of strikes if these demands aren’t met.
Higher wage bills add to the price pressures companies were already facing, and many companies –particularly SMEs– will only have limited room to increase pay.
After all, productivity has hardly increased, so higher wages will erode profit margins. So any wage increases will probably come out of employees’ own pockets: Bloomberg continues that many of these European firms warn that they may have to raise prices again next year, but this time as a direct result of higher wages.
Even if wage demands are not met fully, this dynamic could still lead to a wage-price spiral that delays the return of inflation to the ECB’s 2% target.
In her slides, Schnabel referred to a new ‘wage tracker’ that has been developed by Indeed and the Central Bank of Ireland. It determines wage developments based on the texts of job advertisements, and the data is therefore much more timely than the ECB’s current indicators. Although the index is still new and could overstate wage dynamics as it only reports on ‘job changers’, it suggests that wage pressures have accelerated markedly in recent months.
So, while we are reluctant to call this a wage-price spiral yet, the ECB must be careful that the economy is not drawn into one. That could be as difficult to get out of as it is to get out of an annual gym membership.