Monthly UK economic outlook: September

Our economists share their views on the key economic trends to watch in the month ahead.

Ever-increasing energy bills are weighing on households and businesses alike, while the labour market is cooling. All this makes for a complex macroeconomic environment to navigate. Financial markets are bracing themselves for higher prices and faster rate hikes.

Economic growth weakens as the income squeeze intensifies

It’s becoming clearer and clearer that the UK economy is slowing down. GDP fell by 0.6% in June, dragged down by the extra holiday for the Queen’s Jubilee and Covid-related spending being wound down.

The UK Composite PMI fell from 52.1 in July to 50.9 in August, with the manufacturing sector – which is now firmly in contractionary territory – driving the fall. Weaker demand, supply disruptions and labour shortages are all having a negative impact.

While the economy looks set to grow again in Q3 thanks to fiscal support, it seems unlikely that this will mark the beginning of a sustained upturn. The outlook remains challenging, with a further rise in inflation likely in Q4 as the energy price cap will go up by 80% in October and probably even further early next year.

UK PMIs signal further slowdown in business activity

Sources: Markit, NatWest

But there are pockets of resilience in the UK economy. For one, demand for consumer services is holding up. For example, restaurant diner numbers were 32% above their pre-pandemic level as of the week ending 28 August. What’s more, business investment – an area in which the UK needs to catch up with other countries – jumped by 3.8% in Q2. Lastly, consumer spending was only marginally down in Q2, even though real incomes fell. That’s because the relatively healthy balance sheets of both households and companies are helping cushion some of the shock from inflation.

Upwards revisions to peak inflation rate as gas prices soar again

Wholesale natural gas prices continued to soar in August, worsening the inflation outlook for the winter.

CPI rose to 10.1% in June, hitting a 40-year high, with petrol and food prices driving the surge. Meanwhile, core inflation accelerated again after weakening in June.

Volatile wholesale gas markets make it tricky to forecast prices. The Bank of England estimates that inflation will peak at 13% year-on-year in Q4. With further energy cap hikes due in January and April and food set to become even more expensive in the near term, prices are likely to remain high until H2 next year and then slowly fall.

But hints from PMI surveys and elevated inventories indicate that some core prices could trend down. What’s more, falling commodity prices, lower transport costs and improving supply chains should help relieve some of the pressure on prices, particularly for goods.

A third of firms are planning to hike prices in September as energy bills soar

Sources: ONS Business Survey results for 8–21 August 2022, NatWest

Labour market conditions still robust, but beginning to cool

Labour markets are still robust. The unemployment rate remained stable at pre-pandemic levels in the three months to June, while redundancies were still at a record low. But we believe a cooler period for the labour market is probably around the corner.

Why is that? For starters, the UK’s workforce grew at an above-trend 0.6% in Q2, driven by a rebound in immigration. This is likely to go up further as the effect of people remaining out of the workforce due to the pandemic wanes, while cost-of-living pressures could entice more people back into the labour market.

Meanwhile, demand for labour is coming off the boil as the growth outlook weakens. Future employment growth indicators such as online job vacancies are on the decline and employment surveys are also pointing to weakening hiring intentions.

Labour demand is easing, reflected in fewer job openings

Sources: ONS, NatWest

More tightening ahead, but disagreement over how much

The Bank of England delivered its largest hike since 1995 in early August, raising the Bank Rate by 50 bps to 1.75%. The MPC voted 8-1 to hike rates as it expects inflation to hit 13% later this year.

Market expectations for interest rates have risen drastically since, such that they are now pricing in a peak Bank Rate of 4.25% early next year. That’s because the Bank of England is expected to act in response to a dramatic spike in natural gas prices this month amid further Russian restrictions on gas supplies to Europe. What’s more, a resurgence in core inflation in July has raised the risk that inflation expectations could become unanchored.

By contrast, economists and analysts believe an interest rate of 2.50% should be enough to contain inflation over the medium term.

UK Bank Rate forecasts have moved up further

Sources: NatWest

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