Will May be the last Bank of England interest-rate rise in this series?

Today we have an opportunity to look at both the latest data on the UK economy and also how the Bank of England will respond to it. Along the way we have a further confirmation of the theme that I established on the 29th of January 2015 which is that high inflation leads to weak Retail Sales, So let me start with that as looking at the retail sector inflation is certainly high. The emphasis is mine.

Compared with the same period a year earlier, sales volumes over the last three months rose by 5.4% while sales values rose by 13.8% reflecting an annual implied deflator (or implied growth in prices) of 8.4%. 

In fact the deflator or implied growth in prices was 9.7% in March. You may note that this is much closer to the inflation numbers from the Retail Prices Index or RPI than the officially promoted by widely ignored CPIH measure.. This subject is also on my mind because I attended a seminar on the plans for UK statistics to include scanner data on Wednesday which started with the usual rubbishing of the RPI.

So according to my theme we should have weak volume numbers in response to the high inflation.

Retail sales volumes fell by 1.4% in March 2022, following a fall of 0.5% in February 2022 (revised from a fall of 0.3%).

As you can see we have yet another correlation via both the downward revision to the existing February fall and the accelerated decline in March. We can look further back because if we ignore the 2021 post lockdown bounce we have seen a decline from the 107.4 for the index in July 2021 to the 101.3 of this March. So as inflation has picked up the index has fallen and we are in danger of eliminating this.

sales volumes were 2.2% above their pre-coronavirus (COVID-19) February 2020 levels.

Non store retailing

If we look into the detail here we see that this sector seems to be particularly reflecting my inflation effects theme.

Sales volumes fell by 7.9% in March, down from a fall of 6.9% in February 2022. This follows increases of 4.5% in January 2022 and 2.3% in December 2021, when strong online sales may have been linked to consumer concerns about the Omicron variant of coronavirus (COVID-19).

So volumes have slowed and even the official analysis suggests high inflation is to blame.

Some of the fall in February and March 2022 may also be linked to affordability concerns. Results from our Opinion and Lifestyle Survey (OPN) covering the period 16 to 27 March found that of the actions taken because of an increase in the cost of living, 54% of adults reported spending less on non-essentials.

Actually the same looks to be in play for automotive fuel sales.

Automotive fuel sales volumes fell by 3.8% in March 2022. This follows an increase of 3.8% and 3.7% in January and February 2022 ,

High fuel prices are leading to less driving.

Our Consumer price inflation March 2022 release reported record high petrol and diesel prices in March 2022, which may have reduced travel. Results from OPN covering the period 16 to 27 March found that of adults who said that their cost of living had increased, 39% were cutting back on non-essential journeys in private vehicles.

Bank of England

We can now review the developments above via a speech given yesterday by policymaker Catherine Mann.

Inflation

According to Catherine she targets 2% inflation all the time.

By remit, the Monetary Policy Committee is tasked to maintain inflation as measured by the Consumer Price Index at 2% and that this target applies “at all times”.

Well until it doesn’t.

However, the remit also recognises that shocks will push inflation away from 2%, and that appropriate monetary policy can temporarily tolerate such a deviation.

So we can file “at all times” next to “transitory”

Although she does not put it like that she confesses that the Bank of England has got things wrong.

In the first type of uncertainty, if the shock is truly persistent, but is misperceived as transitory, the policymaker initially under-reacts relative to the full information case. Even as they learn about and respond gradually to the true nature of the shock, the inflation overshoot is both larger and more persistent than under full information

The Economy

Catherine quickly pivots to her worries bout the economy as inflation will be targeted at all times gets another review. Interestingly she starts with an implied critique of the average earnings figures which told us that real wages soared post pandemic.

The first issue with demand was that the negative shocks to real income were coming at a time when the level of real average disposable income had stagnated for the 2 years of COVID, rather than rising at some 0.8% per year as in the decade before the pandemic.

In fact she fears quite an economic contraction from this.

A back-of-the-envelope calculation of the impact of a doubling of consumer-facing energy prices – about what the October price cap might be relative to before-Covid – generated a reduction in real aggregate non-energy consumption of roughly 2%. This would come on top of any reduction in demand caused by the 2% drop in real post-tax labour income that was projected for 2022 as of the February forecast.

So for non energy spending we may see a 4% decline in consumption.

Too late she seems to have oined my theme that high inflation weakens the economy.

If these items get more expensive but households cannot meaningfully reduce the real amount that they consume of them, their nominal spending on these bills will have to rise. This spending will then need to be financed either by dis-saving, borrowing, or by reducing the consumption of everything else, implying a shift in aggregate consumption shares. Of course, not only have prices risen for gas and electricity, but the price of non-energy consumption has gone up as well, albeit not by as much.

Also she has discovered that factors which central bankers have dismissed as “non-core” and thereby less important are in fact the most important.

She also signaled that today’s news would be significant.

As of the March meeting, notwithstanding then-current robust nominal wage increases and employment growth, retail sales were at best holding up (or even falling in real volumes) and consumer confidence had weakened, particularly the forward-looking balances

We now know that retail sales fell and as for consumer confidence we learnt this earlier.

LONDON, April 22 (Reuters) – British consumer sentiment tumbled in April to its second-lowest reading since records began nearly 50 years ago, as the worsening cost-of-living crisis hurt households’ confidence in the economy and their personal finances.

Comment

It looks as though Catherine is getting ready to bail out on her concern about inflation. The emphasis is mine.

For the May meeting, key topics for me are an assessment and judgment on how much and when the expected consumption drag materialises, and whether we start to see any indication of price forecast revisions in the DMP survey. If they do, this potentially would short-circuit the expectations-formation process underpinning the domestic inflation ratchet, which has been my central concern.

Meanwhile if today’s numbers are any guide her worries about the economy are already here.

For the May meeting, key topics for me are an assessment and judgment on how much and when the expected consumption drag materialises,

To this will be added the increasingly disastrous looking National Insurance tax of Chancellor Rishi Sunak.

So May could quite easily be the last interest-rate rise and today’s news points us towards 0.25% rather than the previously expected 0.5%.

Oh and the 1% fall in the UK Pound today is equivalent to a 0.25% cut in Bank Rate.