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7 May 2024 | EY ITEM Club comments:

April's construction PMI adds to the evidence of a strengthening recovery

• A 14-month high for the construction Purchasing Managers’ Index (PMI) provided more evidence that the economic recovery is becoming more established. The EY ITEM Club expects to see a solid rebound in construction output in Q2, after Q1 was affected by unusually wet weather.
• April’s S&P Global survey reported that the housing sector remains a drag on construction activity. But the EY ITEM Club expects the outlook for housebuilders to improve quickly, given increasing evidence that housing transactions and prices have passed their trough.

Peter Arnold, EY UK Chief Economist, said: “The construction PMI rose to 53.0 in April, up from 50.2 in March and the strongest reading for 14 months. The construction PMI has been a relatively good leading indicator of the official measure of construction output over the past couple of years. Though the most recent official outturn showed a significant fall in output in February, the EY ITEM Club attributes that mainly to the exceptionally wet weather during the month. And while the UK has endured a damp spring, the drag from that source should fade, so the EY ITEM Club expects to see a solid recovery in construction output in Q2, mirroring the recent improvement in the survey data.

“Evidence of stronger activity in the construction sector comes on the back of similarly upbeat reports elsewhere in the economy, particularly from last week’s S&P Global services survey. After two years of stagnation, the economic recovery is becoming more established and is broadening. On Friday, the EY ITEM Club expects the Office for National Statistics (ONS) to report that GDP grew by 0.4% quarter-on-quarter in Q1. And though it’s still very early days, another solid increase in GDP in Q2 seems a feasible prospect.

“The April S&P Global survey reported strength in the commercial sector, after a lengthy period of falling activity, but much softer trends in housebuilding. However, the EY ITEM Club expects the outlook for housebuilders to turn around quickly. Experience suggests that housebuilding reacts to movements in housing transactions and prices with a lag. With increasing evidence that both activity and prices have passed their troughs, housebuilding should start to pick up soon.”

7 May 2024 | EY ITEM Club comments:

Halifax shows house prices broadly flat since the start of the year

• A small increase in April left house prices broadly flat since the turn of the year. The stabilisation in market conditions reflects the large fall in mortgage rates since last summer, with transactions and prices appearing to have passed their trough.
• However, the recent rise in mortgage rates is likely to dampen the recovery in the short-term. And looking ahead, the recovery in prices is unlikely to be rapid given that poor affordability continues to significantly limit the pool of potential buyers and mortgage rates are only likely to fall back slowly. 

Peter Arnold, EY UK Chief Economist, said: “The Halifax measure of house prices rose by 0.1% month-on-month in April, after a 0.9% fall in March. However, it is important to note that, as with the Nationwide measure, the month-to-month profile has been volatile. Overall, prices have been broadly flat since the start of the year.

“There is growing evidence that the housing market has passed the bottom. The substantial fall in mortgage rates since last summer, combined with strong growth in nominal wages, has reduced the scale of the mortgage affordability problem. This has helped to entice some buyers back to the market, leading to a recovery in transactions and putting a floor under prices.

“More recently, mortgage rates have begun to edge up again in response to rising swap rates, as financial markets anticipate a slower pace of Bank of England rate cuts. This is likely to constrain the pace of the recovery in transactions and prices in the near-term. But so far, the increases have been small and mortgage rates remain well below last summer’s peaks. Therefore, the EY ITEM Club does not expect to see a renewed downturn in the housing market.

“Looking ahead, the EY ITEM Club expects a slow and steady recovery in house prices. After the Global Financial Crisis, prices were broadly flat for three years before a recovery took hold. Though mortgage affordability is much better than it was last summer, it remains very stretched relative to historical norms, and the EY ITEM Club expects only a relatively slow fall in mortgage rates over the next couple of years. Furthermore, it’s not just the affordability of mortgage payments that is limiting the pool of potential buyers. The relatively small fall in house prices over the past couple of years means that both loan-to-income and loan-to-value ratios remain very high, preventing many people from accessing mortgage finance. Tight supply, resulting from very low levels of housebuilding, will provide some offset to subdued demand. However, the EY ITEM Club expects a very slow pickup in prices over the next few years.”

3 May 2024 | EY ITEM Club comments:

MPC set to reiterate that rate cuts are coming

• The EY ITEM Club expects Bank Rate to remain at 5.25% following May’s Monetary Policy Committee (MPC) meeting. But the MPC is likely to reiterate that rate cuts are around the corner.
• The MPC is expected to cut its inflation forecasts in response to lower energy prices and higher market expectations for interest rates. If its forecast shows inflation below 2% in two years’ time, this will be a signal that the MPC thinks market pricing is too high.
• Though the Bernanke review recommended substantial changes to the production and presentation of the MPC’s inflation forecasts, the EY ITEM Club expects those changes to be introduced over a long period.

Peter Arnold, EY UK Chief Economist, said: “May’s MPC meeting is expected to see Bank Rate remain at 5.25%. A few months ago, the EY ITEM Club had been cautiously hopeful that this meeting could see the first rate cut, but sticky private sector wage growth and services inflation have significantly reduced the chances of the MPC moving at this month’s meeting.

“The EY ITEM Club expects the MPC to cut both its short and long-term inflation forecasts, which will be published in the accompanying Monetary Policy Report. The MPC’s current forecast for H2 2024 looks too high, particularly in light of recent developments around energy prices. And its new long-term forecast will be based on market expectations that range between 60 to 90 basis points (bps) higher than the February version for the next three years. If the MPC’s new forecast shows inflation below 2% at the two-year horizon then this would be a signal that market pricing is too high and the MPC expects to cut Bank Rate more substantially than consensus expectations. 

“The Bernanke Review recommended significant changes to the production and presentation of the MPC’s forecasts, but the EY ITEM Club does not expect major changes in May’s Monetary Policy Report. The Bank of England’s response to the Bernanke Review made clear that it will take time to implement the scale of change recommended.”

3 May 2024 | EY ITEM Club comments:

April's services PMI suggests Q2 started on a strong footing

• April's final UK services Purchasing Managers’ Index (PMI) reported the strongest pace of activity growth for 11 months, following an upturn in new orders. This adds to the impression that stronger household finances are paving the way for a consumer-led recovery.
• Though the survey pointed to an acceleration in cost pressures due to the large national living wage increase, companies appeared reluctant to pass this on to consumers in full. This is consistent with the EY ITEM Club’s forecast that services inflation will continue to cool in the coming months despite the elevated rate of pay growth. 

Peter Arnold, EY UK Chief Economist, said: “April's final S&P Global survey pointed to a strong rise in services activity, with the PMI climbing to an 11-month high of 55, from 53.1 in March. Survey respondents linked this to an upturn in new orders, due to firmer consumer and business spending. The improvement in services activity was partially offset by the fall in production in April's earlier manufacturing survey, so the rise in the composite PMI was smaller. Still, the composite PMI of 54.1, up from 52.8 in March, was the strongest reading in a year.

“The sustained run of composite PMI readings above the 50 'no-change' mark since the end of last year suggests the upturn in private sector activity is becoming more entrenched. Though the details of today's survey signal a strong start to Q2, quarter-on-quarter growth may not be quite as robust as seen in Q1, which was boosted by the rebound from December's short-lived retail decline. But the EY ITEM Club expects the underlying momentum in the economy to gradually build throughout the year, as real household incomes continue to improve.

“A key tenet to this outlook is the EY ITEM Club’s forecast of lower inflation. On that front, today's survey saw output prices grow at their slowest pace in three years, despite a rise in input costs that largely resulted from April's significant national living wage increase. This is consistent with the EY ITEM Club’s view that the official services inflation will continue to cool. Businesses will likely continue to pass on the savings from lower energy prices to customers, and once the impact of the higher national living wage has faded, pay growth should slow as labour market conditions steadily loosen.”

1 May 2024 | EY ITEM Club comments:

April's PMI pointed to a renewed fall in manufacturing activity

• The UK manufacturing Purchasing Managers’ Index (PMI) fell in April, signalling that activity slipped back into contraction. Nevertheless, the EY ITEM Club still sees the potential for a modest recovery in manufacturing output this year, with solid real household income growth offering support to producers of consumer goods.
• The survey suggested that higher transportation costs and raw material prices were behind a further pick up in input cost inflation. There was evidence that this was passed on to customers. These developments may slow the decline in core goods inflation, but the EY ITEM Club thinks the impact on headline Consumer Price Index (CPI) inflation will be outweighed by downward pressure in other inflation categories.

Peter Arnold, EY UK Chief Economist, said: “March's upturn in manufacturing activity proved short-lived, with April's final S&P Global manufacturing survey signalling that the sector shifted back into contractionary territory. The PMI fell to 49.1 in April from 50.3 in March. This reflected lower levels of production and new orders, following weakness in the intermediate and investment goods industries.

“More expensive transportation and raw material prices contributed to a rise in input cost inflation for manufacturers. And the survey suggests that this cost burden was largely passed on to customers, as selling price inflation rose to an 11-month high. However, the EY ITEM Club thinks the impact of these pressures on headline CPI inflation will be limited, given the substantial downward momentum in other inflation categories in the coming months.

“Lower headline inflation should help the broader recovery become more established, which will offer some support to manufacturers' domestic order books. But the drags from past interest rate increases and tighter fiscal policy will mitigate this boost to household and corporate budgets. On the external front, global growth is beginning to regain some momentum, which provides the potential for stronger sales in key export markets. As a result, the EY ITEM Club expects manufacturing output to pick up this year, but growth is likely to be steady rather than spectacular.”

1 May 2024 | EY ITEM Club comments:

Nationwide reports another small fall in house prices in April

• The EY ITEM Club attributes a second successive small fall in house prices to noisy data rather than anything more significant. Though mortgage rates have nudged up in the past couple of months, they remain well below last summer’s levels, and the EY ITEM Club thinks that transactions and prices have passed their trough.
• Still, the recovery in prices is unlikely to be rapid. Poor affordability continues to significantly limit the pool of potential buyers. And the EY ITEM Club expects only a modest fall in mortgage rates over the next couple of years.

Peter Arnold, EY UK Chief Economist, said: “Nationwide’s measure of house prices fell by 0.4% month-on-month in April, following another small decline in March. This still left prices marginally higher than a year ago. However, the EY ITEM Club wouldn’t recommend reading too much into April’s fall. The lenders’ house price series can be volatile from month-to-month, particularly in times when transaction levels are relatively low, making it harder to mix-adjust the data. Just as the apparent strength in January/February looked out-of-keeping with fundamentals, the latest data is unlikely to mark the start of a renewed fall in property prices.

“A broad range of housing market indicators for the early months of 2024 suggest that the market has passed the bottom. The substantial fall in mortgage rates since last summer, combined with strong growth in nominal wages, has reduced the scale of the mortgage affordability problem. This has helped to entice some buyers back to the market, leading to a recovery in transactions and putting a floor under prices. And though mortgage rates have ticked up in recent months, in response to rising swap rates, the increases have been small and the EY ITEM Club does not expect this to derail the nascent recovery.

“Still, the EY ITEM Club thinks a strong recovery in house prices and activity is unlikely. After the Global Financial Crisis, prices were broadly flat for three years before a recovery took hold. Though mortgage affordability is much better than it was last summer, it remains very stretched relative to historical norms, and the EY ITEM Club expects only a slow fall in mortgage rates over the next couple of years. Furthermore, it’s not just the affordability of mortgage payments that is limiting the pool of potential buyers. The relatively small fall in house prices over the past couple of years means that loan-to-value ratios remain very high, preventing many people from getting onto the property ladder. Tight supply, resulting from very low levels of housebuilding, will provide some offset to subdued demand. But the EY ITEM Club expects a very slow pickup in prices over the next few years.”

30 April 2024 | EY ITEM Club comments:

Higher interest rates temper recovery in mortgage demand

• UK mortgage approvals rose to an 18-month high in March, although this increase was much smaller than those seen in the previous two months. This likely reflects the effect of rising mortgage interest rates. With mortgage rates set to edge up further, as the impact of higher swap rates feeds through, the EY ITEM Club expects the recovery in mortgage approvals to continue to cool.
• Another strong rise in gross unsecured lending adds to the evidence that consumers are shedding the caution that overshadowed 2023. Combined with solid real income growth, the EY ITEM Club expects stronger demand for credit to drive a consumer-led upturn in activity through 2024.

Peter Arnold, EY UK Chief Economist, said: “The recovery in mortgage demand continued in March, with approvals for new house purchases rising to 61,325, an 18-month high. However, the increase in mortgage interest rates over recent months appears to have taken some of the momentum out of the recovery, with the rise in approvals between February and March being much smaller than the previous two months. Net mortgage lending slipped to just £0.3bn in March, from £1.6bn in February, but February's outturn had been flattered by a temporary slump in repayments.

“With swap rates having climbed further during April, and mortgage rates continuing to edge up in response, the EY ITEM Club expects the recovery in approvals to continue to cool in the near-term. 

“Net unsecured lending rose to £1.6bn in March from £1.4bn in February, with another strong rise in gross lending mitigated by repayments remaining high. The continued pickup in gross lending is consistent with the EY ITEM Club’s assessment that consumers will shed the cautious attitude of last year and make more use of what is likely to be solid growth in real household incomes. A stronger appetite for credit is a crucial part of this story, and the steady improvement in GfK's measure of consumer confidence offers some cause to believe this trend will continue. The EY ITEM Club expects the combination of solid income growth and less cautious behaviour to drive a consumer-led upturn in activity through 2024.”

23 April 2024 | EY ITEM Club comments:

Flash PMIs suggest economic recovery is gaining momentum

• The UK flash composite Purchasing Managers’ Index (PMI) rose to an 11-month high in April, due to stronger growth in services activity. The fact that the index moved further into expansionary territory bolsters the EY ITEM Club’s confidence that an economic recovery is underway.
• The survey provided mixed news on inflation. Input cost pressures rose significantly, linked to the increase in the national living wage. However, lower output price inflation suggests this hasn't been passed on to customers immediately. If reflected in the official data, this supports the EY ITEM Club’s view that the Bank of England will start to loosen its monetary policy stance over the summer.

Andrew Goodwin, Senior Economic Advisor to the EY ITEM Club, said: “April's flash S&P Global survey reported a strong rise in the composite PMI to 54.0, up from 52.8 in March. The index has remained above the '50 no-change' mark for six consecutive months now, signalling a healthy period of private sector activity growth. The divergence in prospects at a sectoral level widened, with the momentum in services activity increasing on the back of improvements in new orders, hiring, and business optimism. However, manufacturing output contracted in April, after March's short-lived upturn.

“Over the past 18 months, the S&P Global survey has had a reasonable record as a leading indicator of official output for the sectors it covers. But the link to GDP has been weaker, primarily due to industrial action in the public sector – a factor not captured in business surveys. The fact that there have been far fewer working days lost to strikes in recent months suggests the link between the composite PMI and GDP should strengthen. Therefore, the positive results of today's survey bolster the EY ITEM Club’s confidence that an economic recovery is already underway.

“The degree to which April's national living wage increase will pass through to services prices has been a key factor in the near-term outlook for interest rates. Today's flash survey reported a strong pickup in input costs, led by robust service sector pay growth. But output price inflation was the slowest seen since February 2021, suggesting that so far companies have only passed part of the higher cost burden on to customers. If reflected in the official data, this would support the EY ITEM Club’s view that the Bank of England's Monetary Policy Committee will have enough confidence to start loosening policy over the summer.”

23 April 2024 | EY ITEM Club comments:

Borrowing overshot OBR's forecast in 2023-2024

• The first estimate of UK public sector net borrowing for fiscal year 2023-2024 came in £6.6bn higher than the Office for Budget Responsibility's (OBR) forecast. However, fiscal data tends to be revised, so the EY ITEM Club would recommend treating this preliminary reading with a degree of scepticism.
• Media reports have suggested that the Government plans another pre-election cut to employee National Insurance Contributions (NICs). But more hawkish market pricing has halved the Chancellor's already-thin margin for error against the fiscal rules, so the EY ITEM Club thinks another NICs cut is unlikely. 

Andrew Goodwin, Senior Economic Advisor to the EY ITEM Club, said: “Public sector net borrowing was £11.9bn in March, down from £16.6bn in the same month of last year. This meant the initial estimate for fiscal year 2023-2024 was £120.7bn, slightly higher than the OBR’s forecast of £114.1bn. But the preliminary estimate relies heavily on forecasts, and experience tells us that the data can be heavily revised over the following months and even years.

“Reports over the weekend speculated on the likelihood of another fiscal event before the next general election and whether this could implement another cut to employee NICs. But the EY ITEM Club thinks that scenario is relatively unlikely. The package implemented at the Budget left a very narrow margin for error against the fiscal rules of just £8.9bn (0.3% of GDP). Since then, markets have turned more hawkish on the outlook for interest rates. Based on current market pricing, the EY ITEM Club calculates that more than half of that already-small leeway has been lost to higher debt servicing costs. So, unless the Chancellor is prepared to assume even greater spending restraint, it's unlikely there will be another tax-cutting fiscal event before the election.

“Fiscal policy is expected to be tightened significantly over the next five years through both higher tax revenues via the ongoing freeze of most allowances and thresholds, and very tight spending plans. Labour has vowed to maintain the existing debt rule, so whatever the outcome of the next general election, a marked change in approach to fiscal policy is unlikely.”

19 April 2024 | EY ITEM Club comments:

Flat sales in March caps off a strong Q1 for retailers

• Flat sales in March capped off a strong Q1 for UK retail sales, which were up 1.9% quarter-on-quarter. Noisy data likely exaggerates the strength of the pickup in early 2024, but it looks increasingly likely that activity has passed its trough. GDP is on track to have grown by 0.4% quarter-on-quarter in Q1.
• The EY ITEM Club thinks the building blocks are in place for a decent consumer recovery this year. Real incomes should grow at a solid pace, but the mindset of consumers will be key – a repeat of last year's cautious behaviour would likely cause the recovery in spending to disappoint.

Andrew Goodwin, Senior Economic Advisor to the EY ITEM Club, said: “Retail sales volumes were flat in March, after gains in the two previous months. Fortunes varied significantly across different sectors, with food sales falling back and a substantial month-on-month decline in the non-store sub-sector, but there were large gains for non-food and, in particular, fuel sales. 

“Curiously, the Office for National Statistics (ONS) release contained no mentions of Easter, but it's likely that the earlier-than-normal bank holidays had an influence on the data. Indeed, between 2000-2023 there were six instances where Good Friday was in March, and on four of those occasions sales fell month-on-month in March, with three of the declines being more than 1%. So, in that context, the March 2024 performance looks reasonable.

“Sales grew by 1.9% in Q1, after a 1% fall in Q4 2023. Retail sales data is notoriously volatile, and noise undoubtedly exaggerates the extent to which the performance of the retail sector has improved in Q1. That said, the EY ITEM Club thinks we are clearly past the trough in terms of consumer demand and activity more broadly, with the benefits of the significant fall in inflation and recovery in real wages beginning to emerge. GDP remains on track to have grown by 0.4% quarter-on-quarter in Q1.

“The EY ITEM Club expects the improving trend to continue throughout this year, although it won't all be plain sailing for consumers. The effect of tighter fiscal policy will continue to be felt, while borrowers with fixed rate mortgage deals expiring this year face a sizeable increase in their interest payments. But the EY ITEM Club expects to see solid real income growth and, provided that consumers move away from the very cautious behaviour they exhibited last year, a decent consumer recovery is in prospect.”

17 April 2024 | EY ITEM Club comments:

Inflation surprised to the upside in March

• Although UK Consumer Price Index (CPI) inflation fell again in March, the scale of the decline underwhelmed as services inflation proved surprisingly sticky. Base effects will continue to push inflation down in the coming months, but it's now uncertain whether inflation returns to the Bank of England's 2% target in April.
• The Monetary Policy Committee (MPC) has suggested it would need to see further progress on services inflation and pay growth before loosening policy. Today's data therefore significantly reduces the chance of a rate cut in May. The EY ITEM Club still thinks the first rate cut will come in June, but April's pay and services inflation data will be key.

Andrew Goodwin, Senior Economic Advisor to the EY ITEM Club, said: “CPI inflation edged down to 3.2% in March, from 3.4% in February. The decline was due to base effects in the food and core categories, after unusually large rises in these components between February and March last year. This downward pressure was only partly offset by higher petrol prices. Nevertheless, March’s figures represented an upside surprise, with sticky services inflation the main factor behind this.

“A more substantial fall in next month's inflation data is highly likely. The 12% cut to Ofgem’s price cap will mean the downside effect from energy prices will grow. Services inflation is also likely to fall back as lower headline inflation should mean April’s annual indexation of inflation-linked contracts and regulated prices results in much smaller price rises than last year. The stickiness of services inflation means it’s uncertain whether inflation returns to the Bank of England's 2% target in April. But even if it doesn't, inflation should fall below 2% in H2 2024.

“The MPC has signalled that further evidence of cooling services inflation and pay growth will be required before the majority are prepared to loosen policy. At 6%, services inflation was above the Bank of England's latest projection of 5.8%, and yesterday's pay data was also surprisingly firm. Therefore, the chances of a May rate cut look very remote. However, the EY ITEM Club still thinks there's a good chance that the first rate cut will come in June, provided that there are no unexpected surprises in the key April data for pay growth and services inflation.”

16 April 2024 | EY ITEM Club comments:

Pay growth remains resilient, reducing chances of a May rate cut

• A surprisingly firm outturn for UK private sector regular pay growth reduces the chances of the Monetary Policy Committee (MPC) cutting interest rates in May.
• But the EY ITEM Club thinks the MPC’s June meeting looks likely to deliver the first cut. The MPC will have two more sets of pay and inflation data by then, including the key April outturns. Survey data points to pay growth continuing to slow, while there is fairly strong evidence that labour market conditions are loosening.

Andrew Goodwin, Senior Economic Advisor to the EY ITEM Club, says: “Today’s labour market release reported that private sector regular pay growth – the Bank of England’s favoured measure – edged down to 6% in the three months to February. However, a strong outturn for February itself indicates greater resilience than earlier data had suggested, with the three-month-on-three-month annualised growth rate rising, albeit from very low levels. 

“Labour Force Survey (LFS) data continues to be published with a large health warning, given that the Office for National Statistics (ONS) is still in the early stages of implementing the methodological changes it hopes will improve the reliability of the data. So, the rise in unemployment in the three months to February must be treated with a healthy dose of scepticism. That said, it does fit with vacancies continuing to drift lower and the HMRC payroll measure of employment falling, so overall there is fairly strong evidence that labour market conditions are loosening.

“Hopes of a May interest rate cut had always appeared to rest on there being a significant downside movement in the February data for pay growth or inflation. Therefore, today's surprisingly strong outturn for pay growth reduces the chances of a May move. 

“The EY ITEM Club expects the first cut to come in June. Two further sets of labour market and inflation data are due to be released before then, including the key April data. Timelier survey data suggests the downward momentum in pay growth has continued, and if this is mirrored in the official data, and labour market conditions continue to loosen, the EY ITEM Club thinks the majority of MPC members will have seen enough to vote for a rate cut in June.”