Tale of two halves

As Q2 begins, the UK economy is a tale of two halves. Services flourishing but manufacturing faltering. Public borrowing falling, yet missing targets, while interest rate uncertainty chills consumer spending. Across the channel, the Eurozone recovers some steam. Meanwhile, the US faces an economic puzzle: worse than expected growth and sticky inflation leaves the Fed this week in a bind. 

From strength to strength. New PMI figures suggest the UK economy is back on a modest growth path in Q2. The composite index rose to 54.0 in April from 52.8 in March, exceeding expectations and marking the fastest expansion in 11 months. Once more, services remain the engine of growth, hitting 54.9 in April. The manufacturing PMI dipped to 48.7 from 50.3 in March as demand softened. Encouragingly from an inflationary perspective, the services output price index dropped to 56.4, from 57.1, the lowest in 3 years. Nonetheless, stubborn cost pressures aren’t going away, with the services input price balance jumping to 68.7 in April (up 5 points from March), with the National Living Wage a key driver.

Better but worse. Britain's public finances show some signs of improvement, with borrowing falling to £120.7 bn in the 2023/24 financial year, down from £128.3 bn a year earlier. However, it remains £6.6 bn higher than the Office for Budget Responsibility (OBR) had forecasted. As a share of GDP, borrowing fell from 5% to 4.4%, which is still well above the 3.0% average in the five years before the Covid pandemic. Public debt also reached a 60-year high, climbing to 98.3% of GDP (89.4% excluding Bank of England holdings). The public finances outlook is complicated by the recent rise in market interest rate expectations which could raise government’s debt interest costs and complicate the Chancellor’s desire for further tax cuts.

Marginal gains.  The brightening outlook for personal finances saw consumer confidence return to its joint-highest since late 2021 in April. That promises well for growth in household spending in coming months. Yet uncertainty around the scale and timing of interest rate cuts means consumers remain reluctant to commit to big ticket purchases. A loosening of the purse strings can’t come soon enough for many businesses. Company insolvencies declined 5% y/y in Q1 thanks to a 17% m/m drop in March. But despite this welcome news, company failures are still elevated, with the insolvency rate running nearly one-quarter above the pre-pandemic norm.

Inescapable expense. Whether you renewed your mortgage or your rental agreement in 2023, chances are the cost went up a lot.  London, inevitably, saw the biggest increases in both due to having more expensive housing.  A typical rental payment rose by £175 to almost £2,000 a month. But it was the North West that saw the biggest percentage increase of over 12% to £800pm. The North East saw the smallest changes, but even there the extra £110 in mortgage payments or extra £63 in rental payments will still make a dent in the wallet.

Rates and Renewables. The UK's path to net zero depends on large investments in decarbonising the electricity system. However, recent rate hikes present significant challenges, making private infrastructure investment more costly. Unlike financing gas-generated electricity, renewable and nuclear energy requires higher upfront expenditure, which is more susceptible to increased borrowing costs. The cost of capital for offshore wind projects has surged, with nearly half the total cost now due to financing. While falling renewable costs have helped its rapid growth over the last decade, higher rates will provide a new challenge.

Sitting on the fence. As the Bank of England’s May 9th meeting approaches, speeches by MPC members have pulled market rate expectations in opposite directions. Chief Economist Huw Pill's recent speech took a hawkish tone, cautioning against premature rate cuts. Reason being the economic backdrop has changed little since early March when he voted to leave rates on hold. His scepticism arises from the slower-than-expected retreat of services inflation alongside stickiness in wage growth over April data releases. Overall, “the absence of news and the passage of time have brought a Bank Rate cut somewhat closer”, but it gave him little reason to depart from a baseline view that rate cuts are “somewhat off”.

Bouncing back. Eurozone business activity is gaining steam: the PMI jumped to 51.4 in April, from 50.3 in March. Services led the charge at a near one-year high (52.1), suggesting a modest pickup in growth to perhaps 0.2% in Q2 (q/q) as falling inflation supports consumption. Germany, the bloc’s biggest economy, registered strongest growth. However, a manufacturing slump (47.1) throws cold water on the party, with industry demand under pressure and fall in new orders accelerating. Yet both services and manufacturing firms reported a bigger increase in input costs in April than March. Regardless, the PMI price indices remain consistent with declining inflation, so it seems an ECB rate cut in June is a done deal.

Jury’s Out. Is the US economy knocking it out the park, or does stagflation beckon? Both contested views seem overblown. US GDP chalked-up annualised growth of 1.6% in Q1, less than half the 3.4% enjoyed in Q4. Optimists can highlight strong private sector demand. Personal consumption rose by 2.5%, business investment by 3.2%. The private sector is humming, let down by weaker exports and slower government spending. That said, the ‘flash’ PMI for April decelerated from 52.1 to 50.9. And although input prices also eased, they remain elevated and sticky. Almost as sticky as the situation the Fed is in regarding its next move.