Interest rate worries

Interest rate worries

The latest Deloitte survey of UK Chief Financial Officers is released today. It shows that confidence among the CFOs of the UK’s largest corporates edged lower in the second quarter, partially unwinding the sharp pickup in business sentiment seen in the first quarter survey which took place in March. The full report is available at: https://www2.deloitte.com/uk/en/pages/finance/articles/deloitte-cfo-survey.html

• Higher than expected inflation and a sharp rise in interest rate expectations are weighing on business confidence. Since the first quarter survey, financial market expectations for UK interest rates in 12 months’ time have risen by over 150 basis points. CFOs now see tight monetary policy as posing the greatest threat to their business, eclipsing the concerns around geopolitics and energy prices that have dominated for the last two years. Credit is seen as being more costly than at any time since 2009, during the credit crunch.

• The three months since the last survey have been marked by a series of unexpectedly high readings for UK inflation and earnings growth. For major corporates these numbers appear to signal a more prolonged period of high inflation, with CFO expectations for inflation in two years’ time rising from 2.9% in the first quarter survey to 3.6% now. On these forecasts, the current bout of above-target inflation, which started two years ago, has at least another two years to run.

• Yet it is not all doom and gloom. Recruitment difficulties have eased significantly since the start of the year. Supply chain disruption and labour shortages have dropped down CFOs’ list of worries. While credit conditions are tight, CFOs see the Bank of England cutting base rates to 4.5% by the middle of 2024, well below the rate of about 6.25% priced into futures markets.

• Our special question this quarter examines CFOs’ views on hybrid working. Our respondents estimate that on average, employees in their organisations, who can work remotely, split their time evenly between office and home. CFOs say they would prefer to see more time being spent in the office. 56% of CFOs also believe that employees will be spending more time in the workplace in two years’ time, 38% think the current balance will continue and only 6% expect to see a further reduction in time spent in the office.

• The burst of business optimism seen in spring has faded under the weight of inflation and rising interest rates. (German business confidence also saw a revival earlier in the year, but has since fallen back.) UK corporates have responded with an increasing focus on cost reduction, which CFOs rate as their top balance sheet priority, and increasing cash flow, which is in second place. Businesses have negotiated a series of major challenges in the last four years: departure from the EU, the pandemic, supply shortages and an energy shock. The legacy of those earlier shocks, in the form of inflation and high interest rates, is now the central challenge.

PS: The UK, uniquely among major industrialised nations, has seen a marked loss of people from the workforce since the start of the pandemic. This exodus, reflecting increases in the numbers of students, early retirees and people on sickness benefits, has acted as a drag on growth and has become a major policy issue. By late summer last year about 600,000 more people of working age were neither in employment nor seeking a job than would have been expected before the pandemic. The good news is that since then economic inactivity has fallen significantly and now stands only around 280,000 above pre-pandemic levels as students have entered the workforce and rates of early retirement have fallen. But worryingly, levels of inactivity due to poor health have continued to increase. This partly reflects the continuation of a trend of rising sickness to which the pandemic has added with long COVID, increasing mental health problems and delays in health treatment. In addition to the human cost the Office for Budget Responsibility estimates that the post-pandemic increase in inactivity due to long-term sickness is costing the Treasury over £15bn a year in foregone tax revenues and additional welfare spending.

OUR REVIEW OF LAST WEEK’S NEWS

The UK FTSE 100 equity index ended the week up 2.5% at 7,435. The index regained most of the losses seen the previous week as US inflation came in lower than expected, raising hopes of a lower peak in US interest rates.

Economics

• Business and academic economists polled by The Wall Street Journal put the probability of the US entering a recession in the next 12 months at 54%, down from 61% in the two previous surveys 
• US inflation fell to 3% in the 12 months to June, down from 4% the previous month. Despite a more modest fall in core inflation from 5.3% to 4.8%, US stock markets rose to 15-month highs
• A survey of US consumer sentiment conducted by the University of Michigan rose to an unexpected two-year high in July
• Research by the UK Office for National Statistics found that four in ten renters and three in ten mortgage holders were finding it difficult to pay their mortgage or rent
• UK GDP declined by 0.1% from April to May due in part to an additional bank holiday for the King’s coronation
• The UK government offered pay rises of 5% to 7% to millions of public sector workers. The move is expected to avert some further strikes, including those of teachers
• UK prime minister Rishi Sunak said that the pay increases would not be funded through higher borrowing or increased taxes but through other measures including higher fees for visas and greater charges for migrants to use the NHS
• Data from the ONS highlighted the continued strength of the UK labour market, which added 102,000 jobs in the three months ending in May and saw wage growth accelerate to 6.9%
• UK unemployment rose to 4% in the three months ending in May while working-age inactivity fell easing concerns over the post-pandemic rise in economic inactivity
• The Bank of England reports that the burden of servicing household mortgage debt across all UK households is set to rise from 6.2% of post-tax income to 8.0% over the next three years. Nonetheless, this would be lower than in the 2007-08 and the early-1990s housing recessions
• UK mortgage brokers report that homeowners are hurrying to remortgage due to fears that rates could rise further
• The number of UK homes available for rent hit a 14-year low as landlords face rising costs
• UK headline inflation is expected to slow from 8.7% to 8.2% when CPI numbers for June are published on Wednesday
• The UK signed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), a trade pact established in 2018 which includes Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. Membership loosens restrictions on trade between members and reduces tariffs
• Chinese exports fell by more than expected in June and consumer prices fell by 0.2% from May to June, adding to concerns about the pace of growth in the world’s second largest economy
• The Chinese Academy of Social Sciences, a government-sponsored think tank, called for fiscal stimulus 
• Sentiment among investors in Germany dropped sharply in July, according to the ZEW institute, as higher interest rates and weakness in key export markets weigh on the German economy
• Minutes from the ECB’s last meeting in June said that “monetary policy had still more ground to cover to bring inflation back to target in a timely manner”
• Southern Europe has been experiencing an intense heatwave with last month being the hottest on record, according to EU climate monitoring service Copernicus
• Public health researchers published estimates that last year’s heatwave in Europe killed over 60,000 people in Europe
• The price of olive oil has rocketed to record highs as hot weather in southern Europe has damaged crops, adding to food price inflation

Business

• Japanese automaker Mitsubishi has suspended production in China. Some commentators have said that Chinese automakers appear to be pulling ahead in the electric vehicle market
• Nearly 1,000 workers at Gatwick Airport will strike for eight days over the summer in a dispute over pay
• A number of US banks reported a rise in earnings, benefitting from higher interest rates
• The US Federal Trade Commission opened an investigation into ChatGPT-creator OpenAI to examine whether it has harmed people by creating false information
• The World Health Organisation classified aspartame, a widely used artificial sweetener, as “possibly carcinogenic”

Global and political developments

• Ukrainian president Volodymyr Zelenskyy criticised NATO for not providing a clear timeline for the country’s accession to the alliance
• Turkey agreed to support Sweden’s bid to join NATO, having blocked it for a year, alleging that Sweden was harbouring Kurdish militants
• The UK has invited Saudi crown price Mohammed Bin Salman to visit in the Autumn, the first such visit since the murder of journalist Jamal Khashoggi five years ago, the FT reports
• A report by the UK parliament’s Intelligence and Security Committee found that “Chinese state-owned and non-state-owned companies, as well as academic and cultural establishments and ordinary Chinese citizens, are liable to be (willingly or unwillingly) co-opted into espionage and interference operations overseas” and that it has managed “to successfully penetrate every sector of the UK’s economy”
• North Korea launched a ballistic missile into the Sea of Japan. The missile flew for 74 minutes, a new record for North Korea

 And finally… Sky News reported last week that Dutch researchers had observed magpies ripping up anti-bird spikes to use as nest-building material. One nest observed contained over 1,500 spikes. The birds often use thorny branches to defend their eggs from other birds but have also been observed using barbed wire and knitting needles as protection – making a virtue of nest-cessity