We now know Britain sank into a technical recession in the second half of 2023. As recession is a known side effect risk of monetary tightening, could this mean the Bank of England will hurry up with its first cut? Some observers have argued that this state of negative growth strengthens the case for cutting early given the risk the recession will deepen. Only one member of the Monetary Policy Committee, Swati Dhingra, thinks so too. Her view is that the outlook for headline inflation is “bumpy but downwards” and that there are downside risks to living standards from keeping policy tight.
But it’s unlikely the confirmation of recession has increased the chance of a Bank of England rate cut to the current level of 5.25 per cent before or even by June.
First, while all three main sectors contracted, the recession is about as light as can be, as Andrew Bailey noted this week. The economy shrank by 0.3 per cent in the three months to December and by a mere 0.1 per cent in December. Economists are therefore labelling it a technical recession, pointing out that in the US the decline would need to be much greater to qualify as a recession. “The broader economic picture,” says Kallum Pickering at Berenberg, “is not consistent with a typical recession.”
Not only that, but some of the data used to measure GDP can be erratic and there’s a chance that revisions to the numbers in the coming weeks will mean the downturn never happened.
Second, even if the recession label stays, January numbers are looking strongly positive, although this is not to say that projected growth rates for this year are expected to be anything other than weak – the average of all new forecasts puts 2024 GDP growth at 0.4 per cent. Still, the composite PMI number for services and manufacturing rose last month indicating clear green shoots, and retail spending which was expected to rebound in January by 1.5 per cent grew 3.4 per cent, pointing to the economy expanding not contracting at the start of 2024. Most economists expect consumer confidence and therefore spending to keep rising as wage growth outpaces inflation.
A minor recession set to be a blip will not persuade the Bank to be less cautious.
Third, and far more significantly, the Bank is focusing primarily on the labour market for a signal that it is safe to make the first cut. Although headline CPI and services inflation are falling and wholesale energy prices have dropped, meaning the inflation rate will ease again, what the Bank is waiting for is a consistent pattern of slowing wage growth and a loosening in the jobs market.
But while wage growth has slowed somewhat (to 6.2 per cent in the year to December), it continues to outpace general price growth and that’s an unwelcome potential driver of secondary inflation. In its November report, the Bank stated its Decision Maker Panel expects wage growth of 5.1 per cent this year – if that transpires, it will be the biggest rise in real wages for 17 years, says Pantheon Macroeconomics.
One difficulty is that the Bank is operating in the dark on job numbers. The ONS stopped reporting labour force data for several months following concern that the sample sizes being completed in its surveys were too small. It recommenced publishing a selection of estimates this month and while it cautions that the data is only provisional (reliable figures will resume in September), the indications are the labour market may have been tighter than believed in the second half of 2023 – with the unemployment rate shrinking slightly to 3.8 per cent in the final quarter – which the ONS says is partly down to Britain’s high sickness levels. Whatever the reason, Samuel Tombs at Pantheon notes that the MPC’s estimate of the equilibrium rate of unemployment is higher at 4.5 per cent.
At the heart of Bank caution is the concern that inflation could easily reignite and if the economy has landed softly, it’s unlikely to rush to throw away the opportunity to repress it for good. So while some economists expect the first cut will come in June – Berenberg is in this camp – if there is scant evidence the labour market is slackening, and any stickiness in the inflation rate, we cannot rule out an overly cautious MPC waiting until August.
