Economy in Brief: August 2022

With the Bank of England hiking its key rate by 50 basis points and planning to squeeze its balance sheet, the U.K. housing market (the RICS survey covers England and Wales) has been reacting to the central bank's tightening; expectations for prices three-months ahead have lost a lot of momentum. The chart looks at house prices over the last three-months comparing them to expectations for the prices over next three-months. While current prices have begun to soften slightly, there's a much bigger impact on prices expected over the next three-months.

If we rank performance of the last three-months historically, it ranks in the top seven percentile of where prices have been over the last 23 years. And if we rank current house price expectations on that same timeline, they have a 44-percentile standing, below their median (the median stands at a 50-percentile ranking). And this, of course, is occurring in an environment where inflation is hot and is driving prices in the economy higher.

House prices are affected by inflation, but they're affected more immediately by interest rates when there are consequences for mortgage rates. When mortgage rates rise, house payments rise at every given price for housing. And in a market that may have gotten a little overripe with housing prices ramping up in a slightly inflationary environment, an acute vulnerability can develop. Houses can become overpriced or ‘fully priced’ such that increases in official rates can have an outsized impact on the market. Rising mortgage rates would take an already fully priced housing market and create a financing burden for new buyers, depressing prices and sales. And for existing homeowners (well, partial ‘owners’), who are paying their mortgages at variable rates, payments will go up as well.

The Bank of England’s 50 basis-point hike is the biggest hike since 1997. And it's occurring in an environment with a good deal of inflation and where the Bank of England thinks that inflation is going to escalate further before it's able to gain control of it because of past increases in energy prices. Currently the Bank of England looks for its consumer price inflation to peak at just over 13%. Previously had expected the peak to occur at 11%. This is the major reason for the Bank to have adopted the 50-basis point rate hike in August.

Sales expectations have been hit hard, too. Sales expectations had been at a net of +9 in the RICS survey back in April, but in June that figure sits at -9 and has a 9% queue standing which means that it has been weaker historically only 9% of the time over the last 23 years.

New sales are also weakening. But the series ‘new sales’ has been a peculiar series that was extremely strong in May 2021 but then by July had slipped into relatively deep negative readings and then made some recovery posting positive readings in February and March of 2022. However, since then, it has slipped to a reading of -4 in April, to -5 in May, and to -13 in June. The -13 reading has a 23-percentile standing in its queue of data back to 1999. That means that sales were weaker than this about one-quarter of the time historically. And this is only the impact on current sales; sales expectations, as we mentioned above, are still being reduced. We are going to see weaker readings in the months ahead.

The economy is under stress and there are some expectations of a recession. The GfK consumer confidence rating for the U.K. slipped to -41 in June from -40 in May. The reading had been at -38 in April. The 12-month average is -22. Clearly, this series has been slipping significantly in recent months. In June, it has fallen to its all-time low since 1999.

The S&P composite PMI indexes that combine the services and manufacturing sectors in July show conditions deteriorating month-to-month in all but six of the 22 entries in the table. Doing better on the month in terms of their composite PMI reading are Russia, the UAE, Singapore, Ghana, Egypt, and Nigeria. Large industrial economies are not on this list.

In July, six countries showed month-to-month improvement. In June, seven improved. In May, 12 of the 22 entries in the table showed improvement month-to-month. Clearly there has been a deterioration in the last two months.

Over three months, nine countries show improvement compared to their six-month averages. And over six months, 10 countries show improvement compared to their 12-month averages. Over 12 months, 13 show improvement compared to their year-ago 12-month average. These broader averages also show weakening in progress.

The queue standing statistic positions the current composite PMI readings in a queue of values over the last four and a half years. Expressed in this way, only 7 of the entries in the table have PMI queue standings above the value of 50% which marks their median for this period. The relatively strongest readings are in Singapore, with a 96-percentile standing, in Hong Kong with an 88.9 percentile standing, Brazil with an 88.9 percentile standing, as well as India with an 85.2 percentile standing. However, there are a number of countries with percentile standings in the lower 15-percentile of their queue of values or less. These weak entries include the United States, the European Monetary Union, Germany, Italy, Ghana, Egypt, and Kenya. This disparate group includes some quite small developing economies as well as very large well developed economic entities.

There is in this report both a sense of a relative weakening and absolute weakness. Looking at some of the PMI average values for the U.S., U.K., EMU and Japan, a composite average PMI unweighted average fell to 49.8 in July from 53.4 in May and compares to an average of 53.8 over 12 months. The BRIC group, excluding Russia, shows an improvement in July to 55.3 from 51.7 in May and compares to a 12-month average of 52.1. The average for the full sample of countries falls to 52.3 in July from 54.2 in May and compares to a reading of 53.8 over 12 months. The median falls to 52.2 in July from 54.6 in May and compares to a 12-month average value of 54.5. The average queue standing puts the group's unweighted average at 45.6% while the median standing is at 44.4%. Both of those metrics, of course, reside below 50% which means they're below their historic medians.

These are quite uneven results; the queue standings tell us that these are readings that are extremely weak relative to the historic (4½ year) standings. However, the averages constructed from the PMI diffusion readings show us diffusion metrics of around 52 which imply moderate growth still prevails across the group. Of course, as moderate growth goes, this is considerably weaker growth than what we've seen over the past four and a half years that's the message of the queue standings. A second group of standings based on high-low percentiles that take the current reading and expresses it as a percentile of the highest and lowest reading for the period shows an average percentile standing for the group of 77.9% which is quite a bit stronger. However, these high-low standings, while interesting, are achieved using only three entries the highest the lowest in the current standing while the queue percentile standings use every observation in the period.

The clear conclusion here is that conditions are weakening, and they've become weak by recent standards. There's a growing number of countries showing composite PMIs slowing: There are 17 of these in July, 16 in June, and 12 in May. However, for the 12-month average there are only three of them. In July, there are 7 that report PMIs below 50 indicating contraction; that compares to four in June and four for the 12-month average. These are cautionary statistics. They warn us that conditions are very uneven with some pronounced weakness; the seven observations below a diffusion value of 50 in July is worrisome because of the number and the group's membership: the United States, EMU, Germany, Italy, Ghana, Egypt, and Kenya.

Unemployment rates in the European Monetary Union are stable in June; the overall rate is at 6.6%. Unemployment in the EMU has been at 6.6% for three months in a row; it fell to 6.6% in April from 6.7% in March; it had been at 6.8% in February; it stood at 6.9% in January.

The EMU unemployment rate has stabilized after falling in the economic recovery in the post-COVID period. But unemployment progress has slowed. Unemployment rates rose month-to-month in June in Finland, Portugal, Ireland, and the Netherlands. Month-to-month unemployment rates were unchanged in Belgium, France, and Luxembourg.

The pace of decline in the unemployment rates has slowed in recent months. The number of countries in the table with unemployment rates falling over three months has varied between 12 (all of them) and 10 from mid-2021 until May 2022. This month the number of countries with the unemployment rates falling over three months is down to 7. That is still the majority, but there's a clear fall off in the tendency for unemployment rates by country to fall.

Still, unemployment rates are not dramatically increasing either. There is some tendency for unemployment rates to rise, but it's too soon to call it a significant trend. In April there was one country that saw the unemployment rate rise; that was Belgium. In May there were month-to-month increases for unemployment in Austria, Belgium, Portugal, and the Netherlands. In June there were also four Finland, Ireland, Portugal, and the Netherlands.

These may or may not be isolated cases. But if we look at correlations among unemployment rates across this group of 12 EMU member countries, we find the country with the highest correlation among the countries in the table is the Netherlands where there is a correlation of 0.70. France ranks second with the correlation of 0.65. Belgium ranks third with the correlation of 0.64. Two of these countries are showing unemployment rate increases in May or June or both. If we calculate correlations on changes in unemployment rates for this same group of countries, the Netherlands ranks first, Spain ranks second, France ranks third, and Belgium ranks fourth. The point still holds; two countries where the unemployment rate is rising tend to be relatively important bellwethers for the EMU in terms of unemployment rates and their changes.

Just for the record, and for comparison, the three countries with the lowest correlations with fellow members are Germany, Luxembourg, and Ireland, in that order. While Germany is a very important economy in the euro area and the largest economy as well, it tends to go its own way. That is a problem in terms of making policy for the union, because Germany is often doing things differently from the rest of the monetary union but because Germany's economy is so large it will be dominating and pushing pooled statistics for EMU in a certain direction that may not be representative of the union as a whole - certainly not representative of the union as represented by individual countries.

Recovery is complete but... Based on the data in the table, it is reasonable to call the recovery from the COVID recession complete. Unemployment rates across all countries in the table are below their historic medians except for Greece whose employment rate is almost exactly on its median at a 50.9 percentile standing. Only Belgium has an unemployment rate above where it was just before COVID struck. Belgian's rate is higher by 0.3 percentage points. Irelands rate is equal to what it was before COVID struck. By comparison, the United States and Japan have unemployment rates that are just a tick or two higher than they were before COVID struck.