The outlook for growth and inflation has improved markedly in the UK and Europe in recent weeks, largely as a result of tumbling natural gas prices. Lower inflation will boost confidence and should mean that Europe’s consumers begin to draw down their covid piggy banks – all that money that governments threw at us during Covid that we were unable or unwilling to spend. Consumers here have been so frightened by the prospect of soaring energy prices that they have actually been saving more not less. By contrast, their US cousins have had the confidence to spend more, using their Covid piggy banks.
I expect inflation should fall towards 3% by year end in the UK and Europe.
The impact should be particularly strong in the UK. We expect the Chancellor, Jeremy Hunt, to cancel the increase in the energy price cap, to £3,000, previously planned to take effect from April. Indeed, the chances are that the current £2,500 price cap won’t be binding from July onwards. Actual prices could be closer to £2,000. These prices are all much higher than they were before Russia invaded Ukraine but the outlook has improved so much in recent weeks and months. Favourable weather is partly responsible. But European and UK gas prices have also fallen for next winter. They have halved since early December. The powerful forces of supply and demand are working well.
Fiscal deficits will also benefit. Germany allocated a stunning Euro 200bn, 5% of its GDP, to its energy price scheme. It should only spend a fraction of that. In fact, the national campaign to cut electricity and gas usage by 20% in Germany has been very successful. Reduced demand in Europe’s biggest market cuts prices everywhere.
So, will lower inflation mean lower interest rates? Sadly, no. As the impact of soaring energy prices fades, stronger wage inflation means that the Bank of England (BoE) and European Central Bank have to keep monetary policy tight. It is possible that the housing recession in the UK leads to higher unemployment and does the BoE’s work for them but I think the easing of the cost-of-living crisis will offset this. Wage inflation was relatively low in Europe but recently it has accelerated markedly. Mortgage rates has also risen in the euro area but the impact is nothing like as strong as in the UK.
Europe will also benefit from an improved outlook for global growth. I thought the US would be in recession by now but the recent data on consumer spending and employment there has been remarkably strong. China is also enjoying its lockdown easing bounce. Expect to see queues of Chinese tourists outside the LMVH store in Paris and more American accents on the golf courses in Scotland.
I’ll be discussing all these issues in more detail in my macro webinar on Thursday at 11am UK time. Please contact your Columbia Threadneedle representative if you’d like to tune in.
That’s all from me this week. Goodbye.