Aurelia Butler

The UK economy returned to growth in April, driven by the rebound in consumer spending and fewer strikes, but the prospect of higher interest rates clouds the outlook. Gross domestic product grew 0.2 per cent between March and April, reversing some of the contraction of the previous month, according to data published by the Office for National Statistics on Wednesday.The figure was in line with analysts’ expectations and was driven by the services sector, which expanded 0.3 per cent.The expansion “will further raise hopes that the economy will escape a recession this year”, said Ruth Gregory, economist at the consultancy Capital Economics. However, she added that with the “full drag from high interest rates yet to be felt, it is too soon to sound the all-clear”.

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Interest rates have risen from a record low of 0.1 per cent in November 2021 to the current 4.5 per cent. The strong labour market and the resilience of the economy support market expectations that the Bank of England will continue raising rates in the months ahead to bring inflation down to its 2 per cent target.Neil Birrell, chief investment officer at Premier Miton Investors, warned that with “such robust data across large parts of the economy and inflation staying stubbornly high, interest rates can only be going higher”.Chancellor Jeremy Hunt said: “High growth needs low inflation, so we must stick relentlessly to our plan to halve the rate this year to protect family budgets.”The outlook for the UK economy has improved during the past few months, largely reflecting the fall in wholesale gas prices from their peak in the summer. Earlier this month, the OECD upgraded its forecast for the UK economy and no longer expected an economic contraction this year, following similar upgrades by the IMF and the Bank of England.GDP for April “bounced back after a weak March”, said Darren Morgan, ONS director of economic statistics. “Bars and pubs had a comparatively strong April, while car sales rebounded and education partially recovered from the effect of the previous month’s strikes,” he added.

The ONS reported that output in consumer-facing services, such as stores and restaurants, grew 1 per cent in April, following a fall of 0.8 per cent in the previous month. But the sector was still 8.7 per cent below its level in February 2020, before the pandemic, reflecting the impact of high inflation on household finances. Growth in those sectors was partially offset by falls in health, which was affected by the junior doctors’ strikes, along with falls in computer manufacturing and the often erratic pharmaceuticals industry. Housebuilders and estate agents also had a poor month, with construction posting a 0.6 per contraction. In the three months to April, a less volatile measure of the trend, the economy was little changed from the previous three months, up only 0.1 per cent. Output is still lower than at its recent peak reached in May and it is only 0.3 per cent up from its pre-pandemic levels.“GDP still is oscillating around a broadly flat trend,” commented Samuel Tombs, economist at the consultancy Pantheon Macroeconomics. More

Good morning. Today is Fed day. Everyone expects Jay Powell et al to say “no rate increase today, but maybe in a month”. We expect this too, and think it would be a sensible decision, given yesterday’s inflation report (about which more below). More excitingly, Unhedged’s first podcast episode, hosted by Ethan and featuring the irrepressible Katie Martin, dropped yesterday. Sign up! Also, email us with ideas before we run out: [email protected] and [email protected]: falling, but to where?Because we like tempting fate, last month’s letter on CPI inflation was called “Inflation inflection”. The point was that inflation’s trajectory had shifted for the better, even if the problem wasn’t yet resolved. The great shelter disinflation had begun, as indicated by two months of falling CPI rents; and goods prices, other than for used cars, had stopped rising.To our relief, both facts remained true in yesterday’s May CPI report, further confirmation that the inflection point is real. Yes, there was an uptick in core inflation. As one dejected economist, Stephen Stanley of Santander, wrote: “It should be pretty clear that core inflation is trending at about a 5 per cent clip, with very little downward momentum . . . Sadly, the data suggest that the Fed has made very little progress in getting underlying inflation back down.”We don’t agree. Take out used cars and rents and inflation looks a hell of a lot better:Someone in the comments section is already midway through an 800-word screed about how the Unhedged bubble-denizens think prices are falling so long as you don’t eat, use energy, rent a home or drive a car. But this misses the point. The purpose of data adjustments is to pick turning points in the underlying rate of inflation, not to wave away the problem of rising prices. And there is, at the moment, very good reason to put aside rents and used vehicles.The Manheim used-car price index, which is based on wholesale car auction data, closely tracks the CPI used cars and trucks component most of the time. But an unusually large demand pop in January was captured first by Manheim in February and March, and is only now showing up in CPI. This is why CPI used cars has shot up 4.4 per cent in each of the past two reports.But as more car inventory has come to market, the Manheim index has fallen fast. Soon enough, CPI used cars should follow. To illustrate, the chart below shows Manheim shifted forward one month:The shelter story is a familiar one by now: CPI captures both new and existing leases and takes time, perhaps nine to 12 months, to reflect real-time market conditions. May’s report was the third in a row to show a markedly slower pace of rent inflation (don’t be fooled by the superficial jump in CPI shelter, which reflects volatile hotel prices, not rents). The chart below, showing the year-over-year trend in CPI rent and the more timely Zillow rent index, suggests that there is more good news to come:There is, however, a warning in the Zillow new rentals index above. If you look at the month-to-month numbers, Zillow comes down sharply at first but has more recently re-accelerated:It’s not that CPI rental inflation is going to soar again, but rather that there’s a limit to how low inflation can fall on its own, without growth falling first. Say CPI shelter stabilises around a 4-5 per cent annual rate (versus today’s roughly 6 per cent rate), which the Zillow index suggests is plausible. That’s still higher than the long-run 3 per cent average, and too high for the Fed.The point goes beyond shelter. Unless conventional economic models are simply wrong (possible!), strong growth sets a floor for inflation. This is because falling inflation raises consumer purchasing power, sustaining the spending that lets companies pass along price increases. As Neil Dutta of Renaissance Macro put it to us yesterday:If your landlord says ‘I need to cut your rent to keep you in this unit’, you just basically got a tax cut. In other words, all the disinflation I think we’re likely to see is akin to a tax cut for households.I keep coming back to this idea. Ultimately, price inflation is likely to slow more rapidly than wage inflation. Then you have an increase in real wages. What does that do? It’s good for growth. What does that mean? It’s going to be good for demand. If it’s good for demand, it’ll at a minimum keep companies from cutting prices.This raises the prospect that inflation will fall more on its own — but not all the way to the Fed’s 2 per cent target. To get to 2, growth probably has to weaken. So how is the Fed supposed to feel about inflation that is running at, say, 3.2 per cent? How about 2.9? Should central bankers sacrifice growth, or their hard targets? (Ethan Wu)Falling earningsHere is a chart that might worry you, if you were an anxious type:

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That’s the annual change in nominal gross domestic product growth and S&P 500 earnings growth. I made the scales different for the two series to make the relationship between them more legible, despite earnings being much more volatile. The zero line is the same for both and earnings growth, the blue line, has just crossed it. The spooky thing about this is that past recessions (the shaded areas in the chart) have been preceded by earnings going negative.There are, however, two arguments against taking the recent fall in earnings all that seriously. First, an earnings decline is a necessary, but not a sufficient, precondition for a recession. In the mid-cycle slowdowns of the late 1990s and 2015-16, earnings breached negative territory and the economy avoided recession.More importantly, the reason that earnings are falling now is that they were unnaturally high during the pandemic, as both demand and profit margins leapt. In the two decades before the pandemic, earnings growth compounded at about 6.4 per cent (indeed, over whatever multi-decade period you choose, earnings rise at roughly that pace). Even after falling in recent quarters, earnings are still ahead of that pace over the past three years:There are some companies that saw demand pulled forward for their products during the pandemic, and their sales and earnings are going to be hit hard (I wouldn’t want to be selling RVs right now). This need not be an economy-wide phenomenon, though. Yes, the chart shows that in the past, periods of above-trend earnings are followed by a nasty period of below-trend earnings. But this is just the economic cycle; earnings peak just before the cycle turns. And it’s not clear that what we have had in the past few years is a cycle at all. It may have been an anomalous profit boom financed by high fiscal spending, and the next phase is a reversion to the long-term trend, rather than a crash below it.One reason for worry is that a decline in sales, margins and earnings — even from an anomalous and unsustainable high — might be self-perpetuating. When companies see profits fall, they cut jobs. A weaker job market not only reduces aggregate demand directly; it scares everyone, too. This leads to still lower demand and profits, and so on. But I’m not at all sure something like this has to happen this time around. But it’s worth thinking about. One good readIt’s the summer of pork, people. Armstrong does a nice all-day pork shoulder on the Weber grill; email for the recipe. More

France’s finance minister Bruno Le Maire has promised a renewed push to cut public spending on everything from energy subsidies to real estate tax credits as the government seeks to rebuild its credibility with credit rating agencies. France narrowly avoided a downgrade from S&P Global Ratings earlier this month and remains on a negative outlook with the next review set for December. Fitch already downgraded the eurozone’s second-largest economy in April. “The decision by S&P is an incentive to do more and to do better,” said Le Maire in an interview. “We need to stick to our debt reduction program and to cut public expenditures.”The reprieve from the rating agency was a boost for Emmanuel Macron’s government as it emerged from a bruising fight over raising the retirement age and after losing its parliamentary majority needed to enact reforms.Le Maire, who is Macron’s longest serving minister, said France was now taking a more stringent approach ahead of a conference on public finances in Paris on June 19 where he expected “to announce quite a high level of reduction of public expenditures”. France has maintained persistently high debt levels and budget deficits since 2020, as the government spent heavily to support businesses and households through the Covid-19 pandemic and energy crisis. The electricity price shield that has protected consumers from price rises will be phased out by the end of 2025. That could lead to between €25bn and €40bn in savings. © Eric Gaillard/ReutersIn April, it accelerated plans to bring public deficits back under the target set by the EU of 3 per cent of national output by the end of 2027. The deficit target is around 5 per cent this year, with some economists warning it will be challenging to hit it if growth slows or a recession hits.Rising interest rates mean that the annual cost of servicing France’s debt will increase from €50bn last year to €70bn by 2027, according to official forecasts. By then, the servicing costs will amount to more than annual spending on defence and only slightly less than on education. Despite this backdrop, Le Maire said the government would not severely cut public spending, preferring to stick with its strategy of enacting business-friendly reforms. “Austerity is not an option . . . This would be an economic and political mistake,” he said. “We need more growth, more productivity. How? By implementing difficult reforms, such as the pension reforms, and phasing out the protections we put into place during Covid-19 and energy crisis, so as to further cut public expenditures.” France will end subsidies for natural gas this summer, and the so-called electricity price shield that has protected consumers from price rises will be phased out by the end of 2025. That could lead to between €25bn and €40bn in savings. Other areas being targeted are a popular buy-to-let tax credit known as the Pinel law that costs about €2bn a year, and programmes that subsidise the wages of young workers in apprenticeships and other professional training. “As France nears full employment, it can also reduce the level of support to the labour market,” said Le Maire. The country’s unemployment rate was 7 per cent in April, according to Eurostat, the EU’s statistics office. In its decision on June 2, S&P said it was keeping France on a negative outlook because of the “downside risks to our forecast for France’s public finances amid its already elevated general government debt”, adding that it could lower its rating in the next 18 months if certain metrics were not met. “We believe there are risks to the execution of official budgetary targets.” The focus on French public finances also comes as European Union member states are haggling over a new version of the bloc’s fiscal rules, known as the Stability and Growth Pact, reigniting old disputes over how member states’ budgets should be managed.

Germany has taken a particularly hardline position on the Brussels’ proposed reforms that would, for the first time, enable debt-reduction agreements to be reached directly between the European Commission and national governments. Berlin would prefer firmer rules with specific annual targets for cuts based on debt-to-GDP ratios. While more heavily indebted countries would have to make steeper cuts, even less indebted countries would not be exempt. France disagrees with Germany’s stance that less indebted countries must comply with specific rules on annual spending cuts.German finance minister Christian Lindner told the FT recently that he saw “no landing zone” to agree on a deal that many in Brussels hope to reach by year end.But Le Maire was more optimistic. “By the end of the year it should be possible,” he said. “A large majority of countries have already found consensus.” Given the need for European countries to spend on everything from green technologies, artificial intelligence, education and defence, now was not the time to be overly prescriptive, he argued. “If we want to be part of the race of the 21st century between China and the US, this is time to invest more,” he said. Additional reporting by Martin Arnold in Frankfurt and Sam Fleming in Brussels More

African leaders are “working to bring pressure” on Russia’s Vladimir Putin and others to end the war in Ukraine that has caused a cost of living crisis on much of their continent, according to the president of Sierra Leone.Julius Maada Bio, who is seeking re-election this month, said Africa “always suffers disproportionately” during global crises, from wars to epidemics, but it was often ignored because “our voice has not been strong enough to stop what’s happening out there”.Speaking on the eve of a high-profile peace mission by a group of African leaders to Moscow and Kyiv this week, Bio said: “We’re working to bring pressure to bear on President Putin and all those concerned so the war can come to an end, so we can live peacefully.”Many nations rely on food imports, but few are as dependent as Sierra Leone, which has to buy in almost everything its 8.4mn citizens consume. The country ranks 112th of 121 countries on the Global Hunger Index compiled by a group of European NGOs, making it one of the world’s most food insecure nations.The leaders of South Africa, Egypt, Senegal, Zambia, Uganda and the Republic of Congo will travel to Kyiv to meet Ukrainian president Volodymyr Zelenskyy on Friday, and then to Moscow the following day for talks with Putin. The exact topics that will be discussed are unclear but Jean-Yves Ollivier, the veteran French middleman who helped broker the trip, has said the talks would focus on freeing up exports of Russian fertiliser and Ukrainian grain that the continent has come to rely on.“War is never good for anyone — there’s destruction and lives are being lost, and it’s affecting the economies of different countries and the global economy,” Bio told the Financial Times from Freetown, capital of the west African nation. “All we hope for is that the powers that be understand what impact the situation is having on us.”The former army brigadier, 59, who has been in power since 2018, has good reasons to want the Ukraine war to end. Economic concerns stemming from the conflict have dominated the election campaign ahead of the June 24 vote. Bio, who seized power as military leader for a short time in the 1990s amid the ruinous civil war that ended in 2002, is facing a robust challenge from Samura Kamara, a former finance and foreign affairs minister. It is a rerun of a contest that Bio won in a second-round vote run-off five years ago.Annual inflation in Sierra Leone surged to 43 per cent in April driven by soaring food costs. Its economy, which is heavily reliant on commodities, particularly iron ore, was reeling from “successive external shocks” even before Russia’s full invasion of Ukraine last year, according to the IMF. The fund forecasts Sierra Leone’s growth at 2.7 per cent this year, from 3.6 per cent in 2022.The country was already dealing with the after-effects of an Ebola outbreak that killed thousands of people over three years and the coronavirus pandemic, as well as the commodity prices crash.Many ordinary Sierra Leoneans blame Bio’s government for the country’s predicament, although he has insisted the inflation issue was “imported”. This also explained why his initiatives, including waivers for import duties on essentials such as rice and flour, have had a negligible impact, he said.Import costs have also risen because the leone has lost almost a fifth of its value against the US dollar this year. Central bank efforts to curb inflation have included re-denominating the currency by cutting three zeroes from the notes, although the slide in its value and the fact that the old and new notes circulate side-by-side suggests limited success.Frustrations have erupted into street protests, notably in August when 21 civilians and six police officers were killed. Bio called this an insurrection effort engineered by the opposition. Kamara, the opposition leader, has rejected this version of events and also said his supporters were recently attacked on the campaign trail. More

The writer is chief economist at Enodo EconomicsThe technological revolution epitomised by startling advances in artificial intelligence opens up rich opportunities for investors, but it also confronts them with a stark choice: are they on the side of the US or of China?For the world is dividing as Washington and Beijing battle for economic and geopolitical supremacy with the weapons of choice being cutting-edge technologies such as AI and quantum computing.The US and China are so far ahead in this high-tech arms race that others have no realistic chance of carving out their own independent sphere of influence. The EU has ambitions and money but is politically fragmented. India is one country and has scale but is behind in economic development.As such, given that both China and the US are happy to use economic coercion and sanctions to press their technological advantage, countries, companies and investors will be under growing pressure to choose whose technology they want to use and cannot do without.The choice US allies had to make over Huawei’s telecommunication equipment and whether to join US efforts to deny China advanced semiconductors are just stepping stones in a long and all-encompassing confrontation. Hankering for the evolution of a multipolar order is now, sadly, just wishful thinking.Decoupling will be costly, as will its close cousin de-risking. But any divorce, even the most amicable one, is costly. Both Washington and Beijing have made it explicit that national security concerns trump economics.Even Treasury secretary Janet Yellen, a relative China dove, has said protecting national security will be the US priority in its relations with China, regardless of the economic expense. Hence the bans that Washington has imposed on exports of high-end chips are now to be followed by curbs on outbound investments in some technologies with significant national security implications.For his part, Chinese leader Xi Jinping vowed last month to push forward what he called the “profound unity” of economic development and national security. Xi’s comments are a clear indication that China will take steps to boost growth, including encouraging more foreign direct investment, only if they do not jeopardise national security, in other words the authority of the Chinese Communist party. The party had already sent out the same message by launching raids earlier this year on the Chinese offices of US consultancies Bain, Capvision and Mintz. Beijing also banned the sale of some products from US memory chipmaker Micron.This sharpening of strategic competition between the world’s two biggest economies requires a fundamental rethink of investment approaches.Valuation models based on past performance will be unable to capture the tectonic shifts that are now taking place. Indeed, no model can factor in unpredictable, politically motivated actions that can upend the prospects of individual firms or entire sectors in an instant. Complicating matters further, it is unclear which countries will end up in the two spheres of influence. The US is successfully strengthening its military links in the Indo-Pacific, but traditional allies such as South Korea and the Philippines are all too aware of the gravitational economic pull of their near neighbour China.Or take India, which is a partner of the US in the Quad diplomatic alliance but is also a member of the Brics, a grouping dominated by China. The Brics group hitherto has punched below its weight but more than a dozen countries are interested in joining the club, something that would bring them closer into China’s orbit. Some of them, including energy producers Saudi Arabia and the UAE, have traditionally been firmly in the US camp.Western companies with substantial business in China, such as Apple, BASF, HSBC, Tesla and Volkswagen, may also find it hard to keep riding two horses in a confrontational, bifurcating world. Manufacturing supply chains and global finance are highly integrated so excluding China from your portfolio is not just simply a matter of avoiding its stock market or firms.Against this background, a successful decoupling strategy for equity investors is likely to involve being long those firms that are less exposed to the bifurcation and going short the ones that are stuck in the middle with, say, revenues derived from the US but costs incurred in China.The geopolitical outlook is changing as fast as technology is progressing. Pension funds and other institutional owners of assets need to move with the times and rethink from first principles the remits they give to their fund managers. More

The Federal Reserve is set to hold its benchmark interest rate steady for the first time in more than a year following 10 consecutive increases even as it holds out the prospect of further rises later this year.At the end of its two-day gathering on Wednesday, the Federal Open Market Committee is expected to forgo a quarter-point rate rise and keep the federal funds rate at the current target range between 5 per cent and 5.25 per cent.A pause would mark the first reprieve in the US central bank’s aggressive monetary tightening campaign since it first started raising rates in March 2022, ushering in a new phase in its battle against stubbornly-high inflation.The Fed will also release an updated “dot plot” that collates officials’ forecasts for the fed funds rate until the end of 2025, which is expected to signal support for at least one more quarter-point increase this year.Another increase of that magnitude would lift the benchmark rate to a new range of between 5.25 per cent and 5.5 per cent. The Fed could implement an additional rate rise as early as next month, when its policy setting committee is scheduled to meet again. For that reason, economists say holding rates steady on Wednesday could amount to more of a “skip” than a “pause”.In March, when the dot plot was last updated, most policymakers projected the central bank would not raise rates beyond the current level, in large part because of banking stress following the failure of Silicon Valley Bank and other lenders.The Fed is facing the tricky task of determining how much more to squeeze the economy amid uncertainty about the degree to which a credit crunch will weigh on growth and hiring. Officials are also assessing the cumulative effect of their monetary tightening given that rate rises take time to be fully felt in the real economy.Jay Powell, the Fed chair, said last month that the central bank could afford to look at the data and make “careful assessments” in terms of the path forward for policy.

Since then, the economic picture has been mixed and has stoked an intense debate among officials over if and when more rate rises will be needed. Economists polled by the Financial Times last week believed the central bank would raise rates at least two more times this year to between 5.5 per cent and 6 per cent.The latest consumer price index report, released on Tuesday, showed a deceleration in annual inflation despite persistent price pressures across many segments of the economy. The labour market has lost some momentum but remains very strong, encouraging consumers to keep spending.Fresh inflation, growth and unemployment estimates are also due to be released by the Fed on Wednesday. In March, most officials thought “core” inflation, based on the personal consumption expenditures price index, would decline to 3.6 per cent this year before slowing further to 2.6 per cent in 2024. It currently hovers at 4.7 per cent.In March, policymakers estimated economic growth of just 0.4 per cent in 2023 before a rebound in 2024 as the unemployment rate peaked at 4.6 per cent. Fed staffers have adopted a more downbeat view, however, forecasting a “mild” recession this year. More