Europe Macro – January 24, 2022

| January 24th, 2022

The ECB is not only lagging the BoE when it comes to realising that inflation is an issue, but it is also trapped thanks to its fiscal support operations. Meanwhile, supply chain problems are slowly easing as shown by (flash) PMIs. Unfortunately, automotive production will continue to face semiconductor shortages going into 2023. Last but not least, we focus on an underreported story that will be key going forward: the EU’s disastrous plans to reduce agriculture emissions.

1.  CENTRAL BANKS

1.1 The ECB remains in crisis mode – Frankfurter Allgemeine

In December 2021, the Council of the European Central Bank rightly decided to end its Pandemic Emergency Purchase Programme (PEPP). Anyone who now believes that the most important programme for stabilising the European bond markets during the pandemic is about to come to an end is far wrong. In March 2020, at the beginning of the pandemic, the PEPP had its justification. It was supposed to cushion the economic consequences of the pandemic, was designed for 750 billion euros and was limited in time. Since then, the purchase framework has been more than doubled to a total of 1850 billion euros. The extensive stabilisation programmes of governments and central banks worldwide as well as the vaccination campaigns have since had an effect. The economy has stabilised, and so in December 2021 the Central Bank Council logically decided to end the bond purchases under the PEPP by March of this year.

It would be a mistake to conclude that the ECB has thus ended the crisis mode. In December, the Council took another decision that unfortunately received too little attention: The securities in the PEPP portfolio that mature before 2024 must be fully reinvested. This means that the volume of the programme will not shrink in the next two years. Interestingly, this is already the second time the purchase programme has been extended. In this way, the ECB has created – without much public fuss – a powerful purchasing instrument whose permanent availability only requires a small further step, namely a further extension of the reinvestment period beyond 2024.

[…] It is noteworthy that PEPP reinvestments in the government bonds of individual euro countries do not require any fiscal discipline on the part of the governments. PEPP purchases could be made unconditionally. It is sufficient for the ECB to assess that certain interest rate differentials between member countries are unjustified. What such assessments might be based on has not been communicated. This approach may have been warranted at the beginning of the pandemic, also because the time to negotiate an adjustment programme within the framework of the European Stability Mechanism (ESM) would have been too short. But in the meantime, even supporters of the PEPP are asking themselves why the ECB needs the discretionary leeway it is creating for itself with the handsome reinvestment programme, and what criteria should be used here.

Comment: This FAZ article was written by two University of Mannheim professors. The issue they are highlighting is fiscal dominance. As we have discussed in recent months, central banks who expand their balance sheet with sovereign bonds may struggle to offload those afterwards, for fear of creating a fiscal crisis. 

Italy is the centre of this debate due to its debt-to-GDP ratio of more than 100% and its political risks. The graph below, created by Robin Brooks, chief economist of the IIF, shows that the main buyer of Italian debt is the ECB – and it isn’t even close.

The ECB is buying time by basically financing Italy’s budget. The problem is that it prevents the bank from hiking rates and ending QE to combat inflation. What this means is that Italy needs to quickly improve its economy. It needs to increase productivity by all means necessary in order to be able to handle higher rates.

The ECB is putting itself in a position where it is prone to attacks from countries like Germany, who might (again) seek legal action to end QE. In the past, this failed because the professors never accepted the notion of a symmetric inflation target, and wrongly assumed that the constitutional court would agree with them. What the court did instead was to accept that the ECB has the right to conduct asset purchases for a specific monetary policy purpose. That principle was underlined in the ruling of the CJEU.

1.2 We must ‘lean against strong-for-longer’ inflation, warns Bank of England’s Catherine Mann – The Times

A Bank of England rate-setter expects inflation to remain “strong for longer” if companies’ expectations for wage and price growth are realised.

Inflationary pressures could continue well into next year if firms raise their prices by 5 per cent this year and increase wages by more than the 3.5 per cent recorded last year, according to Catherine Mann, an external member of the Bank’s monetary policy committee.

She said that the MPC must try to prevent companies from being sucked into a self-perpetuating cycle of pay and price rises over the next couple of years.

“Residual strength in both wages and prices likely will continue for a time into 2022 as the domestic and global mismatch of supply and demand slowly resolves, as firms try to recover margins eroded in 2021 and as labour markets stay tight,” Mann said in a speech to the Official Monetary and Financial Institutions Forum think tank yesterday.

“The question for monetary policy then becomes whether the real factors on the one hand and expectations on the other could together create a reinforcing cost-price dynamic.”

The MPC will meet in a fortnight to consider its next policy move, having raised the base rate for the first time since 2018 last month.

In December the Bank of England became the first of the world’s big central banks to increase the cost of borrowing, increasing interest rates from 0.1 per cent to 0.25 per cent. Investors believe that there is an 89 per cent chance that the central bank will opt for a quarter- point rate rise early next month.

“Going into 2022, current price and wage expectations coming . . . are inconsistent with the 2 per cent target and, if they are realised in 2022, are likely to keep inflation strong for longer,” Mann said, adding that her objective for monetary policy was to “lean against this ‘strong-for-longer’ scenario”.

Comment: The BoE is way ahead of the ECB. Although the situations are not that comparable, the BoE is also far ahead when it comes to its communication with the public: inflation is here. It’s here to stay. And we will act.

On the other side of the channel, communication is different. The ECB went from “there’s no inflation” to “we underestimated inflation” according to Lagarde remarks commented byFrankfurter Allgemeine.

“ECB President Christine Lagarde admitted at an online event at the World Economic Forum Davos that the European Central Bank had underestimated inflation – like other institutions. Now, however, Europe’s monetary guardians expect inflation rates to fall in the current year. However, the outlook is “fraught with great uncertainty”: “This does not mean that we should not be open to changes in the inflation outlook,” the ECB president said.

The ECB does not currently see a wage-price spiral that could drive inflation further. Inflation in Europe is also not “out of control”. “On the contrary,” Lagarde said, “we expect energy prices to stabilise in the course of 2022 and then inflation rates will gradually decline.”

Bear in mind that the ECB is basically hoping that energy inflation is coming down. Yet, as we discuss almost daily, that’s not likely. While the inflation rate likely has peaked, normalisation is not likely.

Another thing worth mentioning is that the ECB isn’t even discussing food inflation, which is currently picking up (we discuss this today in the “agriculture” segment). And, as if that’s not enough, it says that a wage inflation spiral is not happening. This is a two-edged sword. If the ECB is right and wages do lag inflation, it will create consumer weakness. If the ECB is wrong and wage inflation is picking up, it will have to act as this is more or less one of the bank’s biggest fears. After all, a wage inflation spiral could put a solid foundation under long-term above-average inflation.

2.  ENERGY/CLIMATE

2.1 Utilising the UK’s oil and gas reserves is not inconsistent with net zero – The Telegraph

[…] The public are already feeling the pinch from rising inflation. Currently at 5.4 per cent, it is the highest for nearly 30 years – acting as a stealth tax on earnings and hitting those with the least the hardest. And in a few months, the pockets of hard-working families will come under siege as the National Insurance (NI) rise kicks in, town halls threaten rises in council tax, and energy bills soar. For an average constituent of mine in Newark, the cumulative impact is akin to a 10 per cent cut in disposable income.

[…] The market price for energy has quadrupled since before the pandemic, mainly because of an insatiable desire for gas in China. This upward pressure is compounded by Russia restricting the flow of gas for geopolitical ends – the bleak picture in Ukraine points to this continuing. The world may be structurally short of gas through the 2020s as China gobbles it up and Europe turns its back on coal. We should expect high energy prices to be with us for the foreseeable future.

Alleviating the cost-of-living challenge requires us to confront hard realities. First, it means recognising the need for the Government to intervene to help those facing brutal decisions as to what they must do without. But these should be targeted measures that are focused on low- and middle-income families. The size of the state is already the largest in my lifetime, and growing.

In the medium term we need to address our exposure to volatile energy markets by increasing domestic output, and this involves utilising the oil and gas that our islands have been blessed with. It is absurd that we have foregone cheap, reliable energy in the name of saving the planet, only to import it at higher prices from abroad – in the process, ceding jobs and creating vulnerabilities to unsavoury actors.

It is not inconsistent with our net zero commitment to utilise the UK’s oil and gas reserves. Natural gas accounts for 40 per cent of our electricity generation and we cannot put a significant dent in this figure any time soon. Although we have undergone a wind technology revolution, we will always have to contend with its intermittent nature – indeed, the still summer was a major contributing factor to the current energy price rise.

[…] So we must go hell for leather at both the renewable technology that will allow us to reach net zero in the long term and maximising recovery of gas right now. It comes at no cost to the net zero project to seize opportunities like the Jackdaw development in the North Sea. And we should be encouraging investment to accelerate production, not scaring it off with talk of windfall taxes.

Comment: A cornerstone of our energy/climate comments is based on greenflation, and the push to become net zero. As long-term demand for oil and gas is only increasing further due to emerging markets, we’re working towards a severe demand/supply demand imbalance as soon as economies open up post-pandemic. Goehring & Rozencwajg have been on top of this issue for a long time as it highlights the spending plans of the four “super-majors” – Exxon, Chevron, Shell, and Total. 

Prior to the pandemic, these companies invested $15 billion in CapEx per quarter. This number has now fallen by over 50%! While smaller (often private) companies continue to increase production, we’re seeing that the big firms are reducing production. Even through demand is up again. So, since 2019, production of the four super majors is down 10%. 

One issue worth mentioning in light of this Telegraph article is the absurdity we’re dealing with. For example, Exxon is considering abandoning two massive natural gas projects. A 75 trillion cubic foot Rovuma LNG project ($30 billion in CapEx) and a 5 trillion cubic foot Ca Voi Xanh offshore-Vietnam gas project with a $10 billion CapEx tag.

Some of Exxon’s board members tied to a recent proxy fight with the Engine Nr. 1 hedge fund were involved in the decision as these projects would emit an above-average amount of CO2.

Yet, producing natural gas would allow i.e. Vietnam to reduce its dependency on an even bigger polluter: coal. Vietnam’s electricity is 50% coal based. Only 8% comes from natural gas. Vietnam could easily reduce emissions by 30% with the help of natural gas. Yet, “we” rather engage in virtue signalling instead of using fact-based assessments that not only reduce pollution, but also protect consumers – which is currently an issue in Europe.

In this case, we can replace “UK” in The Telegraph’s headline as it applies to multiple countries. It all comes down to prolonging the use of natural gas and allowing companies to explore and produce it. The way things are going now, we’ll continue to discuss “greenflation” for years, maybe decades to come.

3.  SUPPLY CHAINS

3.1 Infineon sees end of chip crisis in 2023 – Handelsblatt

Semiconductor manufacturer Infineon expects the chip crisis in the automotive industry to end in the next twelve months. “I assume that we will be able to cover demand well in 2023,” Infineon’s automotive boss Peter Schiefer told Automobilwoche in an interview distributed on Sunday. “For microcontrollers, which we have manufactured off-site, we will still have a strong limitation in 2022.”

But the second half of the year will be better than the first, he said. In the case of products manufactured in-house, such as power electronics and sensors, he said, there are already no bottlenecks today in some cases. “And we will be able to deliver as far as possible by the summer,” Schiefer said. “The last issues will be resolved in 2023.”

At the same time, Schiefer announced a significant expansion of production. “We will greatly expand our capacity and invest in Villach, for example, to meet the growing demand in silicon carbide.”

The shortage of semiconductors and other products has severely slowed down the German economy. The automotive industry in particular is struggling due to the lack of components. As a result, the production gap in the industry as a whole has risen to seven and a half per cent, according to the employer-affiliated Institut der deutschen Wirtschaft (IW Cologne).

Comment: The biggest problem when it comes to semiconductors is that the ones used in the car industry do not offer high margins for producers. That’s why most producers prefer to sell their product to other (high-tech) markets that come with both high demand and good margins. Hence, automotive production is one of the last segments to recover from supply chain issues – at least the ones caused by semiconductors.

This is doing serious damage to the European car industry. According to France24, EU car sales fell to a new low last year as the auto sector was hobbled by the Covid pandemic and a shortage of computer chips, industry figures showed Tuesday.

Registrations of new passenger cars in the EU slid by 2.4 percent in 2021, to 9.7 million vehicles, the worst performance since statistics began in 1990, according to data from the European Automobile Manufacturers Association (ACEA).

While problems will start to ease in the second half of this year, we need to expect that these issues will last going into 2023. 

Related to this is the next article.

3.2 Pandemic costs German economy 350 billion euros so far – Frankfurter Allgemeine

This article is connected to the one above as both articles cover supply chain issues caused by the pandemic.

According to a study, the Corona pandemic, which has lasted two years so far, has cost the German economy around 350 billion euros. This sum has been lost in economic output, the employer-affiliated Institut der deutschen Wirtschaft (IW Cologne) announced on Sunday. In the current first quarter, another 50 billion euros could possibly be added. Other experts even fear a new recession as a result. “The recovery will take years,” said IW economist Michael Grömling.

According to the institute, Germans spent 270 billion euros less on their consumption in the past two years than they would have without the pandemic. That corresponds to about 3,000 euros per capita. In addition, companies invested about 60 billion euros less. “Government spending and exports at least partially absorbed the economy in the second year,” the institute explained. In the second year of Corona, problems with supply chains were the main obstacle. The lack of components was particularly hard on the automotive industry, it said. As a result, the production gap in the industry as a whole has risen to seven and a half per cent.

But the researchers also see light at the end of the tunnel with the emergence of the rapidly spreading Omikron variant. “Should we enter the endemic phase this year, things should start to look up again,” Grömling said. “In the next few years, it will take strong growth to make up for the losses accumulated so far.”

Comment: Latest numbers reveal how much money Germany lost because of the pandemic. The number is EUR 350 billion, which is roughly 9% of its $3.9 trillion GDP in 2019 (pre-pandemic). Germans, who are considered to be conservative spenders reduced spending by roughly EUR 3,000 per capita. On top of that, companies reduced CapEx by EUR 60 billion.

Issues involved supply chain problems that are still a drag on production and that won’t fade until 2023 as well as government policies that suppress consumer spending. As the graph below shows, German industrial production is contracting again. Most recent numbers show a contraction of 2.4% in November, which indicates significant recession risks. This means that Germany will not be able to close the pandemic GDP gap anytime soon.

It also does not help that Germany – unlike other major countries – is not easing COVID restrictions quick enough. Health minister Karl Lauterbach is using harsh measures to combat the virus. According to Handelsblatt:

“The SPD politician advocated a continued cautious course. “We will stick to that,” he said, pointing out that unlike other loosening countries, Germany has the second oldest population in Europe. He said he expected the wave to peak in mid-February, with several hundred thousand people newly infected every day. But: “When we have that behind us, then of course it can’t stay with the restrictions. And then, step by step, we would open up again. To envisage that now is the right thing to do.”

He believes that there will be more variants because there are still too many people worldwide who could become infected. This could lead to virus combinations. He feared: “In autumn we will have problems again”, Lauterbach said.

In his capacity as a member of parliament, Lauterbach said that the proposal of an inter-factional group of members of parliament around the Social Democrat Dirk Wiese for a time-limited obligation to have three vaccinations was conceivable.”

Germany is now looking for ways to get mandatory vaccines passed in the Bundestag. When adding ongoing supply chain issues and deindustrialisation caused by regulations, high energy prices, and technology issues, it is no wonder that Germany is losing its leadership position in Europe.

Now, the German DAX has a hard time outperforming the Euro Stoxx 50 – starting in 2017 when its automotive production peaked. Prior to that, German stocks were in a much better position to outperform the European benchmark.

4.  AGRICULTURE

4.1 Farm to Fork strategy – European Commission

The Farm to Fork Strategy is at the heart of the European Green Deal aiming to make food systems fair, healthy and environmentally-friendly.

Food systems cannot be resilient to crises such as the COVID-19 pandemic if they are not sustainable. We need to redesign our food systems which today account for nearly one-third of global GHG emissions, consume large amounts of natural resources, result in biodiversity loss and negative health impacts (due to both under- and over-nutrition) and do not allow fair economic returns and livelihoods for all actors, in particular for primary producers.

Putting our food systems on a sustainable path also brings new opportunities for operators in the food value chain. New technologies and scientific discoveries, combined with increasing public awareness and demand for sustainable food, will benefit all stakeholders.

The Farm to Fork Strategy aims to accelerate our transition to a sustainable food system that should:

–       Have a neutral or positive environmental impact

–       Help to mitigate climate change and adapt to its impacts

–       Reverse the loss of biodiversity

–       Ensure food security, nutrition and public health, making sure that everyone has access to sufficient, safe, nutritious, sustainable food

–       Preserve affordability of food while generating fairer economic returns, fostering competitiveness of the EU supply sector and promoting fair trade

The strategy sets out both regulatory and non-regulatory initiatives, with the common agricultural and fisheries policies as key tools to support a just transition.

A proposal for a legislative framework for sustainable food systems will be put forward to support implementation of the strategy and development of sustainable food policy. Taking stock of learning from the COVID-19 pandemic, the Commission will also develop a contingency plan for ensuring food supply and food security. The EU will support the global transition to sustainable agri-food systems through its trade policies and international cooperation instruments.

Comment: The “Farm to Fork” strategy above is not an article that just started trending. It’s an EU strategy that deserves some more attention. What seems to be a collection of virtue-signalling buzzwords is the EU’s strategy to radically change farming.

The reason this desperately needs more coverage is because of its ability to do significant damage to the European (and world) food security as found by multiple organisations including the Dutch Wageningen University and the American USDA. As discussed by L’Opinion:

“The modelling has, in fact, been done after the fact. The first studies date from November 2020. Analysts from the USDA, the US Department of Agriculture, had published a vitriolic assessment, incredulous that Europe was scuttling itself by causing both its imports and the cost of its food to soar. They calculated that if the world followed suit, world production would fall by 11% and food prices would rise by 89%. The study was looked down upon by Brussels as a tool of economic warfare. Also scorned was an assessment conducted by the University of Kiel for German grain producers, which was seen as corporatist propaganda.

It was not until the summer of 2021 and the publication of a study by the JRC, an analysis office of the Commission itself, that Europeans woke up. Although it was not methodologically an “impact study”, its alarming conclusions led the Commission to hide it for more than a year from the parliamentarians specialised in the subject. Food volumes have fallen by 10 to 17.5% depending on the sector, prices have risen by 12%, exports have ceased and farm incomes have fallen. The icing on the ecological cake: two thirds of the carbon emissions supposedly saved would in fact be… deported elsewhere. The proponents of Farm to fork had a bias: not everything is taken into account by the model used.

The conclusions of this fourth scenario are, not surprisingly, frightening. The estimated production cuts are between 10% and 20% for the main crops throughout Europe. With products sacrificed, such as beetroot or apples, which would lose 30% of their volumes. Overall, all perennial fruit and vine crops would be severely affected. According to the researchers, the increase in the cost of food in general would reduce the attractiveness of organic production, making conversions less attractive. Another problem highlighted was the decline in product quality.

“As a result, significant changes in international trade should be expected. Exports would decline (by half for wines, olives and horticultural products) and food imports would increase – their volume could double,” write the researchers. Europe, the world’s largest food exporter (€138 billion in 2018), would not only lose its rank and power, but would have to rely on the rest of the world to feed itself, putting itself at a “competitive disadvantage” and “trade dependency. It would also mean that farm incomes would fall faster than costs… And a reduced contribution of the continent to the global “zero hunger” strategy. For what ecological benefit? The study highlights the need to cultivate an additional 2.6 million hectares elsewhere in the world to feed Europe… while deforestation is already on the rise.”

No surprise the Commission was hiding its plans as they have to the potential to be devastating. It would make the EU dependent on imports, reduce food quality, cause prices to explode, and it would hurt farmers. Outside of the EU it would increase deforestation while it would also take away much needed supplies in other parts of the world.

Long story short, Farm to Fork does not solve inequality or sustainability. It makes it worse, and it would cause long-term food inflation in the EU and beyond. 

4.2 ‘Farms Are Failing’ as Fertilizer Prices Drive Up Cost of Food – Wall Street Journal

From South America’s avocado, corn and coffee farms to Southeast Asia’s plantations of coconuts and oil palms, high fertilizer prices are weighing on farmers across the developing world, making it much costlier to cultivate and forcing many to cut back on production.

That means grocery bills could go up even more in 2022, following a year in which global food prices rose to decade highs. An uptick would exacerbate hunger—already acute in some parts of the world because of pandemic-linked job losses—and thwart efforts by politicians and central bankers to subdue inflation.

“Farms are failing and many people are not growing,” said 61-year-old Rodrigo Fierro, who produces avocados, tangerines and oranges on his 10-acre farm in central Colombia. He has seen fertilizer prices double in recent months, he said.

[…] There is also a shortage of fertilizer. “This year, you pay, then put your name on a waiting list, and the supplier delivers it when he has it,” she said.

The coffee beans won’t develop as they should for lack of fertilizer, she said—not just this year but also in 2023. “It’s like a child that’s malnourished,” she said.

Farmers in the U.S. are also feeling the pinch, with some shifting their planting plans. But the impact is expected to be worse in developing countries where smallholders have limited access to bank loans and can’t pay up front for expensive fertilizer.

Fertilizer demand in sub-Saharan Africa could fall 30% in 2022, according to the International Fertilizer Development Center, a global nonprofit organization. That would translate to 30 million metric tons less food produced, which the center says is equivalent to the food needs of 100 million people.

“Lower fertilizer use will inevitably weigh on food production and quality, affecting food availability, rural incomes and the livelihoods of the poor,” said Josef Schmidhuber, deputy director of the United Nations Food and Agriculture Organization’s trade and markets division.

[…] Diammonium phosphate, or DAP, a commonly used phosphate fertilizer, cost $745 per metric ton in December—more than double its 2020 average price. December prices for Eastern European urea, a widely exported nitrogen fertilizer, were nearly four times the 2020 average.

[…] A more recent factor is European Union and U.S. sanctions on Belarus, a major exporter of potash, which is a key ingredient of mineral fertilizers. Norway-based Yara International ASA, one of the world’s largest fertilizer makers, said this month it would wind down its sourcing of Belarusian potash by April.

“Belarus represents 20% of the global production of potash so clearly they are a significant supplier,” said Chief Executive Svein Tore Holsether in an interview. “If that part doesn’t make it out of Belarus then I don’t see anyone ready to turn up the volumes,” he said.

Comment: One of the biggest topics to watch for is food inflation. We made this case last year, and we’re now increasingly confronted with the facts. Global agriculture markets are a mess. Major fertiliser exports have reduced exports to protect domestic demand. High energy prices are making production less profitable, and high demand is further supporting strong prices for fertilisers, machinery, and crops.

On January 20, for example, we reported that month-on-month inflation in the euro area was led by food and services. That’s an indication that:

1.     Inflation is not transitory as it is now working its way through the economy

2.     Food inflation is starting to hit the shelves in Europe

On the one hand, inflation rates may have peaked. And that’s understandable as inflation ran hot last year. This will make it harder to “beat” the rates in the second half of 2022 (versus 2021). On the other hand, inflation is not going back to “normal” levels close to 2% anytime soon as price pressure is lasting. There are many reasons like supply chain issues, greenflation, labour shortages, and others. One of them is that producers have to hike prices to deal with input inflation. According to Handelsblatt:

“Most experts assume that the inflation peak has thus been reached. However, consumers and companies alike must prepare for continued price increases: The barometer for price expectations fell only slightly in December to 44.6 points and thus remained only 0.3 points below the historic high reached in November, as the Munich-based Ifo Institute announced on its survey on Wednesday.

Companies were asked about their plans for price increases in the coming three months. “This will filter through to consumer prices,” Ifo’s head of business cycle Timo Wollmershäuser said. “Inflation will come down only slowly in the course of this year.””

It is, therefore, very likely that food inflation continues to be a hot topic in the months ahead (and beyond). After all, producers are now adjusting prices to deal with 2021 price hikes. This year, they are likely to encounter more issues as agriculture inflation is set to last.

5.  SOFT DATA

5.1 Eurozone growth slows as Omicron hits services – IHS Markit

–       Flash Eurozone PMI Composite Output Index at 52.4 (53.3 in December). 11-month low.

–       Flash Eurozone Services PMI Activity Index at 51.2 (53.1 in December). 9-month low.

–       Flash Eurozone Manufacturing PMI Output Index at 55.8 (53.8 in December). 5-month high.

–       Flash Eurozone Manufacturing PMI at 59.0 (58.0 in December). 5-month high.

“The Omicron wave has led to yet another steep drop in spending on many consumer-facing services at the start of the year, with tourism, travel and recreation especially hard hit. However, so far the overall impact on the wider economy appears relatively muted, and most encouraging is the further easing of manufacturing supply chain delays despite the renewed virus wave. Not only has the alleviating supply crunch helped factories boost production, but cost pressures in manufacturing have also moderated.

“Importantly, while the Omicron wave has dented prospects in the service sector, the impact so far looks less severe than prior waves. Meanwhile, perceived prospects have improved among manufacturers, linked to fewer supply shortages, adding to the brightening outlook.

“In the meantime, however, prices for goods and services are rising at a joint-record rate as increasing wages and energy costs offset the easing in producers’ raw material prices, dashing hopes of any imminent cooling of inflationary pressures.”

Comment: Overall, the (flash) PMI report for the month of January falls in the “growth slowing” category as the composite output index hit an 11-month low. Yet, manufacturing is doing better than expected as output hit a five-month high – as a result of easing supply chain problems. 

Additionally, manufacturing was able to see accelerating new orders as new orders came in above 55. Meanwhile, services is coming dangerously close to contraction (50 = neutral) as a result of the ongoing pandemic.

Another factor to keep in mind are rising prices. While input prices in manufacturing eased to a multi-month low, they remained at elevated levels. The same is happening in services, which saw a slight uptick in input prices. Note that the surge in services occurred after the surge in manufacturing input prices. We’re slowly but steadily seeing that inflation is working its way through the “system”, which is not what supporters of the “transitory” thesis want to see.

5.2 Two-speed recovery in January as Omicron variant continues to weigh on customer-facing parts of the economy – IHS Markit

–       Flash UK Composite Output Index January: 53.4, 11-month low (December final: 53.6)

–       Flash UK Services Business Activity Index January: 53.3, 11-month low (December final: 53.6)

–       Flash UK Manufacturing Output Index January: 53.8, 5-month high (December final: 53.6)

–       Flash UK Manufacturing PMI January: 56.9, 11-month low (December final: 57.9)

“A resilient rate of economic growth in the UK during January masks wide variations across different sectors. Consumer facing businesses have been hit hard by Omicron and manufactures have reported a further worrying weakening of order book growth, but other business sectors have remained encouragingly robust.

“Looking ahead, while the Omicron wave meant the hospitality sector has sunk into a third steep downturn, these restrictions are now easing, meaning this downturn should be brief. Many business and financial services companies have meanwhile been far less affected by Omicron, and saw business growth accelerate at the start of the year.

“Business confidence in the outlook also picked up, driving sustained solid jobs growth. With inflationary pressures remaining elevated at near-record levels, this all adds to the likelihood of the Bank of England hiking interest rates again at its upcoming meeting.”

Comment: While both services and manufacturing showed weakness in January, there is good news. Employment demand remains at multi-year highs and supplier delivery times have eased at a pace not seen since the end of the first lockdowns in 2020.

Given Boris Johnson’s efforts to reopen the economy and to put an end to Plan B restrictions, the UK is in a good spot to bounce back hard in terms of services demand and manufacturing output.