With the holidays drawing to a close, here’s our two-minute view of the main economic developments over the summer.

The world economy continued, by and large, to do slightly better than expected, with economists nudging up their forecasts for growth this year in the US, Japan and the UK. Inflation is falling and, for the first time in some time, has been coming in below market expectations. It’s not, however, a particularly rosy picture. Europe’s growth is weak, China’s recovery has stalled and oil prices have risen almost 20% in the last three months. The timeliest measure of economic activity, the purchasing managers’ surveys, suggests that after a second-quarter bounce, activity in the US and Europe flagged in June and July. Labour markets in the US and Europe remain tight but, in a sign that higher rates are working, unemployment rates edged higher and vacancies fell.

The US remains the growth outlier among rich economies. Its economy, while slowing, continues to show decent growth while inflation has dipped more sharply than in Europe, to just 3.2%.  Manufacturing activity has softened but consumer spending, the principal driver of growth, remained solid over the summer. In July, the US Federal Reserve said that it no longer expected the US to fall into recession. The odds of the US achieving a soft landing for its economy have continued to rise, but such an outcome is in the realms of probability, not certainty.

European growth has been weaker over the last year than in the US but the latest GDP data, released last month, show UK and euro area growth picking in the second quarter. Germany and Sweden have seen their economies shrink over the last year. Spain, Ireland and Portugal have outperformed.

The picture for UK growth over the pandemic has been rewritten by official revisions to previous estimates of GDP released on Friday. These show that the decline in growth in 2020 was less severe than previously thought and the recovery in 2021 stronger. The revisions upend the story of chronic UK underperformance. Within the G7 group of industrial nations, the UK has risen from the bottom of the growth pack to above Germany and is roughly in line with France and Italy. The new data show that by the end of 2021 the UK economy was 0.6% larger than before the pandemic, not 1.2% smaller as had been thought.

Important though these data are, they relate to growth more than 18 months ago, and do not change the picture of an economy which, at best, is growing sluggishly. The UK slowdown is most apparent in the housing market, where last week the Nationwide reported that house prices fell by 5.3% in the last year. Mortgage rates are the problem. In recent months rates have risen markedly with fixed rate deals in July hitting the highest level in 15 years.   

Higher interest rates have helped slow but have not crushed inflation and over the summer the US Federal Reserve, the European Central Bank and the Bank of England raised rates again. Markets think that the Fed and the ECB have probably finished raising rates, but anticipate a further two 25bp rate increases from the BoE. UK GDP growth may be lacklustre, but wages have rocketed, with regular pay excluding bonuses rising by 7.8% in the last year, the fastest rate since records began 22 years ago.

Financial markets think that interest rates are at or near their peak, but they do not expect a return to the very low rates seen before the pandemic. This can be seen in the bond market where yields on US ten-year government bonds have reached 4.2%, a level that has not been seen since 2008. This roughly corresponds to an expectation of the federal funds, or short-term interest rate averaging 4.0% over the next ten years, compared with an average rate of 1.2% in the last ten years.  The bond market is signalling that it expects interest rates to stay well above the sort of levels we have become used to in the last decade or so. The other big bond market news was last month’s decision by the credit rating agency Fitch to downgrade US government debt from AAA to AA+. Fitch said concerns about the quality of fiscal management – reflected in repeated standoffs over the US debt ceiling – and high levels of government borrowing were behind the decision. 

Concerns about China’s economic performance have grown over the summer. A hoped-for post-Covid boom has failed to materialise and, far from suffering the inflationary excesses of the West, price pressures have receded rapidly. Inflation has turned negative, down 0.3% over the last year stoking fears of deflation. Last month China ceased reporting its soaring youth unemployment rate, a move that critics see as an attempt to obscure the slowdown in growth. The authorities have sought to bolster the economy by cutting interest and mortgage rates and by stepping up support for the renminbi, which has fallen by more than 5.0% against the dollar this year.

While Chinese recovery has stuttered, Japan’s has moved up a gear over the summer. Japanese economy grew by a remarkable 1.5% between the first and second quarters, far faster than any other major industrialised country including China. A surge in exports explains much of the growth but it seems unlikely to last. Nonetheless, Japanese businesses are more upbeat about prospects than their rich world counterparts and the Japanese GDP growth seems likely to outpace (admittedly lacklustre) euro area and UK rates this year and next.

On the political front, the accumulation of charges facing Donald Trump has not materially dented his poll ratings. He remains the front-runner for the Republican nomination, widening his lead over the summer against his main challenger, Ron DeSantis. An average of major national polls released since early July put Joe Biden on 46% of the vote and Donald Trump on 44%. In the UK, the Labour Party’s opinion poll lead over the Conservatives averaged 19% over the summer, in line with readings in the previous 18 months. On the basis of August’s polls, the website Electoral Calculus puts the probability of a Labour achieving a parliamentary majority at the next general election at 93%.

This summer’s good news came in the form of falling inflation and decent growth numbers for Europe, Japan and the US. The question is whether the boost to growth that comes from falling inflation will offset the dampening impact of a weaker job market and high interest rates. It’s a hard call, but my guess is that after a spring bounce, activity in Europe and the US will ease in the second half of the year.

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’. 

Please join me for our annual “Back to School” webinar on Wednesday, 13 September, 13:00 BST, as I examine prospects for the UK and global economies. Register here. 

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