Why this week is so important for the economy

Upcoming data may give us a clearer picture of whether we are on the brink of a recession ‘Last week the Governor of the Bank of England was at it again, with pessimistic noises about inflation’

The coming week promises to be full of interest and excitement for all those people who keep a close eye on the economic data, not least as a guide to interest rate prospects and asset prices. By the end of it, we may have a clearer picture about where the economy is heading.

Tomorrow we will see the latest labour market data and this may help to clear up a bit of a muddle.

In October, the Office for National Statistics (ONS) suspended its long-serving labour market indicator, the Labour Force Survey.

Unfortunately, the survey response rate had dropped dramatically and this made the ONS fear that its results were no longer reliable (lest you should think this is another example of basket case Britain, a similar phenomenon has been observed in many other countries, including the US, although not quite to the same degree).

In its stead, for the four months to October, the ONS published limited and experimental data. But we had no idea whether this other measure was reliable or how it ties in with the picture given by the old survey. We are told that tomorrow the ONS will release the results of a fuller Labour Force Survey for November. This may well be accompanied by revisions to past data. We don’t know if these releases are going to be a damp squib or whether they are going to revise previous estimates of unemployment significantly – either up or down.

Yet our understanding of the tightness of the labour market is extremely important, especially with regard to inflation prospects and therefore monetary policy. It is particularly apposite to the other part of tomorrow’s data release, namely the part pertaining to pay.

After all, a softening labour market is supposed to put downward pressure on pay inflation and that is a large input into companies’ pricing decisions, which feed into inflation.

So far as we know, there are no serious doubts about the integrity of the pay data but there are several measures of pay inflation and that can create confusion. The one thought to give the most reliable picture of what is going on is the three-month average of year-on-year percentage rises. That comes either with bonuses or without.

Last month’s release for October showed the measure including bonuses up by 7.2pc, down from a peak of 8.6pc in July. Based on more timely PAYE data from HMRC, November’s figures published tomorrow could well see a drop to about 6.7pc.

Admittedly, this is still much too high. Since productivity growth cannot be expected to be much more than about 1pc (with a following wind), to be consistent with 2pc price inflation, pay inflation has to be about 3pc. Nevertheless, the drop in this month’s release could potentially be quite significant, not least because it would continue the pattern of pay inflation turning out weaker than the Bank of England had forecast. On

Wednesday we get figures on the most closely watched of economic statistics at the moment, namely on inflation itself. Last month there was a surprise drop in November’s rate of CPI inflation to “only” 3.9pc. I doubt whether there is much scope for a big improvement this month but the rate could fall a bit to, say, 3.8pc. Again, this would compare favourably with the 4.6pc that the Bank was expecting, thereby giving hope and sustenance to all those putting their shirts on an early reduction in interest rates.

Interestingly, over the past year, inflation developments here have closely matched what has been happening in the US. Its inflation data for December, published last week, were disappointing as the year-on-year rate of CPI inflation increased from 3.1pc to 3.4pc. In fact, this number was heavily influenced by what happened the previous December, as well as by big increases in second-hand car prices and the cost of accommodation, both of which seem certain to be temporary. So US inflation should soon resume its downward progress, boding well for inflation here.

Yet last week the Governor of the Bank of England, Andrew Bailey, was at it again, making pessimistic noises about inflation, this time reflecting concern that shipping costs are being increased by the diversion of cargo ships from the Suez/red Sea route round the Cape of Good Hope, which is much longer and therefore more expensive. This could be yet another adverse supply-side shock, creating a spike in inflation or, at the least, delaying its fall.

The Governor may well be right about this danger but, assuming that the worst fears are misplaced, the next really big change in the UK’S inflation figures is likely to come with April’s figures. Just as with the US December figures referred to above, what happens to the annual inflation rate here is as much about what happened a year ago as it is about what happens now. Last April the price level jumped sharply on a broad range of components, partly reflecting what had happened to the international price of energy and commodities.

This April those sharp increases will drop out of the annual comparison and the inflation rate should fall back markedly. Indeed, it could fall below 2pc, which is the Bank of England’s target. Now that would set the cat among the pigeons.

Friday sees publication of the latest figures on retail sales. Normally, one month’s sales figures do not cut much ice but these are for the month of December, which is a very heavy sales month. Actually, this year, November’s figures were very strong and so (seasonally adjusted) sales may have fallen a bit in December.

Even so, anything weaker than minus 1pc, implying that sales were broadly flat over the two months, would give support to all those warning that the economy is teetering on the brink of recession and that interest rates need to be reduced PDQ.