Inflation down, bond yields up. What’s going on?

Annualised inflation in the UK in July fell more than a full point compared with June. Good news, surely. Rishi Sunak may yet deliver one of his five pledges for 2023, to see inflation down to 5% by Christmas; 10-year Gilt yields already at 15-year highs did not miss an upward beat, effectively giving the riposte “so what?”. In another case of “yes, so…?”, in the US, reported inflation has fallen two thirds from its peak of more than a year ago, and yet Treasury yields have just surpassed where they were in the depths of the global bond hiatus last autumn sparked by the disastrous mishandling of the Truss/Kwarteng budget and the LDI (Liability Driven Investment) crisis in the UK pension sector. In both the UK and the US, persistently high bond yields suggest that policy to deal with inflation is more akin to economic whack-a-mole than it is a precision instrument to kill it cleanly.

US: “Slow down! Hold your horses!”

The problem is other data subsets pointing ways other than the desired direction of travel. In the US this week, strong retail sales growth in July (whether measured year-on-year at 3.6% or month-on-month at 0.7%, both were double the market consensus estimate and accelerating) indicates that despite the most aggressive rate tightening period in living memory, the US consumer is not getting the message. With full employment and annual wage growth averaging 4.4% against the Consumer Price Index (CPI) of 3.2%, real wages are rising; further, the norm is for US mortgages to be taken out at a fixed rate for 30 years, so only those who are new to the housing market or who are moving house and raising new borrowings are affected by the big rise in the cost of financing. For the US Federal Reserve whose mandate says that it must manage the economy to an average target rate of Core inflation of 2% (which excludes food and fuel), Core inflation at 4.7% is falling slower than headline CPI and proving more stubborn.

The overall economy is still growing at 2.6% year-on-year. Despite the big increase in interest rates it is showing a greater inclination to accelerate rather than to slow down. This in turn is inconsistent with being able to achieve a 2% inflation rate and to keep it there without the risk of it popping up again. The most recent Federal Reserve monetary policy committee meeting minutes also released this week reveal the divisions between members as to what happens next: continue with further interest rate increases and risk killing the economy through over-tightening? Or halt here and run the risk of inflation flaring up again? Damned if you do, damned if you don’t. The markets concluded that all other things being equal, further rate rises are still a possibility and that interest rates are likely to remain at elevated levels for longer than anticipated before heading south again. It is an evolving and dynamic story, prone to bouts of volatility.

UK wages accelerating faster than prices

In the UK, the labour market has reached the cross-roads we predicted a couple of issues ago: unemployment is creeping up slowly (now 4.2% having been 3.5% a year ago) as the economy flirts with recession; however, jobs remain tight for reasons we will explore below and as seen this week, average wages are still accelerating across the workforce, now 7.8% up on a year ago. That 7.8% average reflects 8.2% in the private sector and 6.2% in the public arena. Growing faster than average prices (CPI in July 6.8%), real wages adjusted for current inflation are now rising in the private sector and fast approaching the cross-over point in the public sector too.

The government is clearly hoping that the steam will now come out of the momentum behind wages as the pressure for consumers to manage the cost-of-living crisis eases with disinflation. Potentially still frustrating that is the competition for labour and the need for employers to pay up to fill vacancies. And there is that persistent nagging itch needing to be scratched that a decade or more of falling real earnings still leaves a sizeable proportion of the workforce worse off than they might have been with much catching up to be done. Despite high job security and attractive pensions, this is the nub of the issue in the public sector. Although some unions have already or are now settling claims (e.g. nurses, junior doctors in Scotland, some sectors in education), others are still hanging out for more. Notables are the Rail Maritime and Transport (RMT) union, ASLEF (the train drivers), university lecturers and the junior doctors in England represented by the British Medical Association (BMA).

Economically, the most important of these is the BMA. Rail strikes and overtime bans are a persistent irritant to the travelling public but thanks to the ability to work from home among many passengers, the economic impact is much less than historically. Likewise the university lecturers: the disruption to potential careers and the inconvenience for students emerging saddled with debt from university but without a graded degree is significant to them personally but it is immediately irrelevant to the wider economy. The doctors are different: with an estimated 61,200 patient appointments and procedures cancelled or deferred this week alone, and approaching 900,000 suffering the same fate so far this year thanks to industrial action by health workers across the piece, there is a measurable economic impact created by the disruption (the direct cost to the NHS is estimated already at approaching £1bn, leaving aside broader indirect costs).

The BMA takes political instruction from RMT’s Lynch

As an aside, and a sign of a more insidious political agenda, the co-leader of the increasingly militant junior doctors in England, Rob Laurenson, gave the game away. A media amateur in the hands of a professional journalist, the hapless Laurenson had easy rings run around him by interviewer Justin Webb on the Today programme on 11 August before the latest 5-day strike: he admitted that this is no longer just about pay, it is politically and ideologically motivated; he and his co-chair were forced to issue a denial later that their aim was to bring down the Tory government. Leaving aside Laurenson’s own Today outburst, the evidence is stacking up that the denial rings hollow. At the end of July, Mick Lynch, general secretary of the RMT, was invited to address a gathering of the BMA’s Junior Doctors’ membership. As reported in the socialist journal Left Foot Forward, ‘Lynch said: “our wealth is being transferred to the super rich, the oligarchs are running the country right now and they’re running it for their benefit.” Lynch received a standing ovation when he told the crowd that “change is coming”’.

Such political motivation among doctors presents a direct challenge to the government and NHS management. It also presents the General Medical Council, the doctors’ regulator and registrar, with an ethical dilemma: at what point does an otherwise qualified and clinically competent practitioner become non-compliant for registration if for ideological reasons he/she persistently withdraws his/her labour and in doing so is demonstrably careless (in its literal sense) of patients’ health and wilfully puts them in potential danger? Is this simply an ‘HR’ issue? Or does it go to the heart of what defines a doctor’s vocation that whatever the circumstances the duty of care to patients comes first, the self-interests of doctors second. The medical profession exists because of its patients, not despite them; both patients and medical practitioners are in trouble when doctors think and behave otherwise.

Health strikes and the deeper malaise

Whatever the motivation, the doctors’ protests are symptomatic of the wider enduring dysfunction of the NHS. There is the oft-repeated joke that the UK is a National Health Service with a small group of islands in tow. Even if exaggerated, there is an underlying truth behind it. Health swallows up 11.3% of GDP (gross domestic product), and with 1.7m employees across the home nations the NHS is the country’s biggest employer (not only here: it is the biggest employer in Europe and allegedly the 7th largest in the world) and yet by measures such as treatment waiting times its patient outcomes are deteriorating, but its cash and resource demands are literally insatiable to no discernible incremental benefit.

Its fiscal gravitational pull is extraordinary. It is also clear the model is broken. Offered a clean sheet of paper and looking to create a health service fit for purpose in 2048, no rational person would invent today’s spaghetti-like confection, one built higgledy-piggledy on the narrow foundations of 1948.

NHS reform: time to get a grip

It becomes a preoccupation for investors when the NHS specifically is fingered by the Bank of England as a strong contributory factor behind the inefficiencies in the national workforce and sluggish economic growth. The latest government data shows that 2.55m economically inactive people aged 16-64 in the UK are signed off on benefits as being defined as ‘long-term sick’, 29.6% of the inactive cohort and 8.5% of the total nominal workforce; this compares with 1.97m in April 2019 before the pandemic. Contributing in turn to this additional half-million people unable to work because of sickness is lengthening NHS waiting list times, appointment cancellations and procedure deferrals. Getting as many of these 2.55m working-age people fit and well and active as quickly as possible is not only good for them but also for the broader economy, augmenting economic productivity. In adding to the supply of available labour, they would take some of the pressure off wages and help alleviate general inflationary pressure (in context, of the 8.7m or 21% of all 16-64 year-olds who are defined as economically inactive, in addition to those 2.55m listed as ‘long-term sick’, 1.25m have opted out for no reason and 1.07m have taken early retirement; the rest are students and carers; completing the total labour force picture, 4.2% of the total are unemployed, leaving 74.8% employed).

It is a formidable political challenge to reform the National Health Service, particularly when during the pandemic it was a national totem, cheered with almost religious fervour every Thursday night at 8pm, and then awarded the George Cross by The Queen. But that lustre has tarnished, not least with junior doctors and latterly consultants striking not only for pay settlements into double digits but now in the case of the juniors, with significant political intent in which patients’ interests are collateral damage. Rather than tinkering around the edges, the need for reform to be confronted head-on but constructively to restore the NHS’s efficiency in the wider national economic interest (including helping reduce government debt and the tax burden) has never been more obvious. With less than 18 months to the election, who is going to take it on?

And all of this started back along the trail 1800 words ago with the simple question of why Gilt yields are still going up!

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