Royal Bank of Scotland : Economics weekly - flexibility

The UK job creation machine continues to hum. Unemployment fell to 6.4% in the three months to June, the lowest since November 2008. Inactivity rates are falling, suggesting the labour market is absorbing new workers comfortably. Total employment is up 820k over the past year and the majority are full-time employees.

Firms have been keen to hire but less keen on granting wage rises. Excluding bonuses, average earnings grew by 0.6%y/y in the three months to June, the weakest growth since comparable data began in 2001. Considering that this period saw the Great Recession, this is no mean feat. The continued weakness in wage growth is confusing given that surveys have been pointing to stronger wage growth for many months. But forecasters are putting more weight on the hard data. The Bank of England has halved its estimate of wage growth from 2.5% to 1.25% this year.

Plummeting unemployment and very weak wage growth poses a puzzle for the Bank of England as it deliberates interest rate hikes. A sharp fall in unemployment indicates falling 'slack', which would normally suggest a need to raise rates soon. But the pronounced weakness in wage growth suggests no imminent threat of inflation. Last week the Bank outlined its view that the UK's labour market is more flexible than it previously thought, meaning the economy can support a higher level of employment without generating inflation. So their current thinking is that the recovery can progress further before rates need to rise. And even when they do occur the MPC reiterated its guidance that they'll be gradual and limited.

The second release of UK GDP for Q2 confirmed the healthy 0.8%q/q rise. The advance was almost entirely down to the services sector. Construction output was flat while production rose by 0.3%. Growth was more broad-based over the year to June 2014, when output rose by 3.2%, making the UK the fastest growing G7 economy.

London's housing market may be about to cool down considerably. That, at least, was the message from the latest survey from the Royal Institution of Chartered Surveyors. Buyer enquiries are now firmly falling, while seller instructions are rising rapidly. And with price expectations having wandered into "down" territory, the picture looks very different from one year ago. Even the more "resilient" rest of the country is starting to see some of the heat fade. Time will tell whether this proves to be a soft landing or something harder.

US shoppers kept their purses in their pocketbooks last month. The value of retail sales was flat compared to June. Add inflation and volumes were down. It was the fourth consecutive month of slowing sales growth. Even internet retailers saw a modest decline in values (-0.1%m/m). This sits uneasily with other data which show continuing employment growth and an expanding economy, albeit that wages remain under pressure for many people.

Germany's economy shrank by 0.2% in Q2. The country's mild winter meant some production had been brought forward into Q1. But even taking this into account there are concerns around the prospects for the Eurozone's largest economy. With Germany's links to Eastern Europe, the Ukraine crisis appears to be denting confidence. Meanwhile France's economy stagnated for the second consecutive quarter in Q2. And with Italy in recession, it meant that none of the region's three largest economies managed to grow in Q2. It's also worth pointing out that inflation is just 0.4%y/y, well short of the target of 'below but close to 2%'. The calls for a European Central Bank response to the twin issues of faltering growth and worryingly low inflation are rising in volume.  

New credit entering China's economy fell sharply in July, according to one measure. Indeed, the £27bn of new financing was the lowest monthly figure since the financial crisis. But it will take much more than one month's data to allay fears over China's post-crisis debt accumulation. When we take the past four months into account new credit is still growing at 7.5%y/y, broadly in line with the pace of GDP growth. For the long-term health of China's financial system, it is necessary that credit growth remains broadly at this rate for some time.