US economy

The feelgood factor will remain elusive

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With wars, climate change, and political disarray across the headlines, good news is hard to come by. But this week on both sides of the Atlantic there was, for once, a welcome surprise on inflation. America’s annual price growth for October dropped to 3.2 per cent — just over a percentage point above its target. In Britain, it fell by the most since 1992 to 4.6 per cent. Both were lower than expected. The sky-high price growth of the past 18 months now feels like it is in the rear-view mirror.

This should be welcome news for Joe Biden and Rishi Sunak. Both the US and UK leaders face testing elections next year. Financial markets are now getting giddy over the prospect of a “soft landing” where inflation returns to more normal levels without a significant plunge in economic activity. Falling price growth, a sturdy jobs market and the possibility that interest rate cuts may come sooner than initially thought, ought to be a boon for the broader electorate. But the optimism is yet to reach consumers. 

The US’s Michigan Consumer Sentiment Index recently fell to a six-month low. In Britain, confidence in October dropped by the most since the pandemic started — and it remains dim in the eurozone even though inflation has fallen to a two-year low. What explains the lack of a feelgood factor?

First, while inflation is falling, the overall price level is now considerably higher. In Britain, it has risen 21 per cent since January 2021. Real wage growth may be returning, but it has been negative for most of the past two years. Households still feel poorer. Indeed, in the eurozone perceived inflation is well above the actual rate.

In Europe, easing food and energy costs have been the main driver behind falling inflation — but both are still elevated. In the UK, gas and electricity prices remain higher than two years ago — milk and bread are about 30p dearer. Given the prominence of these items in household budgets, pessimism seems reasonable.

Second, interest rates are increasingly replacing inflation as public enemy number one. Jumps in monthly mortgage bills, for those remortgaging, and heftier credit card interest payments are eating into take-home earnings. Younger generations in particular have little experience of such high rates.

Third, perceptions are shaped by more than jobs, prices and rates. Indeed, Biden is currently performing respectably in the Misery Index — the sum of inflation and unemployment — relative to previous presidents. But indicators of economic uncertainty have also remained elevated since the pandemic, and the challenges households and businesses face in planning ahead has a significant bearing on their mood.

Other factors could be at play. A US study suggests 30 per cent of the gap between economic sentiment and the fundamentals could be down to partisan views. This implies that differences in politics and how people consume news can also affect outlook.

Line chart of Index of Consumer Sentiment (Q1 1966=100) showing US Consumer Confidence

What sentiment surveys actually measure is another issue. Judging by what consumers are doing — rather than what they are saying — it appears they are upbeat. Spending, particularly on travel, leisure, and entertainment across the US and Europe has been resilient — as reflected in still high services inflation. Of course, the demand for ephemeral consumption leaves households more stretched on essentials — which may explain their overall negativity. Others may be genuinely optimistic but respond negatively based on how they think the wider population is faring.

Above all, consumer confidence tends to reflect collective experiences. Americans’ mood took a while to rebound after previous shocks, including the global financial crisis, even as the broader economy improved. Shaking off the gloom of the pandemic is not going to be easy. That means politicians will need more than just falling inflation to boost national vibes.


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