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Hurricane Harvey investment implications and UK wage growth

01 September 2017

What are the potential investment implications of Hurricane Harvey?

It is too early to know the full impact of Hurricane Harvey but when totalled, it is likely to be substantial, running into many billions of dollars. Our first concern should be for the families of those killed by this terrible storm and for those that have lost their homes and livelihoods. As far as the US economy as a whole is concerned and the impact on financial markets, the impact is relatively muted. Oil production was cut as the storm passed through but the rigs are built to stand up to these events and the production cut is limited. The floods have closed refineries and up to a third of the refineries in the US are in the affected area. As refinery capacity is reduced, if crude oil production continues, there will be a short-term negative impact on the Texas oil price. As a result, there is likely to be a shortage of refined products which should push gasoline and heating oil prices higher. However the closures of refineries may only be for a short period and as a result the longer-term impact is likely to be limited.

Insurance claims will be significant and this will impact companies with exposure in the affected region. In the past, disasters like this have had a negative impact on the insurance sector but in the longer term premiums go up and profits return. It also acts as a warning to those without insurance that they should seek cover. Again the short-term impact is a reduction in economic activity but the rebuilding and improvements to drains and infrastructure may, in the end, have a positive impact on economic growth.

Overall while the impact on individuals is devastating, the impact on the broad financial markets is limited.

Why is the UK finding it so difficult to find wage growth?

UK wages have been rising at 2.1% per annum in the last year¹ which is significantly less than the annual inflation rate of 2.6%. Wages rising less than consumer prices constrains consumer spending and hurts the wider economy. In light of this, it is important to consider why significant wage growth has not been achieved. As can be seen from the chart to the right pre the financial crisis, wages were growing at about 4% per annum which was well above the rate of inflation. Unemployment was up to about 5% following the financial crisis but is down to 4.4% now, below the pre crisis levels. Vacancies have been rising and the total number of people employed has risen by over 2 million in the last five years. Today, we have relatively tight employment conditions that one would have expected to lead to a greater increase in wages but this has not been the case.

The reason for this is multifaceted. The rise in jobs has been partially offset by net migration which has averaged about 250,000 per annum in the last five years² (a figure that has been greatly questioned recently). On top of this, it appears that we are creating a lot of jobs in the service sector that are relatively low paid and so would not stimulate average wage growth. Employers in the UK complain of a skills shortage and this may help to explain the rise in vacancies.

Brexit may also have had an impact. The rise in inflation is largely due to the fall in sterling following the Brexit vote. Inflation has risen steeply as this effect comes through and wages may be yet to catch up. However uncertainty about the Brexit process is likely to lead to a lack of investment and to less job security which may make workers reluctant to push for pay rises. Government austerity is a constraint for wages in the public sector.

If Sterling stabilises then the rise in inflation may be temporary. The Bank of England expects it to peak this year and in that case, inflation may fall back below wages. All these factors will need close monitoring in the months to come, especially in light of ongoing Brexit negotiations.

 

 INSERT GRAPH

Source: Office for National Statistics

¹UK AWE Regular pay whole economy 3m average year on year. Source: Office for National Statistics
²Source: Office for National Statistics net migration numbers

 

 

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