The price is right

Inflation has flared up again in the UK, but that doesn’t mean the globe is awash with soaring prices. 

Just one-fifth of the 35 countries in the OECD economic policy network have inflation above 2%. Usually, that would be more like four-fifths. Inflation in the US and eurozone, major drivers of the world economy, have been falling for the past few months. Price growth in China – another big fish – stepped dramatically downward this year because of a sharp fall in food and consumer product prices. It seems global inflation is still very much in check.

Poor Britain is labouring under above-target inflation, however. Prices rose 2.9% in the year to May and should surpass 3% when June’s figure is released. But as painful as it is for consumers right now, given their wages are going nowhere, current levels of inflation are not extreme relative to history. It seems we’ve become a lot more sensitive to inflation after a few years of absence. The rise in UK inflation can be mostly put at the feet of a substantial fall in sterling which has led to hikes in everything from utility and food bills to the cost of clothing.

The recent burst of inflation has fired up speculation that the Bank of England will be forced to raise interest rates to keep a lid on runaway prices. The central bank may reverse its emergency 25-basis-point cut to its interest rate, but it’s unlikely that it would need to go further. As mentioned earlier, global inflationary pressures remain relatively muted along with GDP growth. The BoE can realistically only battle domestically generated inflation. External shocks, such as an oil price shock – or the currency slump the UK suffered – are nigh on impossible for their tools to counteract. The BoE’s gauge of homemade inflation has ticked up recently, but only to around 2%. We will be watching it carefully, but for now it appears that UK inflation should level out or fall slightly over the next few years.

 
Index 1 month 3 months 6 months 1 year
FTSE All-Share -2.5% 1.4% 5.5% 18.1%
FTSE 100 -2.4% 1.0% 4.7% 16.9%
FTSE 250 -2.9% 3.0% 8.5% 22.2%
FTSE SmallCap -0.9% 3.8% 10.2% 28.5%
S&P 500 0.0% -0.9% 3.7% 20.6%
Euro Stoxx -1.8% 4.5% 12.2% 32.7%
Topix 0.7% 1.9% 6.0% 24.2%
Shanghai SE 2.4% -3.1% 0.3% 9.9%
FTSE Emerging -0.1% 0.2% 9.2% 24.1%

Source: FE Analytics, data sterling total return to 30 June

Market momentum

European and UK share markets took a tumble in June after a little misunderstanding in bond markets bled into equities.

The European Central Bank (ECB) and the Bank of England (BoE) gave less clarity about their intentions for interest rates over the next year than investors expect. ECB president Mario Draghi alluded to reducing the amount of bonds his central bank will buy for its quantitative easing programme sometime in the future, which would substantially reduce Continental demand for bonds. BoE Governor Mark Carney simply summed up previously stated views, but people got carried away in the aftermath of the European sell-off and market momentum took care of the rest. We believe the BoE won’t start hiking its benchmark interest rate before the third quarter of 2018. As for the ECB, it could start to taper its bond purchases (although none of its four conditions have yet been met), but it is unlikely to touch interest rates till 2019.

The market was less convinced, however. Sterling leapt higher against the dollar and 10-year Western sovereign bonds yields jumped about 20 basis points in the final week of June. That helped boost banks and other financial companies.

Other parts of the share market have suffered from this shift in yields, with technology and other growth companies selling off. In the UK, retailers, consumer goods businesses and utilities were hit hard.

Increasing hints that US and UK consumers are finding life tough don’t help. American consumer spending is growing, but stubbornly slowly. Easing US inflation is making more of an impact on people’s wallets than higher wages. Meanwhile, consumer confidence is still lacklustre, with the University of Michigan’s measure falling to its lowest level since November. The GfK Consumer Confidence survey showed a particularly sharp downbeat mood in the UK. As did the Asda Price Tracker: it showed weekly income after bills for the poorest was almost 30% lower than a year ago and negative (i.e. income didn’t cover bills). Only the highest-income households’ spending money is keeping pace with inflation, according to the measure. Our research shows real income after tax has dropped for three consecutive quarters, the first time this has happened since 1977. Meanwhile, the UK’s savings rate has hit its lowest point since the 1950s: just 1.7%. There is precious little left in the larder for a rainy day.

 
Bond Yields
Sovereign 10-year Jun 30 May 31
UK 1.26% 1.05%
US 2.30%  2.21%
Germany 0.47% 0.31%
Italy 2.16% 2.12%
Japan 0.08% 0.05%

Source: Bloomberg

Julian Chillingworth, Chief Investment Officer

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