Inflation – Rocket Man

What is to blame for inflation running hot? Central banks, Brexit, Putin’s invasion of Ukraine or Covid-19 and global supply chain disruption? Well, after a hot Glastonbury weekend, part of the blame apparently lies with the demand for music festivals and Beyoncé.

The start of Beyoncé’s world tour in Sweden last month sparked such a frenzy of demand for hotels and restaurant meals that it contributed to hotter-than-expected Swedish inflation of 9.7% in May! Economists expect this to unwind this month. However, there are concerns about the next big concert in Sweden — Bruce Springsteen is due to play 3 nights in Gothenburg at the end of June.

As ever, there are many reasons inflation is high. But in the UK, it is not falling as fast as hoped. Central bankers must take some of the blame for printing money and not turning off the QE tap soon enough. In the UK, it has not been the Bank of England’s finest moment as it has been behind the curve in tackling inflation. Brexit and Putin must take some of the blame too as the war in Ukraine led to both a surge in energy costs and higher food prices.

Looking ahead, there remain many moving parts to inflation. Oil could remain depressed by discounted Russian sales into China and India to fund the war. Gas prices have come down, but are volatile while forward energy prices are keeping electricity prices high. Tesco believes food prices have peaked. Meanwhile, manufacturers and service companies are raising prices to protect margins as wages in the private sector rise. By comparison, the government is maintaining a relatively tough line on public sector wage inflation. PM Rishi Sunak is still pledging to halve inflation, but it is not falling as fast as he or the Bank of England had hoped.

The Bank of England has hiked interest rates to 5% leading to angst for many UK homeowners and the rental tenants. However, due to the higher level of fixed rate mortgages, interest rate hikes are a proving to be a bit of a blunt tool compared with history, taking longer to take effect.

Sadly, it will probably take a recession to snuff out persistently high inflation which is going to a very tough message to sell to UK voters for Rishi Sunak and Jeremy Hunt. Over 800,000 home owners are now facing re-mortgaging misery with substantially higher interest payments on top of the current cost-of-living crisis.

The Bank of England is under fire for failing to get to grips with inflation. The central bank may not be pleased to hear about further inflationary pressure – Harry Styles’ Love on Tour has just started! That won’t be music to their ears.

What have we been watching?

Lots, as ever, for investors to consider. It was a key week for the Bank of England, UK businesses and households. US investors continued to speculate on the path of interest rates and calling the peak in the tightening cycle. Meanwhile, China announced a further series of interest rate cuts to try and bolster its faltering economic recovery which seemed to un-nerve investors. The weekend’s developments in Russia are so far having a negligible impact on markets.

US Secretary of State Antony Blinken met Chinese President Xi Jinping and said they both agreed to ‘stabilise’ US-China relations. Meanwhile, Germany hosted Chinese Premier Li Qiang as it seeks to recalibrate co-operation between the two countries after Berlin branded Beijing a ‘systemic rival.’ Germany is stepping up its efforts to ‘de-risk’ from China, which is a major export customer for German manufacturers.

The aborted Wagner insurrection has laid the crack in Putin’s authority. Meanwhile, we are a very long way from a peace deal between Russia and Ukraine and Putin continues to up the stakes with the deployment of tactical nuclear weapons in Belarus. The World Bank is starting to address the economic cost of the war on Ukraine and the bill for re-building its infrastructure. The re-construction bill was estimated to be $411bn in March, but given the further damage such as the Kakhovka Dam the bill will now be higher.

---

 

In the UK, the inflation data for May was a real shocker. The CPI was unchanged month-on-month at 8.7% while core inflation increased to 7.1%, the highest rate in more than thirty-years. While energy and food inflation pressures appear to be moderating, the bigger issue is services where price increases are more sensitive to increased wages. Elsewhere, while fuel prices were lower, used car prices and air fares were higher. Government borrowing provided another unwanted headline as public sector net debt exceeded 100% of GDP in May for the first time since 1961.  Following the inflation data, the Bank of England (BoE) voted 7-2 for a 0.5% increase in interest rates to 5%. The yield on the two-year UK gilt climbed above 5.05%. Some economists are now expecting a further 0.5% rate hike in August followed by a final 0.25% in September taking the peak BoE rate to 5.75%. Despite this, Sterling dipped to $1.27 on UK recession concerns.

---

 

The Eurozone composite PMI activity indicator is on the brink of recession at 50.3 following an especially sharp decline in the French service sector. As in the UK, persistent wage pressures appear to be offsetting an easing of manufacturing sector costs.

---

 

In the US, futures are currently signalling a 75% chance of a 0.25% interest rate hike by the Federal Reserve (Fed) in July. However, despite the Fed signalling two possible further rate increases, markets appear to be working on the assumption that peak US rates are likely to be in September with only an 11% chance of a further 0.25% hike. Federal Reserve Chair Jerome Powell continued to insist that there is ‘a long way to go’ in the fight against US inflation and suggested two more hikes of 0.25% was a ‘pretty good guess’ of the path of monetary policy for the rest of this year.

---

 

The People’s Bank of China (PBoC) cut two benchmark interest rates which serve as a benchmark for corporate loans and mortgages. The policy easing is the most significant yet as the authorities attempt to invigorate growth, as China hopes to gather momentum after it’s lockdown struggles.

---

 

Brent oil held steady at $75 despite China’s latest interest rate cuts.

---

Finally, traditionally, ‘round-pound’ prices have been attractive to shoppers who find them easier to relate to and practical as well as with no leftover change. However, the proportion of products sold for £1, the single most popular price for a grocery item, has almost halved in a year from 9% to 5%. Due to food inflation, £1.25 has emerged as an increasingly important price point and vies with £2 as the second most popular price for a grocery item. Incidentally, the £2 coin is now 25 years old – how time flies! However, due to inflation, today it is worth the equivalent of 90p!

Read Last Week’s Alpha Bites – Feeling the Heat

 

Further information about Alpha Portfolio Management, our products and services, please visit www.alpha-pm.co.uk or email info@alpha-pm.co.uk. Alternatively, you can call us on 0117 203 3460.

This publication is for informational purposes only and should not be relied upon. The opinions expressed here represent analysis by an Alpha Portfolio Management representative at the time of preparation and should not be interpreted as investment advice.

You should seek professional advice before making any investment decisions. The past is not necessarily a guide to future performance. The value of shares and the income from them can fall as well as rise and investors may get back less than they originally invested. The sender does not accept legal responsibility for any errors or omissions, in the context of this message, which arise as a result of internet transmission or as a result of changes made to this document after it was sent.

Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the FCA.
Registered Office: 1 The Square, Temple Quay, Bristol, BS1 6DG. Registered in England No. 2489639
Copyright © 2021 Alpha Portfolio Management, All rights reserved

Trading name text

Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.