Tag Archives: UK

Bank of England and inflation – Sense of déjà-vu?

UK retail sales in Q1 likely contracted from Q4 2016, despite their rebound in February.

Falling real wages and slowing household borrowing are likely to further dampen retail sales and consumption growth going forward.

The still large pool of available workers is seemingly limiting their wage-bargaining power, with nominal wage growth falling behind rising inflation.

Moreover, investment growth is still only making a negligible contribution to GDP growth ahead of the British government’s decision to trigger Article 50 on 29th March.

Much of the rise in inflation in recent months is attributable to imported inflation driven by Sterling’s depreciation since November 2015 with little evidence of demand-led inflation.

This situation is reminiscent of 2007-2008 when Sterling’s collapse fuelled imported and in turn headline inflation.

Should Sterling remain broadly unchanged going forward, its year-on-year pace of depreciation, currently around 9%, would slow from June onwards and hit zero towards end-year according to my estimates, in turn dampening imported inflation.

I would expect retailers to stabilise prices to maintain market share in the face of tepid demand and for wage-inflation expectations to remain modest. This was certainly the case in the 12 months to September 2009 with CPI-inflation falling from 5.2% yoy to 1.1% yoy.

The question is whether the BoE is willing to look beyond a potentially temporary rise in UK inflation – as Governor Mark Carney suggested – or whether it tries to short-circuit any self-reinforcing rise in prices.

My base-line scenario is that the BoE will look beyond the current rise in UK inflation, unless at least one of three conditions materialise:

(1)       Nominal wage growth accelerates, comfortably outstripping headline inflation and driving consumption growth;

(2)       Commercial bank lending picks up significantly; and

(3)       Sterling depreciates materially from current levels, exacerbating imported and in turn headline inflation.

I expect that neither (1) or (2) will materialise any time soon and that while risks to Sterling are probably to the downside, Sterling is unlikely to weaken sufficiently to push the BoE into hiking. I would however expect it to keep a possible rate hike firmly on the table. Read more

UK inching towards Brexit

British Prime Minister Theresa May will make a speech on Tuesday 17th January in which she will set out in greater details her plans for the UK’s exit from the EU.

There have been few signs that she is willing to tone down her mantra of the UK regaining control over immigration in exchange for a bespoke trading deal with the EU which may exclude access to the Single Market.

If Theresa May sticks to her guns next week I would expect Sterling to weaken further.

A sell-off in Sterling could be partly curbed if Prime Minister May agrees more explicitly to a transition agreement whereby the UK still retains some of the benefits of EU membership even after the UK has officially left the EU.

If MPs perceive Theresa May’s speech as insufficiently detailed or it is not backed up with a detailed and formal government white paper, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

This would at the margin increase the perceived odds of the UK remaining in the EU and may provide some relief for Sterling.

However, I would view this as only a temporary reprieve as ultimately the government has a popular mandate for the UK to leave the EU.

The apparent resilience of British economic growth since the June referendum has given weight to the arguments that the economy can easily weather the UK’s exit from the EU and that the British government is in a strong negotiating position.

However, the risk now is perhaps that too much confidence is being placed in the British economy’s ability to weather a number of possible forthcoming challenges. Read more

EM currencies, Fed, French elections and UK reflation “lite”

Rising US yields, stronger dollar, FX outflows from emerging markets into US equities, President Trump’s still uncertain policies regarding global trade and country-specific concerns continue to weigh on EM currencies.

But the pace of depreciation in EM currencies has abated, with a number of central banks hiking their policy rate and likely intervening in the FX market. China is manipulating its currency but perhaps not the way that US President Trump thinks.

With the market having almost fully priced in a December Fed hike, it will focus on FOMC members’ likely further downward revision to their forecasts for the appropriate policy rate.

Commentators are making a number of assumptions about next year’s French presidential elections and the potential impact on the euro. Some seem reasonable, others less so.

The first assumption is that Fillon will beat Juppé in the second round run-off of the Republican primaries on 27th November. This is indeed the most likely outcome.

The second assumption, which I agree with, is that no presidential candidate will clear the 50% threshold required in the first round of the elections on 23 April to become President.

The third assumption, now seemingly hard-baked, is that no Socialist candidate stands even a remote chance of making it to the second round of the presidential elections on 7th May 2017. I would argue that it is too early to write off that possibility.

The fourth assumption, which I believe is still far-fetched, is that Front National leader Marine Le Pen could win the second round to become President, which in turn would precipitate France’s exit from the EU and pressure the euro.

UK markets’ mixed reaction to Wednesday’s Autumn budget was in line with my expectations of higher yields and stronger Sterling.

Chancellor Hammond’s modestly stimulative package reflects the realities and uncertainties which the UK economy has faced since the June referendum. This is still the over-riding theme markets will have to deal with in the near and potentially long-term.

Hammond had one hand behind his back and a moving target to hit. He has backloaded spending to 2018-19 and beyond with a focus on infrastructural projects to boost languishing UK productivity. Read more

Europe: The Final Countdown

On Thursday 23rd June, the British electorate will hold arguably the most important vote in a generation, with the result of the UK referendum on EU membership due to be announced on Friday.

The latest opinion polls have the remain camp slightly ahead and bookmakers attribute a 75% probability of the UK voting to stay in the EU. But caution is warranted as opinion polls have swung back and forth in recent weeks. Turnout, and therefore the weather, may be a critical factor with a high turnout likely to favour the leave vote.

I am nevertheless sticking to my long-held view that the British electorate will vote for continuity and for the UK remain in the EU.

The popular assumption is that after the referendum UK markets and global risk appetite will move in clear directions. This belief is likely to be tested, particularly if the British electorate votes in favour of brexit as the government is not legally bound to the referendum result.

Specifically, the consensus expectation – which I share to a degree – is that if the UK votes to remain in the EU, sterling, UK equities and to an extent the euro and global equities will rally sharply. But this rally could start to fade after a few days, with “business-as-usual” resuming.

Conversely, the over-riding view is that sterling and global risk appetite will weaken, potentially very sharply, in the days following a vote for the UK to leave the EU.

Importantly I see six potential sources of uncertainty and a number of possible scenarios (see Figure 6), particularly if the leave camp wins by only a very narrow margin and/or turnout is low.  Market volatility could thus persist for weeks and potentially months, keeping sterling and UK equities on the back foot:

  1. Prime Minister Cameron’s future;
  2. The risk of the British government ignoring the referendum result;
  3. The risk of the British parliament ignoring the referendum vote, the government re-negotiating a deal on the UK’s membership to the EU and holding another referendum;
  4. The risk of a second Scottish independence referendum;
  5. The risk of a protracted UK exit from the EU leaving the door open to a decision reversal; and
  6. The re-negotiation of new trade treaties.

Read more

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