Inflation

At a glance

My latest blog considers inflation. The key takeaways from the blog are:

Whilst inflation continues to fall in Europe and the US, inflation in the UK remains stubborn.
Interest rate rises likely to be paused in the US, and potentially start to come down.
UK rates likely to rise further but inflation will come down slowing future rises.
Once inflation comes under control, expect stimulus to grow economies.

As we discuss the hot topic of inflation we stress that in the US and Europe it is collapsing, and this will halt interest rate increases. As an example, Denmark today produced an update confirming it’s in outright deflation.

Several clients have queried this in relation to the U.K. which is still showing high inflation numbers. We agree that the U.K. is having a harder time dealing with price increases primarily because of additional distortions created by BREXIT, but as can be seen by the reduction in wage growth in the graph below employment is weakening and wages are slowing.

We created an internal report re U.K. inflation several weeks ago which is now attached below and explains other elements causing issues to the U.K.

The message however is that whilst inflation will be slower to fall, and we are likely to experience a bigger recession than other countries, it is falling, and rates will therefore stop rising.

UK inflation

The U.K. has the highest inflation rates in mainland Europe and double the US.

Why?

There are three main reasons.

Energy costs

The U.K. has suffered a 79% increase in energy bills and has not benefited in the same way as Europe with energy prices now back to pre-invasion levels.

This is for three main reasons.

We have a broken market because of all the collapsed suppliers such as Bulb.
We use more gas.
Energy suppliers have chosen to keep costs high.

In essence we have lost control of our energy supply due to a combination of failed deregulation, energy mix and the ownership of energy suppliers.

Food

The cost of food has risen 19.2%, mainly due to:

Lower and more expensive domestic production.
Worker shortages and higher wages.
Higher costs of imported food.

There is a lot of BREXIT disruption in all the above.

Labour shortage

The U.K. has experienced a post pandemic shortage of workers especially in the service sector, as have most other countries.

The push upwards on costs due to higher wage requirements has been exacerbated in the U.K. with an estimated 350-400,000 people having left the country and not returned. This is in large part a BREXIT related outcome.

The US by comparison

At the peak in 2021 the US had an inflation rate of just over 9%.

The changes in the constituent parts of the inflation basket (elements used to calculate the inflation rate) below demonstrate that all apart from 3 are falling or are actually negative such as oil, petrol and gas.

The three that are apparently rising are shelter, food (in restaurants) and transport (air travel).

The most important by far as it makes up 33% of the whole index is shelter. This is the combined price movement of rents and house prices.

This is often referred to recently as a sticky number. This does not mean it’s hard to get it down as you may assume, it rather refers to the data lagging behind what is happening.

The chart below illustrates this well. From March ‘21 the actual rise in rents went straight up to over 18% but the shelter inflation measurement (orange line) was much slower to rise. You can see the actual increase in rents today is 1.7% but the shelter inflation is still at 8%.

What we can know therefore is that the inflation rate numbers through the second half of 2023 are going to be coming down hard and fast with shelter going from 8% to 2-3% by the end of the year.

The chart below illustrates another reason inflation will fall away. The 2022 monthly inflation gains for May at 0.9% and 1.2% for June, will be replaced by much lower numbers.

So, we can be fairly confident that:

The fall in inflation will be positive for market sentiment. The fear that higher inflation was going to be a new normal will be calmed.
Further Interest rate rises in the US are unlikely to be needed.
Rates can be reduced if inflation is under control and economies need stimulus (which appears quite likely).

Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog, and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.