August 18, 2015

While people generally focus on the headline number, the more useful information, as always, is contained in the detail of the index. We look at the 80 main sub-components of the index to see if there is any uniformity in the trend for inflation seen at the headline level. Any reversal in trend will be evident at the sub-index level first:

  • Of the 80 components, 50% have deflation over the last 12 months, looking back over the last decade (and more) that is an extraordinary degree of price deflation.

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  • Of the 80 components, 65% have inflation below 1% over the last 12 months and 78% have inflation below the 2% level in the last 12 months.

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  • Most importantly, 70% of the sub components in the UK inflation index have seen their rate of inflation decline in the last 12 months.

There is simply no sign, at this point, of any latent inflationary pressure. Indeed, the Chinese devaluation (the beginning of a trend), persistent global oversupply (compounded by ongoing over investment in China and the Emerging Markets) and the weak global growth environment all suggest disinflation and deflation are the greatest risk.

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There is little evidence here for the Bank of England to justify a rise in interest rates. However, there is more justification elsewhere should the Bank be keen to press ahead:

  1. The private sector in the UK is running a financial deficit of 1.5% of GDP (i.e. its Gross Investment > its Gross Savings) meaning that the private sector, like the public sector, is accumulating net liabilities. This is the first time we have seen this in the private sector since 2002. The economy is accumulating debt at a rapid pace.
  1. The average house price/income ratio now stands at 5.3x and is at 6.5x in the Southeast and a record 7.8x in London. In fact, of the 9 UK regions, all have a price/income ratio above 4 (and 44% above 5).
  1. The UK is running a record current account deficit of 6.2% of GDP (this is not a consequence of a peculiarly British ability to hold very low yielding foreign assets, as some have suggested). With only modest Fiscal Tightening in recent years and the private sector going into deficit, the UK has provided the deficit that, from an accounting position, is the counterpart to the improved deficits/surpluses now being run in many of its trading partners. The final chart shows the change (as a % of GDP) in the UK Current Account since mid-2009 compared with that of the major blocs/countries around the world:

Both China and Japan have seen their surpluses decline sharply as the global economy has corrected. The UK has seen its deficit widen sharply as the Eurozone and US have improved their external positions materially.

You could say the UK, and the UK consumer, has helped hold the world up in this difficult period.

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All told, overvalued housing markets/large current account deficits (private and government sector deficits) have been a warning sign in many a crisis around the world and especially in the UK. The Bank of England will find more justification here than in the inflation data.

Do you tighten to have an impact on something you can influence i.e. domestic credit conditions or tighten to have an impact on something you cannot influence i.e. the massive overhang of global productive capacity and easier Chinese monetary conditions?

 

MONOGRAM CAPITAL MANAGEMENT