Investment Comment
15th March 2024
Inflation Redux
US inflation unexpectedly increased last month, highlighting the challenge faced by the Federal Reserve (Fed) in the “last mile” of its fight against rising prices. US CPI (Consumer Price Inflation) rose 3.2% year-on-year with core inflation (excluding food and energy) still running higher at 3.8%. Expectations for interest rate cuts have been pushed back again with a June cut now looking 50:50 rather than the near certainty expected just a few weeks ago. However, economic data remains mixed, the US unemployment rate increased as new job numbers were downgraded and retail sales were lower than expected. This all paints a fairly confusing economic picture for policymakers to navigate, complicated by the political salience of interest rate cuts in an election year, which has now been confirmed as a rematch between Biden v Trump, assuming that health or the legal system don’t intervene.
US inflation seems to be settling around 3% above the Fed’s target, limiting their scope for action
Source: Artorius, Bloomberg
It is interesting to look at how the components of inflation have changed over the last few years. The sharp rise through 2021 and 2022 was driven significantly by a spike in goods prices (as pandemic supply disruptions hit) and food and energy prices (exacerbated by the Russian invasion of Ukraine), but these inflationary pressures have now almost entirely dissipated and it is now exclusively driven by services inflation. Within that shelter (housing) is the key driver, responsible for nearly 70% of total inflation. Shelter costs are particularly difficult to measure and the impact of market changes tends to lag. Costs have been falling, albeit slowly, and there is evidence from private sector services that it will continue to fall and so this may prove a boon, but this is far from guaranteed.
Inflation is now almost entirely driven by services inflation, particularly housing
Source: Artorius, Bloomberg
Finally some good news
The UK has cut a gloomy figure over recent years with anaemic growth, high inflation, strikes and crumbling public services, but could the outlook be improving?
In a recent note we highlighted that although the UK had technically entered a recession, more timely economic data suggested an uptick in the UK economy and this was confirmed by GDP rising 0.2% in January, which suggests that the recession may already have ended.
Good news on inflation has been hard to find with UK inflation consistently tracking higher than other major economies, but even here there are green shoots. UK CPI (Consumer Price Inflation) is released next week and is expected to fall to 3.5% year-on-year, which would be the lowest reading since September 2021. As you’ll see from the chart below, UK inflation has fallen sharply but seems to have got stuck around 4%, with core inflation (stripping out more volatile energy and food prices) running higher. However, inflation may keep falling from here as high inflation months start to drop out of the annual inflation number. As you’ll see below there were large monthly rises in February, March and April 2023, and over the next few months these will be removed from the calculation, which may give the Bank of England (BoE) scope to cut interest rates. The current market consensus is for 2 or 3 rate cuts this year (that is a reduction of 0.5% or 0.75% in the headline rate) starting in August, but if inflationary pressures subside that may prove too cautious.
UK inflation has fallen sharply from its peak but is still well above the BoE’s target rate of 2%
Source: Artorius, Bloomberg
Large monthly rises in inflation in early 2023 will shortly fall out of annual inflation calculations and the headline rate may drop back to (or below) the BoE target giving scope to cut rates
Source: Artorius, Bloomberg
Vinyl Revival
The Office for National Statistics (ONS) makes annual changes to the basket of goods to better reflect how spending habits have changed. This year sees the inclusion of the increasingly ubiquitous air fryer and thankfully the removal of hand gel, as the pandemic moves further away. Interestingly, vinyl records have also returned to the basket, which reflects years of steadily rising sales – in 2023, 5.9 million records were sold in the UK, the highest level since 1990 when vinyl was removed from the basket. Despite this comeback, vinyl is still far from its glory days and remarkably it seems only half of those buying vinyl have a way of playing them!
Gareth Thomas Head of Investment Management
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